FNGU: Derisking May Hurt This Fund (NYSEARCA:FNGU)

MicroSectors™ FANG+™ Index 3X Leveraged ETN (NYSEARCA: FUNGI) is a concentrated leveraged portfolio of some of the top technology names on the NASDAQ (QQQ). FNGU was brought to the market on January 22, 2018, and has a maturity date January 8, 2038. This portfolio targets daily returns of three times the basket of technology stocks with a daily reset. Given the recent investor sentiment towards tech names after the CYq2’24 earnings report, I believe the portfolio may reflect a downward trend going forward, resulting in a cascading effect in the leveraged portfolio. Considering this factor, I recommend FNGU with a SELL rating.

Mechanical wallet

FNGU is a triple leveraged portfolio that seeks to return to ETN holders three times the expected returns on a daily basis of the underlying portfolio, based on its respective weights of supporting assets. Given the daily reset, the ETN is meant to be held for a day to reach the 3x target. Any holding period beyond a single day may result in a capitalization effect, depending on the direction of the portfolio, which may lead to excess returns or excess losses beyond the 3x target. This factor is achieved by using borrowed funds exchanged for a funding fee to obtain the applicable amount of leverage required to earn three times the return on the underlying assets. Because of the daily reset, the fund should not be held for more than a single day. If the securities are held for a long period of time, a capitalization effect may occur that can amplify gains or losses, resulting in a mismatch between the fund’s initiatives and actual results. Returns can also be affected during periods of high volatility, causing the notes to not fully reflect the 3x target. The graph below demonstrates the compounding effect over a long period of time.

It is clear that a long bull run can yield exceptional returns for note holders, assuming the trend holds with minimal consecutive days of decline.

By looking at the ETN during a bearish period, the portfolio’s declining returns compound downward as the underlying stock achieves this effect.

And finally, looking at FNGU for a single day, the ETN appears to be earning three times the return of its cohort of stocks held in the portfolio.

Given these factors, it is imperative that investors understand the underlying risks of owning a leveraged ETN before investing. As a result of the reset factor, leveraged products are not meant to be used for buy and hold strategies and should only be considered for day trading activity. This makes the ETN less viable as an investment from a financial advisor’s perspective, given the daily risks involved in owning such a strategy. This investment may be more practical for day traders or those working in a hedge fund-like function where the only goal is to maximize returns on a daily basis.

The portfolio is benchmarked against the 10-component NYSE FANG+ index, consisting of names such as Amazon.com, Inc. (AMZN), Snowflake Inc. (SNOW), Microsoft Corporation (MSFT), Tesla, Inc. (TSLA), and NVIDIA Corporation (NVDA), among others.

Market risks that can affect the underlying assets

CYq2’24 resulted in some interesting impacts on portfolio holdings, particularly the recent release of NVIDIA Corporation (NVDA). Despite the upbeat earnings release, investors turned bearish on the name after earnings. While I predicted a strong earnings release for Nvidia, the stock’s post-earnings performance took me by surprise. I’m still bullish on the name long term given the strong demand for their H100 chips and their 1 year upgrade cycle.

Snowflake Inc. ( SNOW ) plays a major offsetting role in the portfolio as the company has gone through operational challenges over the past year. Much of this is driven by new management, a changing restructuring strategy, and the consolidation and elimination of non-core software platform offerings. I’ve been covering Snowflake for some time now and have been bearish on the name since its inception. I think the company will come out on top because the company’s platform is best-in-class for game developers; however, the firm has some operational hurdles to overcome before returning to growth.

Netflix, Inc. ( NFLX ), on the other hand, was substantially positive as the firm reshapes its subscription model by entering the advertising space with its own marketplace for advertisers. The company is building on a tiered model, offering a range of subscriptions from premium to ad-supported subscriptions. I remain bullish on Netflix as their tiered business model allows for greater viewer reach across multiple regions.

Broadcom Inc. ( AVGO ) is well positioned for growth as the virtual server and network chip company continues to consolidate in the data center. Despite the firm being one of many AI names, Broadcom’s acquisition of VMware pushed the company deeper into general computing and data center operations.

Conclusion

FNGU is a 3x leveraged ETN that targets a daily return of 3x over the FANG+ asset cohort. The ETN is meant to be actively traded to achieve the 3x return target. Longer holding periods may result in a compounding effect that may result in abnormal upward or downward returns that may not reflect the 3x initiative. I do not recommend this portfolio to be held by those looking for a buy and hold strategy as a result. Given the general sentiment towards the tech industry, I recommend FNGU with a SELL rating.