Can retail investors also short AI debt? High-leverage CDS ETF launches, but analysts pour cold water on it

Notice that two investment firms are seeking to launch exchange-traded funds (ETFs) that would let retail investors bet on concerns about potential credit defaults by AI companies just as the AI trade is enduring one of its most violent selloffs in years. Tuttle Capital Management and Defiance ETFs have separately filed with the U.S. Securities and Exchange Commission (SEC) to launch funds linked to credit default swaps (CDS) on CoreWeave Inc. (CRWV.US) and Oracle Corporation (ORCL.US), respectively, with Defiance also offering one linked to Meta Platforms Inc. (META.US). These derivatives, typically used by institutions to hedge default risk, would also be packaged into high-leverage ETFs linked to a portfolio of companies deeply exposed to the AI buildout boom, including chipmakers. The products are designed to capture growing fears that companies at the center of the AI borrowing boom are taking on more debt than they can handle. As the Nasdaq fell as much as 15% from its October high, the cost of insuring against default on debt issued by companies such as CoreWeave and Oracle Corporation surged to record highs, delivering hefty profits to investors betting on a deterioration in their credit profiles. "There's always an ETF born for a specific moment," said Todd Sohn, chief ETF strategist at Baird Strategas. "But this one is tricky, because CDS aren't a common tool, and people have tried this before." AI credit risk hits record highs Indeed, this is not Wall Street's first attempt to bring credit default swaps to a broader audience. These derivatives gained widespread attention during the 2008 financial crisis, when investors used them to short mortgage-related debt. But when ProShares launched the first CDS ETFs in 2014, the products struggled and ultimately closed down. Unlike earlier funds that tracked the broader CDS market, the new products target individual companies and an AI boom that is coming under increasingly severe scrutiny. These ETFs will compete with short selling and options tools retail investors can already use to bet against stocks. Tuttle Capital plans to launch five actively managed ETFs that would effectively let retail investors buy leveraged credit protection against AI-related companies. Each fund is designed to rise when an issuer's debt situation deteriorates and credit spreads widen, and to fall when the outlook improves and spreads tighten. Defiance plans to launch four similarly structured ETFs. In some cases, investors could actually lose money even as a company's stock is plunging because the ongoing cost of maintaining CDS protection would eat into returns before anything bad enough to impair the company's credit actually happens. In either direction, moves could be magnified several times over, because the fund managers plan to use borrowed money to amplify returns. AI panic In recent weeks, the AI trade has unraveled, with investors increasingly worried that massive AI spending may take years to pay off, while Democrats' landslide victories in Congress have raised the odds of tighter regulation. Demand for protective tools has pushed CDS prices linked to hyperscalers and chipmakers to record highs and a year ago, such tools barely existed. Oracle Corporation, the lowest-rated among the big hyperscalers, is widely seen as the "barometer" of AI debt risk. Last month, its five-year CDS hit a record as credit risk in the tech sector soared and markets worried that a post-earnings borrowing spree would overwhelm an already strained bond market. Oracle Corporation subsequently disclosed that it was committed to adding only US$10 billion in net debt through fiscal 2030, which partly eased investor anxiety. Meanwhile, CoreWeave has tapped both the U.S. high-yield bond and loan markets through multibillion-dollar deals to finance its buildout. Contracts linked to this "neocloud" company began trading a year ago and hit a record high last month after the company unsettled investors by discussing a massive pool of capital from insurers. These swap contracts are now priced for a default probability of more than 60% over the next five years. Debt issued by Oracle Corporation and Meta both carries investment-grade credit ratings. CoreWeave is rated B by S&P Global, Inc. Trading volume hits record Trading in CDS linked to the ten largest hyperscalers and chipmakers is at record highs, making these swaps among the most actively traded contracts in the U.S. market outside the financial sector. According to an analysis of trade depository data by Barclays credit strategist Jigar Patel, Oracle Corporation CDS is by far the most active single-name contract in the U.S. market, at a record US$47.6 billion, compared with just US$8.7 billion cumulative this year through October 30. CoreWeave's trading volume stands at US$4.6 billion, up from just US$145 million. James Seyffart, an industry research analyst, said the new CDS-linked ETFs will struggle to win over retail traders given the products' complexity, but that could change if the AI selloff deepens. "Anyone who has read about the global financial crisis knows what these are. But will they actually buy an ETF based on it? Maybe, but I'm skeptical," Seyffart said. "Still, no matter how niche, a product in the right place at the right time can have a snowball effect."