Chicago Exchange Traded Funds Attorney
Exchange traded funds, usually shortened to ETF’s, have become extremely popular in recent years , while simultaneously growing more complex and risky.
Leveraged and inverse ETF’s have become the newest source of concern for both regulators and investors amongst ETF’s. Though leveraged and inverse ETF’s contain some of the characteristics common to traditional ETF’s, there are some very important differences.
Synthetic ETF’s, like leveraged and inverse ETF’s, contain unique risks. Specifically, leveraged and inverse ETFs are designed to achieve their stated performance objective on a single day basis. Investors who hold these investments for longer than one trading day could see their entire investment portfolio vanish overnight.
Leveraged ETFs work by trying to double or triple the return of a particular index daily. An inverse ETF moves in the opposite direction of the index being tracked. If the index drops 5%, the inverse ETF should rise 5%. Because of compounding and leverage, leveraged and inverse ETFs are not designed to deliver long-term returns.
In addition to their complex structure, there are other issues of concern regarding synthetic ETFs. The key concern is the derivatives that they invest in, which, in turn, introduces counter-party risk for the investor.
Another difference between traditional ETFs and leveraged and inverse ETFs is the cost. Leveraged and inverse ETFs are significantly more expensive in terms of fees and commissions than their traditional counterparts.
In August, both the Financial Industry Regulatory Authority (FINRA) and the Securities and Exchange Commission (SEC) issued a statement on the risks of leveraged and inverse ETFs. In part, the warning read:
“These products are complex and can be confusing. Investors should consider seeking the advice of an investment professional who understands these products, can explain whether or how they’ll fit with the individual investor’s objective and who is willing to monitor the specialized ETF’s performance for his or her customers.”
The bottom line: Investors need to know the risks of leveraged and inverse ETFs before they buy.