The danger of leveraged ETFs

June 12 2009 by Ellen Roseman

As a do-it-yourself investor, I hoped to profit when the stock market went down. So I tried the Horizons BetaPro bear ETF that bet against the TSX index.

It didn’t take me long to realize this leveraged product was for day traders only. After a short-lived foray, I stayed away.

FAIR Canada, a new group that speaks for investors, doesn’t want to see leveraged ETFs sold to the buy and hold crowd. Check out its its investor alert, which is very readable.

The advocacy group is asking securities regulators to beef up prospectus disclosure. (My disclosure: I’m on the board of FAIR.)

Now the Investment Industry Regulatory Organization of Canada has put out its own warning to investment dealers, as has a U.S. financial regulator.

Here’s what the leveraged ETF issuers are not telling investors strongly enough:

Most leveraged and inverse ETFs “reset” daily, meaning that they are designed to achieve their stated objectives on a daily basis. Due to the effect of compounding, their performance over longer periods of time can differ significantly from the performance (or inverse of the performance) of their underlying index or benchmark over longer periods of time.

For example, a Canadian ETF that seeks to deliver twice the daily return of the COMEX Gold Bullion Index fell 5 per cent between Jan. 22, 2008 and May 29, 2009. However, its inverse fund (twice the inverse daily return of the index) fell 38 per cent in the same time period. The underlying COMEX Gold Bullion Index increased by 6 per cent during this period.

I’m happy to see FAIR’s call for investor protection echoed by Canadian and U.S. regulators. I’m also relieved to see IIROC tell advisers that prospectus disclosure, even if beefed up, doesn’t go far enough.

Dealer Members are further reminded that providing risk disclosure in a prospectus or product description does not cure otherwise deficient disclosure in sales material, even if the sales material is accompanied or preceded by the prospectus or product description.

Since I pay attention to my online account, I sold my leveraged inverse ETF before losing much money. But not all investors are self-directed.

Some people may buy — and hold — these products because of a recommendation by a trusted adviser. Let’s hope they stay away once the risks are explained to them..

4 comments

  1. Jerry Hung

    Jun 12 2009

    I agree they are not meant to be hold for LONG (weeks at maximum). Although they do get addictive (qualify of a trader?).

    I bought HXU (2X TSX60 Beta) at $8, and sold too early, now it’s $15. So IF you catch the “RIGHT” tide going up (or down for HXD), you will come out flying, unless you go down with the tide first

    LEVERAGE in general is not to be taken lightly, especially 2X or 3X ETFs. Be warned!

  2. Lior

    Jun 12 2009

    Ever since ETFs were introduced in the early ’90s as convenient passive, low-fee instruments, financial “engineers” working for investment banking behemoths have thought of ways to milk investors, just as they’ve done for decades with mutual funds.

    In fact, some ETFs these days are not passively but actively managed funds, catering to the likes of investors who feel adventurous.

    On top of exposing their investors to unnecessary risk, they milk them dry with expense ratios that are often multiple times higher than the expenses of traditional ETFs from reputable companies such as BGI and Vanguard.

    Wise investors know to stay far away from such “exotic” funds. ETFs were created, after all, to simplify investing so that investors wouldn’t have to keep their hand on the trigger.

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