Outrageous ETFs: Not Appropriate for All Investors

Forbes.com recently published an article entitled “The 15 Most Outrageous ETFs“. The article highlights the explosion in the Exchange Traded Fund (“ETF”) market and the growing trends in ETF development: the kinds of funds that have New York securities attorneys up in arms.

Since 2006, over 900 new ETFs have been launched. These funds utilize various complex structured products and derivatives to help their performance track their target index. Many funds also employ various techniques to increase their returns, called “leveraging”. However, these techniques also increase the risk of these investments.

Some ETFs on the market today that employ leveraging include Direxion Daily Semiconductor Bull 3x Shares, Direxion Daily Financial Bull 3x, Direxion Daily Small Cap Bear 3x, and Direxion Daily Energy Bear 3x. While these funds promise to return three times the return of their target index, many fall short. For example, during a seven month period just this past year, the Direxion Daily Semiconductor Bull 3x ETF returned a loss of 6.25% despite a positive return of 5% on its target index.

Many ETFs also will not track large indices like the S&P 500 or the Dow Jones, but will instead track narrower indices like the energy sector or agribusiness, which further exposes investors to the risks of overconcentration. Both leveraging and a narrow sector focus, individually, can be very dangerous for common investors, but when combined, the results can prove disastrous.

For these reasons, most ETFs on the market are actually designed for experience day traders, not for the common “buy and hold” investor. However, with the boom in the creation of ETFs recently, many common investors have found themselves holding these products in their portfolios. The high risk of these investments can have disastrous consequences.

But this potential for disaster has not gone unnoticed. In fact, the SEC has suspended the launch of any new leveraged ETFs. “There has been a lot of concern generally about derivatives in the last few years, and specifically in our division about the use of derivatives by investment companies, including ETFs,” says Elizabeth Osterman, head of the exemptive applications office of SEC’s Division of Investment Management. “Our decision to defer the review of exemptive applications for derivatives-based ETFs reflects concerns about whether granting exemptive relief for those funds would be consistent with required regulatory standards in light of those concerns.”

However, the SEC has not taken existing ETFs off the market. Unfortunately, many investors have suffered substantial losses in the past and may suffer more in the future because they never understood the product their broker was buying in their account or the associated risks. Many investors who suffer losses as a result of unsuitable recommendations by their broker may be entitled to compensation.

Malecki Law handles all types of Security law matters, including fraud allegations, unsuitability claims, audits and investigations, and whistleblower cases. Call 212-943-1233.