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Briefly Noted

Leveraged and Inverse ETFs: Extra Risks for Buy-and-Hold Investors

The SEC and FINRA have issued an alert expressing concern that individual investors may be confused about the performance objectives of leveraged and inverse exchange-traded funds (ETFs).

Typically these products are designed to achieve their stated performance objectives on a daily basis. The two regulatory agencies have issued an alert concerning leveraged and inverse ETFs because they fear some investors might invest in the products with the expectation that the stated daily performance objectives will be met over the long term as well. The agencies warn, however, that investors should be aware that the performance of these ETFs over a period longer than one day can differ significantly from their stated daily performance objectives.

Leveraged ETFs seek to deliver multiples of the performance of the index or benchmark they track. Inverse ETFs (also called “short” funds) seek to deliver the opposite of the performance of the index or benchmark they track. Like traditional ETFs, some leveraged and inverse ETFs track broad indexes, some are sector-specific, and others are linked to commodities, currencies, or some other benchmark. Inverse ETFs often are marketed as a way for investors to profit from, or at least hedge their exposure to, downward moving markets.

According to the alert, most leveraged and inverse ETFs “reset” daily, meaning that they are designed to achieve their stated objectives on a daily basis. However, their performance over longer periods of time—over weeks or months or years—can differ significantly from the performance (or inverse of the performance) of their underlying index or benchmark during the same period of time. This effect can be magnified in volatile markets. For example, an ETF that is set up to deliver twice the performance of a benchmark from the close of trading on Day 1 to the close of trading on Day 2 will not necessarily achieve that goal over weeks, months, or years.

The regulatory alert notes that the best form of investor protection is to clearly understand leveraged or inverse ETFs before investing in them, and stresses the importance of reading the prospectus, which provides detailed information related to the ETFs’ investment objectives, principal investment strategies, risks, and costs.

Before investing in these instruments, the alert suggests investors seek answers to the following questions:

  • How does the ETF achieve its stated objectives, and what are the risks? Be sure you understand the techniques the ETF uses to achieve its goals.
  • What happens if I hold longer than one trading day? Buy-and-hold investors with an intermediate or long-term time horizon should carefully consider whether these ETFs are appropriate for their portfolios. Because leveraged and inverse ETFs reset each day, their performance can quickly diverge from the performance of the underlying index or benchmark.
  • Is there a risk that an ETF will not meet its stated daily objective?
  • What are the costs? Leveraged or inverse ETFs may be more costly than traditional ETFs. Use FINRA’s Fund Analyzer to estimate the impact of fees and expenses on your investment.
  • What are the tax consequences? Leveraged or inverse ETFs may be less tax-efficient than traditional ETFs, in part because daily resets can cause the ETF to realize significant short-term capital gains that may not be offset by a loss.

Source: FINRA.

A Decade’s Difference: Global Leaders’
Shifting Sectors

The year 2009 marks the 10th anniversary of the Dow Jones Global Titans 50 index, which measures the stock performance of the world’s biggest and most respected companies. Its constituents are typically leaders within their industries, have solid financials and broad client bases, have widely used products or services and have an established history of success.

A comparison of the Dow Jones Global Titans 50 index now vs. a decade ago reveals the shift in dominance of sectors over time. For example, the index currently is much more heavily weighted toward health care and oil & gas companies and less weighted toward telecommunications and financials stocks than it was 10 years ago.

  DJ Global Titans 50
Industry Weightings
 
  July 2009
(%)
July 1999
(%)
Sector
Oil & Gas 20.19 12.03
Basic Materials 1.79 1.39
Industrials 3.58 8.00
Consumer Goods 13.64 13.54
Health Care 14.81 8.08
Consumer Services 2.16 4.54
Telecommunications 9.06 16.04
Utilities 1.33 0.00
Financials 12.75 18.32
Technology 20.70 18.08

 

 

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