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.

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