TAG | ETF
In an article from Forbes.com, May 27, 2011, Zack O’Malley Greenburg writes that a little over a year ago, fund provider Direxion launched an ETF (Exhange Traded Fund) called the Daily Semiconductor Bull 3x Shares. Its aim was to triple the performance of the PHLX Semiconductor Sector Index. Not as simple a task as it seems, apparently: Over the next seven months the index rose 5%, while the Direxion fund returned -6.25%.
Maybe investors should have heeded Direxion’s own disclaimer: “There is no guarantee the fund will meet its stated investment objective.”
This is the way of things in the world of ETFs, writes Greenburg, where offerings have exploded in recent years. Nearly 900 ETFs have been launched over the past five years, leading to a preponderance of funds that straddle the line from obscure to downright bizarre. Among them are leveraged ETFs like the aforementioned semiconductor fund that seek to double or triple the performance of sectors–and don’t always succeed. Examples range from the ProShares Ultra KBW Regional Banking ETF, to the Direxion Daily Agribusiness Bear 3x Shares ETF, which trades under ticker symbol COWS. There is also a smattering of international offerings, which comprised half of all new S&P-based index funds launched last year. Market Vectors parent Van Eck recently announced plans to launch a Mongolia ETF.
Forbes.com writes that there are a few ETFs so outrageous that they’ve already been shut down–for example, the HealthShares Dermatology and Wound Care ETF, shuttered in 2008 due to lack of demand. Others, like the PowerShares Dynamic Brand Name Products Portfolio and the PowerShares Autonomic Allocation Research Affiliates Portfolio, never even made it past the planning stages.
We are reminded that many obscure ETFs like Direxion’s leveraged semiconductor fund can be hazardous to investors who aren’t careful. These leveraged funds are designed for day-traders and backed by derivatives. Though providers warn that these funds are not meant to be held as long-term assets, many investors miss the fine print.
The Forbes.com article says that the SEC launched a review of all funds last March, deferring applications for “actively managed and leveraged ETFs that particularly rely on swaps and other derivative instruments to achieve their investment objectives” in the meantime. 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.”
Greenburg goes on to say that the SEC hasn’t yet resumed allowing providers to launch new leveraged ETFs, but it hasn’t banned existing products or disallowed existing issuers from creating new ones. The three leading providers of such funds–Direxion, Rydex and ProShares–now have something of a lock on leveraged ETFs. And no matter how outlandish their products may sound, they continue to be popular.
If you have invested in an ETFs and lost your investment, you may have valuable legal rights to be compensated for your losses. Call a Securities Arbitration Lawyer at Soreide Law Group for a free consultation on how to potentially recover your losses. To speak with an attorney, call 888-760-6552, or visit www.stockmarketlawsuit.com.
Soreide Law Group, PLLC., representing investors nationwide before FINRA the Financial Industry Regulatory Authority.
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In an article in InvestmentNews.com, Jessica Toonkal writes that with fund firms launching a seemingly endless parade of exchange-traded funds, a dark side to this glut of offerings is emerging. Portfolio liquidations, once rare, are becoming increasingly commonplace. This recent trend is scaring advisers. Indeed, some said they are more than a little worried about getting stuck in an ETF that ends up being shut down.
“With the proliferation of ETFs, this is becoming a greater concern,” said Sailesh S. Radha, a vice president at CCM Investment Advisers LLC, a registered investment advisory firm that manages $2.5 billion in assets. “Telling an investor than an ETF is shutting down is not news you want to give them.” said.
So how can an adviser spot trouble before it strikes? Here are a few warning signs to look for:
Has your ETF been around too long?
It is important to pay attention to how long an ETF has been around. You need to pay attention to how long an ETF has been on the market. “No one launches ETFs, then closes them a couple months later, except for Northern Trust [Corp.],” Mr. Hougan said, taking a jab at the Chicago-based firm, which closed 17 ETFs last February only 11 months after launching them.
We are reminded that an ETF that has has less than $10 million in assets – and has been around for a couple of years or so – should raise a red flag for advisers. It’s clearly not gaining traction with advisers.
Advisers also should pay attention to how an ETF is trading and if the fund is best-in-class, said Matt Hougan, president of ETF analytics at IndexUniverse. An ETF’s assets may be puny, but if it’s one of the few funds in an asset class that is poised to take off, it may stick around longer, he explained.
How are the other ETFs doing in the firm?
The article goes on to remind us that advisers also should take note of the investment adviser for the funds. If the firm manages a large number of profitable funds, it could buy additional time for laggards, said one executive at an ETF company, who asked not to be identified. “As long as you have a few ETFs that are the money makers, you can afford to have a few that take longer to gain assets,” the exec said.
If you have invested in ETFs and lost money, you may have valuable legal rights to be compensated for your losses. Call a Securities arbitration lawyer for a free consultation on how to recover your losses. To speak with an attorney, call 888-760-6552, or visit www.stockmarketlawsuit.com. Soreide Law Group, PLLC., representing investors nationwide before FINRA the Financial Industry Regulatory Authority.
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In an article from InvestmentNews, Jessica Toonkel writes, that with fund firms launching a seemingly endless parade of exchange-traded funds, a dark side to this glut of offerings is emerging. Portfolio liquidations, once rare, are becoming increasingly commonplace.
Some are saying they are more than a little worried about getting stuck in an ETF that ends up being shut down.
“With the proliferation of ETFs, this is becoming a greater concern,” said Sailesh S. Radha, a vice president at CCM Investment Advisers LLC, a registered investment advisory firm that manages $2.5 billion in assets, speaking to InvestmentNews at IndexUniverse’s conference Monday. For advisory firms such as CCM, which has a $20 million country rotation portfolio, choosing the right fund is vital to keeping clients’ trust. “Telling an investor than an ETF is shutting down is not news you want to give them,” Mr. Radha said.
As more advisers rush into sector-based ETFs, the chance of being in a fund that closes is on the rise. In 2007, a mere 10 ETFs closed. Over the past three years, 150 have been shut down, according to Ron Rowland, president of Capital Cities Asset Management Inc. That works out to about one ETF vaporizing each week.
Investors want to know how an adviser can spot trouble before it strikes? Mr. Rowland, who puts out a monthly column about ETFs that might close in his Invest with an Edge newsletter, said: “There is no specific sector that is usually represented in the list. But it’s a lot of smaller ETFs.”
This asset manager also noted that funds headed for trouble tend to have a similar profile. An ETF that has been around for about 28 months and has less than $10 million in assets should raise a red flag for advisers, Mr. Rowland said. He gives new ETFs a six-month grace period to gain assets before they become eligible for his ETF deathwatch.
The advisers also should pay attention to how an ETF is trading and if the fund is best-in-class, said Matt Hougan, president of ETF analytics at IndexUniverse. An ETF’s assets may be puny, but if it’s one of the few funds in an asset class that is poised to take off, it may stick around longer, he explained.
Paying attention to how long an ETF has been on the store shelf is also important. “No one launches ETFs, then closes them a couple months later, except for Northern Trust [Corp.],” Mr. Hougan said, taking a jab at the Chicago-based firm, which closed 17 ETFs last February only 11 months after launching them.
Your advisers also should take note of the investment adviser for the funds. If the firm manages a large number of profitable funds, it could buy additional time for laggards, said one executive at an ETF company, who asked not to be identified. “As long as you have a few ETFs that are the money makers, you can afford to have a few that take longer to gain assets,” the exec said.
When the ETF providers terminate funds, they often put out a press release and let investors know that the liquidation will take place in three to four weeks, experts at the conference said. Often the providers will encourage investors to stay in the funds until they are liquidated, at which time the providers will pay the investors back. Mr. Rowland warned investors against being swayed by this pitch.
“The sales hook is that if you go with them through the liquidation, you save yourself the commission,” he said. “But the risks far outweigh the savings.”
Many ETFs hit investors with a termination fee. Also, fund operators often start liquidating ETFs slowly, which can lead to tracking errors during the wind-down period, Mr. Rowland said.
Sticking with a fund through liquidation could cause advisers to lose an opportunity to put their money somewhere else. “You usually get your money back within six to 10 days of liquidation,” Mr. Rowland said. “However, you have to wait those six to 10 days, and you may have lost an opportunity to employ that cash elsewhere.”
If you had invested in Leveraged and Inverse ETFs and lost money, you may have valuable legal rights to be compensated for your losses. Call a Securities arbitration lawyer for a free consultation on how to ecover your losses. To speak with an attorney, call 888-760-6552, or visit www.stockmarketlawsuit.com. Soreide Law Group, PLLC., representing investors nationwide before FINRA the Financial Industry Regulatory Authority.
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On Morningstar’s website, an investor’s research site, one of their latest articles written by Paul Justices says, that if you’ve ever purchased an ETF labeled as Ultra, 2X, Double Long, or Inverse, please read this article. It just might save your retirement.
Today, there are more than 845 ETFs on the market. Some are great products that have greatly enhanced the investor experience. Others are betting mechanisms that can scorch a portfolio in just a few days. When Morningstar put together an ETF research report, and they currently cover more than 300 ETFs that represent over 94% of the market’s total assets, they want to let you know how to use these products properly. They suggest starting with a suitability assessment, or which type of investor should use each specific product and how. With virtually every leveraged and inverse fund, they are appropriate only for less than 1% of the investing community. Considering that these funds have attracted billions of dollars over the past year alone, it’s pretty obvious that too many people are using these incorrectly.
To summarize, one fund tracks the index and lost 52% last year, one aims to deliver the inverse of the index and gained 20%, and the last aims to deliver twice the inverse of the index and lost 25%. While the fund that held the stocks lost 52%, the one that aimed to deliver twice the inverse also lost a substantial 25%. And the funds worked like they were supposed to. And this was one of the better performing examples. At least the inverse fund, which is meant to be used only for a single day, produced a positive return, as expected. Check out this next example.
Oil and gas producing stocks went for a wild ride in 2008, spiking for the first seven months of the year and cratering the rest. So which of these leveraged ETFs made money for you? Neither. They both lost, with DIG down 69% and DUG down 19%. And again, the funds worked like they were supposed to.
We laud ETFs for their transparency, tax efficiency, low costs, and liquidity. It’s no wonder this group has continued to attract new assets even as the market has floundered. But just because these funds are transparent does not mean that a potential investor does not need to look under the hood before purchasing.
In every leveraged ETF report that Morningstar writes, they warn investors that the math behind daily compounding will not work because of compounding arithmetic and constant leverage, but the message is not getting across.
Let’s say you put $100 in a savings account that pays 10% per year. After one year, you’d have made $10 in interest ($100 multiplied by 0.10), so your balance stands at $110 (your original investment of $100 plus $10 interest). If you leave the entire sum in the account, at the end of year two you would have $121. With the same 10% interest rate, you made $11 ($110 multiplied by 0.10) in year two versus $10 made in year one. As the adage goes: “Your money is working for you.” Continue this same math for seven years, and your account would nearly double, ending at $195. If you divide the $95 you made over seven years, your average return would be 13.55%. Clearly, the average return on your initial investment exceeded the interest rate of 10% that occurred every year, or the rate that compounded.
But there is one interesting characteristic in this example that does not apply to the stock market: The returns were positive in every single period. Stocks tend to wax and wane from day to day, going from positive returns one day to negative the next. It’s true that stocks, on average, have produced higher returns than fixed-income over long periods of time, but average returns and compounded returns are very different animals. Trying to predict the exact timeframe over which your idea will become reality is even more difficult. Finally, actually detailing the path–knowing how volatile the daily price swings will be and in which direction–is nearly impossible. If you intend to hold leveraged or inverse funds beyond their compounding periods, you’d have to be right on all these factors to get double the index’s return. In other words, when employing leverage and compounding returns, predicting your return is only part of the challenge. You also have to correctly predict the path the investment is going to take.
Let’s say you make a $100 investment in each of three funds. One is a simple investment in an index. Then you have two leveraged funds that compound daily; one is double-long and the other is double-short (returning twice the inverse of the index). After one day, the index returns 10%. The index value would then be $110. The double-long would add 20% and end at $120, and the double-inverse would lose 20% and end at $80.
On day two, let’s say the index loses 10%. That means that the average return [(10% -10%)/2] would be zero. However, the index itself would end at $99 because 10% of $110 is $11, and $110 minus $11 is $99. The fund that promises double the return of the index but compounds daily would end at $96. Remember, this fund started the day at $120. Its return for day two is -20% (double the index’s loss), and leaves it with a $24 loss for the day. So, $120 minus $24 is $96. The double-short fund would also end at $96 because 20% of $80 is $16, and $80 plus $16 is $96.
If you were to repeat 10 consecutive days of up 10% days followed by down 10% days, both of the leveraged funds would end up at $81.54, which is a sizable difference from the $95.10 the index would end at. Repeat this process for only six months, and your ‘investment’ in either of these leveraged funds would stand at only $2.54. Yes, that’s a 97.46% loss. Talk about tracking error.
That’s why compounding of daily returns is the dead horse that apparently needs a little more beating. Leveraged and inverse ETFs are NOT meant to be held as long-term investments. Very bad things not only can happen whenever you hold these ETFs longer than their indicated compounding period (typically one day for stock-based ETFs, sometimes monthly for commodities), you are almost mathematically guaranteed to get a return that is not double that of the index. In fact, the longer you hold one of these funds, the probability that you will get nothing close to double the returns increases. Not only will the magnitude of your returns bounce around, you might not even get returns that are in the same direction as the changes in the index.
Here’s the last example. If you’ve already wrapped your arms around the concept, please skip to the next section. This time around, use this table to illustrate the point.
So Why Are We More Concerned Today?
In November 2008, Direxion released the first slate of triple-leveraged exchange-traded funds, and the market welcomed them with open arms. In a matter of weeks, the suit of 14 ETFs attracted more than $1 billion in assets, and the firm has expedited the issuance of similarly structured funds.
Making 300% bull and bear funds available is good thing for the ETF market–but that doesn’t mean it’s right for all. Without blaming the institutions that sponsor these funds, they’ve been very forthright about disclosing the potential shortcomings of these products. The ETF structure is well-suited to house these types of instruments, and there are a few legitimate uses for these funds (mainly for people who manage large sums of money). Any investor that takes the time to thoroughly read and comprehend the prospectus will realize that, when held for anything longer than a few days, the deck is stacked against them under most market conditions.
Here’s an example of who could potentially use these funds. Let’s say that you’re a diversified large-cap mutual fund manager that is facing redemptions. You’re going to have to liquidate several holdings, but you don’t want to lose your exposure to the market. You could purchase these leveraged funds in the morning, sell three times that amount of your other holdings to raise cash, and then sell the leveraged fund at the market’s close. You would have maintained your market exposure for the day without having to rush at the market’s close to dump some holdings.
Another use for these funds is for short-term speculation. If you’re inclined to bet–not invest, yes, bet–as to what a sector or index is going to do over the course of a day or two, go ahead and use these funds. Good luck.
If you had invested in Leveraged and Inverse ETFs and lost money, you may have valuable legal rights to be compensated for your losses.
Call a Securities arbitration lawyer for a free consultation on how to recover your losses. To speak with an attorney, call 888-760-6552, or visit www.stockmarketlawsuit.com. Soreide Law Group, PLLC., representing investors nationwide before FINRA the Financial Industry Regulatory Authority.
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Don’t become a victim of this “trader’s trap” in these leveraged funds!
If you have fallen victim to this “trader’s trap,” contact a FINRA Securities arbitration attorney at Soreide Law Group, PLLC, for a free consultation on how to recover your FAZ and other Leveraged ETF losses. Call 888-760-6552, or visit www.stockmarketlawsuit.com. Soreide Law Group, PLLC, representing investors nationwide before FINRA and the NFA.
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