August 18, 2009 – Leveraged and Inverse ETFs: Specialized Products with Extra Risks for Buy-and-Hold Investors
The Financial Industry Regulatory Authority (FINRA) issued an Investor Alert to help investors understand the performance objectives of leveraged and inverse exchange-traded funds.
Exchange-Traded Funds is an investment fund that holds stocks, bonds, or commodities and typically tracks specific indices representing such asset classes. Introduced in 1993 by State Street Global Advisors, ETFs experienced exponential growth in the last decade from $66 billion in 2000 to $2 trillion in 2010. After all, ETFs are easily accessible to the investors in that they are listed on exchanges and tradable throughout the day, unlike mutual funds which are not on exchanges and are tradable only once a day at net asset value.
Leveraged ETFs leverage an index and inverse ETFs are investments that return the inverse of the return of an index. Both ETFs experienced huge growth the past few years, from $200 million in assets under management in mid-2006 to $32 billion in mid-2010. Holding leveraged and inverse ETFs for a period of longer than a day can cost investors when the ETFs’ returns deviate from the returns of the underlying leverages or inverse investment. For a research paper that discusses in detail this phenomenon, see ‘Leveraged ETFs, Holding Periods and Investment Shortfalls’ published by SLCG.
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