More Leveraged ETF Confusion

by on August 5, 2009

The leveraged ETF issue has become a runaway freight train, picking up momentum with alarming pace and blowing through troublesome roadblocks such as common sense, rational financial analysis, and a little bit of research. Fidelity Investments is the latest to warn against the use of leveraged ETFs, publishing a warning to clients on its web site this week. “Leveraged products are complex, carry substantial risks and are intended for short-term trading,” reads the warning. “Most reset daily and seek to achieve their objectives on a daily basis. Due to compounding, performance over longer periods can differ significantly from the performance of the underlying index.”

The mutual fund giant’s decision comes on the heels of several similar announcements by various financial institutions over the last several weeks. Edward Jones, LPL Financial, UBS, and Ameriprise are just a few of the firms that have suspended or restricted purchases of leveraged products on behalf of their clients. Despite my best efforts to dispel some of the myths surrounding these products, a number industry analysts continue to interpret these announcements as the beginning of the end for leveraged ETFs. A few such “doom-and-gloom” proclamations:

  • Leveraged ETFs Are Going Down at Motley Fool: Despite the title, the author makes some good points about the marketing of leveraged funds: “For the most part, it’s hard to argue that anyone has been misled by these funds. Leveraged ETF providers have been as upfront as possible that returns are based on daily index moves, to the point where many of the ETFs involved have the word ‘daily’ in their name.”
  • Leveraged ETFs: Desperate Times at The Street: “Leveraged ETFs need to mount a new sales effort or they may go the way of the dodo,” writes Don Dion. Dion’s assessment seems a bit dire to me – I’m on record saying that these warnings from brokers aren’t a deathblow by any means, and the volume data is there to prove it.

My counter to a lot of the arguments and predictions in these pieces can be found here.

A couple of very insightful and well written articles on the ETF controversy:

  • Restricting Access to Leveraged ETFs at Trade Radar: “So brokerages attack leveraged ETFs with a big dose of hypocrisy. If I am a lousy market timer, it’s OK to squander my funds on stocks, options or standard ETFs but it’s not OK to lose my money on leveraged ETFs.”
  • Leveraged ETFs: So Misunderstood at ETF Trends: “Leveraged ETFs are now getting a bad rap because some people who didn’t understand them used them and got burned in the process.”

This debate continues to rage and will likely be in the headlines for quite a while. If I had to guess, I’d say we’re eventually going to see more legislation on this issue (just wait until Congress gets a hold of it!), but a lot remains to be seen. Stay tuned.

Disclosure: No positions at time of writing.