UBS Suspends Leveraged ETFs, Wells Fargo To Review

by on July 28, 2009

UBS Wealth Management Americas has suspended purchases of leveraged and inverse exchange-traded funds, saying their inherent short term nature is not consistent with the firm’s long-term view of investing. In addition, UBS cited the recent regulatory guidance on leveraged funds, including comments made by FINRA earlier this month. “Recent regulatory guidance on leveraged and inverse ETFs reinforces the short-term nature of these products, particularly in volatile markets,” the company said in a statement. Separately the Wall Street Journal reported Monday that the SEC issued new rules on short-selling, indicating to investors that information about the size of short interests in companies. The SEC, however, backed off its previous move to require hedge funds and other money managers to disclose short positions on a weekly basis.

UBS is the latest in a string of brokers to cease offering leveraged ETFs. Last week, LPL Investment Holdings prohibited the sale of leveraged products, and Ameriprise Financial told its brokers to stop soliciting orders for leveraged ETFs. During a regular product review, Edward Jones also decided to distance itself from the controversial funds. And Wells Fargo is reviewing its policy “regarding non-traditional ETFs” according to the Wall Street Journal. The concern over the funds centers on their returns when held over multiple trading periods. Although leveraged funds do an excellent job of achieving their stated objective – delivering amplified daily returns on a benchmark index – these funds reset daily, meaning that (due to the compounding of returns), their performance over multiple trading periods may not equal the expected multiple of the target index.

The decision by UBS to discontinue the purchase of leveraged ETFs for its clients is hardly surprising. Many asset managers devote a significant portion of their time to allocating dollars between asset classes (this isn’t a dig – asset allocation adds significant value to investor portfolios). The amount of time required to monitor and trade leveraged funds isn’t practical for 99% of investors out there. And, believe it or not, the sponsors of leveraged ETFs (Direxion and ProShares primarily) don’t want Joe the Investor using their products. They’re meant for sophisticated investors who move in and out of positions with alarming frequency. And these products are loved by this class of investors because they allow them to amplify their bets on broad market movements.

I’m sure there are those out there calling this the “beginning of the end” for leveraged ETFs. Don’t buy that for a second. The vast majority of trades in leveraged ETFs are not coming from Edward Jones and UBS. Daily volumes on leveraged funds haven’t dropped off a cliff since these announcements started coming in (in fact I can’t discern any declines at all). Until they can figure out a way to guarantee that these products are being used responsibly, UBS and others have done the prudent thing and suspended purchases altogether.

I am a bit bemused that UBS included inverse funds in its announcement. Most of the scrutiny to date has focused on leveraged ETFs (which includes inverse leveraged ETFs), with critics claiming that the products don’t behave as investors might expect (despite the abundance of educational material provided by issuers and analysts alike). Inverse funds are very simple in nature – they simply track the inverse of their benchmark index. Although they don’t make a whole lot of sense for long-term buy and hold investing, they might be appropriate “intermediate-term” investment vehicles for bearish investors. Stay tuned – I doubt all the dominoes have fallen in this game.

Disclosure: No positions at time of writing.