Leveraged ETF Fallout Continues

by on July 31, 2009 | ETFs Mentioned:

What started last week in St. Louis has set off a domino effect throughout the country. Following the announcement of Edward Jones’ decision to cease offering leveraged ETFs, a number of other firms have distanced themselves from these controversial products:

  • Ameriprise Financial has suspended the sale of leveraged ETFs.
  • LPL Financial has banned the sale of ETFs using more than 200% leverage (Direxion offers a full line of products targeting 300% exposure to benchmark indexes and ProShares recently expanded into this space as well).
  • UBS announced its decision to stop soliciting the sale of leveraged and inverse funds this week, noting that the short term nature of the products is inconsistent with their long-term view of investing.
  • According to Bloomberg, Morgan Stanley and Wells Fargo announced that they are putting leveraged products under review, a step that more likely than not will lead to their suspension.

Over the last year, inverse and leveraged funds have exploded onto the scene, attracting massive amounts of assets from sophisticated investors who had seen many of their traditional channels for obtaining leverage shrink or close altogether as a result of the credit crunch. “Amid the turmoil of the last year, one constant has been the growth in inverse and leveraged products,” notes John Cronin, an ETF product strategist for State Street.

While the retail base for leveraged ETFs is shrinking rapidly, don’t put any stock in reports that this is the beginning of the end for these products. As I’ve said countless times, leveraged funds aren’t a good match for advisers at these firms who don’t have the time to monitor client accounts on a daily basis. Since these announcements have hit, trading volumes on the most popular leveraged exchange-traded products haven’t seen any discernible drop (check out the tables for SRS and URE on Google Finance). I’m not saying that no one at these firms was ever using leveraged ETFs, but the number pales in comparison to the group of sophisticated that thoroughly understands these products and will continue to use them. Users of leveraged ETFs have a tremendously high risk tolerance, and the time and resources to move rapidly in and out of positions in these funds.

The Wall Street Journal also had some interesting coverage of the leveraged ETF situation, although I don’t agree with the notion that “we’re going to see a narrowing base of investors for this type of ETF going forward.” Don Dion, president of Dion Money Management and publisher of the ETF Report put it best, noting “these products will survive and may thrive, but I think it’s not a product that you want your mother or your grandmother to be buying.”

Disclosure: No positions at time of writing.