Most investors are not well informed about exchange traded funds and 46% describe themselves as “novices,” according to a survey taken by Charles Schwab Corp. Yet the survey also found that 44% planned to increase their exchange traded funds investments. Let’s hope these investors avoid the numerous extreme and exotic funds out there, which add risks that most investors do not understand or want.
The recent episode at UBS in which a trader who structured exchange traded funds on the firm’s Delta One Desk lost $2.3 billion of the firm’s money illustrates the extreme danger of some exchange traded funds. Such funds are extremely concentrated and complex, using derivatives (futures and options contracts) to increase leverage. With the increase in complexity and leverage came a vast increase in the level of risk associated with these products.
Most investors lack the background and expertise to understand and evaluate the risks of such complex investments. Vanguard’s Jack Bogle, who invented the retail mutual fund industry, refers to the growth of extreme and exotic exchange traded funds as “insanity” that “caters to investors’ worst instincts.” Regulators too have expressed concern.
Investors who have never sold short, bought on margin, or who should not do so, should not buy any of the extreme and exotic exchange traded funds that have proliferated in recent years.
Investors who do not understand what a fund tracks or how it tracks what it tracks should not invest in that fund.
Investors who do not understand a fund well enough to explain what the fund does and what risks are associated with the fund should not invest in that fund. It would take a course taught by a competent instructor that the average investor has not taken to have any usable grasp of what many ETFs do. Brokers rarely provide such a course.
Page Perry is an Atlanta-based law firm with over 125 years collective experience representing investors in securities-related litigation and arbitration. While past results are not indicative of future success, Page Perry’s attorneys have recovered over $1,000,000 for clients on more than 45 occasions. For further information, please contact us.