Exotic ETFs Have Far Greater Risks Than Low Trading Volumes


Exchange traded fund assets remain concentrated in a small minority of the 1,400 ETFs on the market today for very good reasons. In fact, twenty-five ETFs based on broad indices are responsible for two-thirds of the trading volume.

Owners of trading platforms for the other 1,375 ETFs are unhappy with this situation and want more of the action. They argue that investors are avoiding their funds out of a mistaken belief that low trading volume means a lack of liquidity (“Trading volume misleading on ETFs,” InvestmentNews). But is that all that is really going on here?

Owners of the trading platforms try to make a case that liquidity is more a function of the bid-ask spread than trading volume. They argue that if the bid-ask spread is narrow, that means that the underlying assets are liquid even if the ETF’s trading volume is thin. Furthermore, they argue, that an undue focus on trading volume would eliminate the 20 best-performing ETFs so-far this year, 13 of which trade less than 200,000 shares per day and 9 of which trade less than 10,000 shares per day. Maybe so. But liquidity is not the same as safety.

Look at Morningstar’s list of the 20 best-performing ETFs year-to-date. They are all ultra-high-risk speculative ETFs that are designed for day-trading and use leverage, short-selling and derivatives to try to achieve returns, or are niche-specialty exchange traded funds. To give you an idea of what they are talking about, the top five are:

ProShares UltraShort DJ-UBS Natural Gas
Direxion Daily Nat Gas Rltd Bear 3X Shares
Direxion Daily Retail Bull 3X Shares
ProShares UltraShort DJ-UBS Crude Oil
ProShares Ultra Nasdaq Biotechnology.

And it’s ultra-high risk all the way down to number 20 and beyond.

These ETFs, which have shot up between 22% and 112% so far this year, could just as quickly lose that much and more. They may be liquid, but it is no place for the average investor to be.

Investors who cannot afford to lose (or are unwilling to lose) every penny of their “investment” have no business buying such ETFs, and financial advisers have a legal obligation not to recommend the purchase of these kinds of ETFs to most investors. According to Morningstar, investors should “beware” of specialty ETFs and use care (to say the least) in considering leveraged ETFs.

Investors and their advisers need to be wary and skeptical of ultra-high-risk securities and misleading sales pitches that seek to entice them to invest in them. These ETFs are about gambling, not investing.

Page Perry is an Atlanta-based law firm with over 170 years of collective experience maintaining integrity in the investment markets and protecting investor rights.