Some exchange traded funds are just plain dangerous, and investors should not be lured by the “siren song of ETF marketers,” according to Dave Kansas’ Wall Street Journal article, “Exchange-Traded Funds Gone Wild.” Leveraged ETFs are unusually volatile and high-risk. They are designed for day-trading and unsuitable for buy-and-hold investors. All 52 leveraged ETFs in existence since Jan. 1, 2008, have lost money, according to Morningstar.
The losses are even higher than might be expected. ProShares UltraShort S&P 500 (SDS), which makes a double bet against the S&P 500, lost 40% last year as the S&P 500 gained 13%, according to Mr. Kansas’s article.
Leveraged and inverse ETFs often contain complex derivatives of assets rather than the assets to which they are purportedly linked. As a result, these ETFs do not track those assets closely, as investors have been led to expect. The variance in performance between a leveraged ETF and the assets it is supposed to track can be quite large.
“ETFs, like their mutual-fund cousins, like to chase the hot trends. The proliferation of certain types of concentrated funds are often signals that an idea is getting a bit too ripe. Think of the large number of Internet funds that blossomed just ahead of the Internet bubble bursting just over a decade ago,” says Mr. Kansas.
Similar concerns are raised by Ken Sweet in his CNNMoney article, “ETFs that raise red flags.” “These products are behaving exactly as they are designed, but retail investors need to know there are products they simply shouldn’t touch,” Mike McGrath, director of ETFs for TD Ameritrade, was quoted as saying.
Many of the more extreme, exotic or narrowly focused ETFs are also high-risk. John Bogle, the founder of Vanguard and the creator of the first index mutual fund in 1975, is one of those who believe that extreme exchange traded funds may blow up in investors’ faces. “It’s insanity,” Bogle has been quoted as saying. “This is a classic case of Wall Street trying to capitalize on the worst instincts of investors.”
Most individual investors should stick to exchange-traded funds that mirror a broadly diversified index such as the Standard & Poor’s 500. Such ETFs offer liquidity, transparency, low expenses, diversification and tax efficiency, unlike the extreme varieties.
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