The North American Securities Administrators Association (NASAA), the organization of state securities regulators, has published its annual list of top 10 investor traps to avoid. NASAA identified Leveraged Exchange-Traded Funds (ETFs), real estate investment schemes, private placement offerings, natural resources investments, and Ponzi schemes as the greatest potential threats to investor safety. Regarding leveraged ETFs, NASAA warns: “Given their volatility, these funds typically are not suitable for most retail investors.” NASAA also warns investors to be wary of pitches for investments in gold bullion and currency scams, life settlements, entertainment investments, short-term commercial promissory notes, and speculative inventions and new products.
In his USA Today article entitled “Leveraged funds earn warning alert,” John Waggonner reports that the Financial Industry Regulatory Authority (FINRA) and the Securities and Exchange Commission have also issued special alerts about leveraged ETFs. This blog also has recent content on problems associated with leveraged and inverse ETFs. Dan Calabria, author of “Mutual Funds Today’Who’s Watching Your Money?” sums it up as follows: “If you want to gamble, go to Vegas?you’ll have a better time.”
Leveraged ETFs also pose dangers to the economy. In his August 22 Wall Street Journal article, “Small Investors Face Big Hit in ETF Push,” Brian Baskin leads off with this point: “U.S. regulators have begun targeting the big-time speculators suspected of artificially inflating prices for oil, natural gas and gold. Turns out some of the big guys happen to be small fry.” Commodity ETFs, which trade futures in inflation-hedge commodities like gold, oil and gas, have ballooned to $59.3 billion in assets as July, and $22.1 billion of that flowed in this year.
As noted in the many articles listed below, leveraged ETFs use leverage to amplify the price variations of their underlying holdings. In addition to that, the ETFs themselves are affected by investor sentiment. Unlike open-end mutual funds, whose prices are based solely on the value of its holdings at the close of each business day (“net asset value”), ETFs are closed-end mutual funds that trade like stocks. Consequently, they may trade at a premium or discount relative to their underlying holdings. For example, Mr. Baskin points out that U.S. Natural Gas Fund is trading at a 16% premium to gas futures. Bubbles are made of such stuff.
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NASAA’s alert can be found at http://www.nasaa.org/NASAA_Newsroom/Current_NASAA_Headlines/11129.cfm.
FINRA’s alert can be found at http://www.finra.org/Investors/ProtectYourself/InvestorAlerts/MutualFunds/P119778.
The SEC’s alert can be found at http://www.sec.gov/investor/pubs/leveragedetfs-alert.htm.
Readers may wish to link to “Leveraged and Inverse Exchange-Traded Funds (ETFs) Are Dangerous to Investors Financial Health,” “Beware Leveraged and Inverse Exchange Traded Funds,” “Regulators Investigate Sales of Leveraged and Inverse ETFs,” “Sales of Leveraged and Inverse ETFs Expose Wall Street Firms to Liability for Misrepresentation and Unsuitable Recommendations,” and “Class Action Filed Over Leveraged and Inverse ETF Securities.”