Regulators Reiterate Warnings Regarding Exotic Exchange Traded Funds (ETFs)

 

Exchange traded funds are one of the fastest-growing and most popular investments on Wall Street. They are mutual fund-like baskets of securities that trade like stocks, but have hidden risks that could harm investors, the North American Securities Administrators Association (NASAA) cautioned recently, according to Matt Krantz’s USA Today article entitled “Exotic ETFs can burn the unwary.”

NASAA, which is comprised of state securities regulators, is most concerned about extreme and exotic exchange traded funds, such as leveraged exchange traded funds, which own securities on margin, and inverse exchange traded funds, which move in the opposite direction of their benchmark. “These exotic ETFS are beyond the ability of mom and pops to evaluate or hold,” David Massey, president of the NASAA, was quoted as saying.

The NASAA advisory arises out of concern that investors do not understand the risks of extreme and exotic exchange traded funds. It calls investors’ attention to the following risks:

?Structure. Most inverse and leveraged exchange traded funds are adjusted each day, causing investors to incur taxable gains. They are also designed for day-trading (a extraordinarily risky strategy), not a buy-and-hold strategy.

?Fees. These funds may have hidden costs, including a differential between the purchase price and the sell price, as well as transaction-based commissions.

?Risk of closure. While closures have not been frequent so far, NASAA expects that many extreme and exotic exchange traded funds will shut down, in which case investors may be hit with redemption fees or having their money tied up during a wind-up period.

Extreme and exotic exchange traded funds are narrowly focused and unsuitably high-risk for most investors. 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 and exotic exchange traded funds can 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 exchange traded funds offer liquidity, transparency, low expenses, diversification and tax efficiency, unlike the extreme and exotic varieties.

Page Perry is an Atlanta-based law firm with over 125 years collective experience representing investors in investment 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. Page Perry’s attorneys have extensive experience in representing investors in cases involving exchange traded funds. For further information, please contact us.