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Tuesday, June 23, 2009

Leveraged ETFs... You Know They Are a Bad Idea When......

.... the regulatory agency responsible for the investment industry issues a strong warning about their use. I have pointed out on May 2 and again on May 31 the dangers of these products before and I can't recall FINRA ever issuing a similar warning with regard to such a widely used products. And the fact that the warning is issued to brokers and registered investment advisors (the supposedly knowledgeable operators in the financial markets) and not just to individual investors imo says volumes about the level of knowledge and fiduciary standards of many in the financial services industry. My May 2 entry noted that advisors are apparently using these instruments as part of their "investment strategies".

From the wsj (my bolds)

Finra Urges Caution on Leveraged Funds
The Perils of Holding for More Than a Day


Regulators appear to be turning a critical eye to sales of leveraged and inverse exchange-traded funds, complex instruments that can magnify not only investors' returns but their risks as well.

The Financial Industry Regulatory Authority has reminded brokers and registered investment advisers about their fiduciary duties when selling ETFs that offer leverage, are designed to perform inversely to the index or benchmark they track, or both. In a notice posted to its Web site earlier this month, Finra reminded the brokers and advisers that these instruments are complex and typically unsuitable for retail investors who plan to hold them longer than one trading session.

"While such products may be useful in some sophisticated trading strategies, they are highly complex financial instruments that are typically designed to achieve their stated objectives on a daily basis," the notice said. "Due to effects of compounding, their performance over longer periods of time can differ significantly from their stated daily objective."

In my May 2 post I noted that some registered investment advisors are making use of these instruments with the objective of augmenting returns for holding periods longer than a single day. As I pointed out then and as the last paragraph above notes, these instruments are not appropriate for such a strategy. That FINRA effectively had to issue a bulletin to brokers and investment advisors explaining obvious points about how leveraged etfs work imo doesnt reflect well on many in those professions.

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