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Leveraged And Inverse ETFs Not For The Uninformed

Leveraged and inverse ETFs have found themselves under the regulatory microscope recently, which makes it all the more interesting that ProShares has decided to launch eight new exchange-traded funds that aim to magnify their benchmark exposures by 300%. The story was first reported Feb. 12 by Investment News

Leveraged and inverse ETFs try to achieve a return that is a “multiple” of the inverse performance of the underlying index. For Proshares’ new series of ETFs, that means the funds seek a +300% or -300% return of their indices for a single day before fees and expenses. 

In the summer of 2009, several investors initiated lawsuits and arbitration claims involving the Ultra ProShares Funds and UltraShort ProShares Funds. Specifically, investors accuse ProShares of issuing “false and misleading registration statements, prospectuses and additional information” in connection to the funds. As a result of the alleged false promotion of the products, many investors suffered enormous losses. 

In June, the Financial Industry Regulatory Authority (FINRA) issued a statement on leveraged and inverse ETFs, reminding broker/dealers that the products “typically were unsuitable for retail investors” who hold them longer than a single day. FINRA later restated its position, saying that member firms could recommend leveraged and inverse ETFs to retail investors provided that the broker/dealer conducted a suitability assessment of the investor and the ETF itself. 

Massachusetts Secretary of State William Galvin also has taken up the issue of leveraged and inverse ETFs. In July 2009, Galvin began an investigation of the sales materials of companies that sold the funds. The state later sent letter to three ETF leaders – ProShares, Direxion Funds and Rydex Investments. 

The bottom line: Leveraged and inverse ETFs are not for everyone. These types of ETFs provide leverage on a daily basis. Above all, leveraged and inverse ETFs are not a save-and-hold investment – a fact that many retail investors were woefully unaware of. 

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