Fri, August 21, 2009
Some ETFs Are Scarier Than Others
Announcements of new exchange-traded funds arrive in my e-mailbox almost daily, but today’s seemed ironically timed: a new inverse ETF tied to the performance of twenty-year Treasuries.
Leveraged and inverse ETFs are useful for short-term traders who understand their risks, but the average retail investor should stay away from them. The last couple of months have seen a lot of regulatory scrutiny of these investment products.
There are legitimate uses for these funds, but they’re just dangerous in the wrong hands. The new ETF, offered by Proshares, yields the inverse of the daily performance of the Barclays Capital 20+ Year U.S. Treasury index. I’ve seen articles in the past in well-respected financial magazines in which people have recommended buying and holding this type of ETF as a way of preparing for an upturn in interest rates. Aaargh.
Unless you know that Treasury rates are going to go up tomorrow, or this week, these ETFs are not a reliable way to invest for an interest rate increase. As I’ve explained, the long-term performance of an inverse ETF usually does not follow the long-term performance of its related index – these products work fairly well on a daily basis, but beyond that their performance can’t be counted on to mirror an index. On a daily basis, these rates tend to bounce up and down, and that almost guarantees that their related inverse ETFs are not going to follow the long-term trend of the rates (see earlier post).
With this new offering, there are five inverse ETFs tracking 7-to-20 year bond indexes: three from Proshares and two from Direxion. Actually, this new one is the least dangerous, because it only offers 100% of the inverse return; the other funds are leveraged ETFs, offering 200% and 300% of the inverse of their indices.
It’s easy to imagine an investor naively thinking that he or she can hedge the risk of a long-term Treasury portfolio using these ETFs, but you cannot. In fact, I’d go so far as to say that it’s a likely way to lose money if you hold these ETFs long-term. It’s good that there has been so much hue and cry over the risks of these products, because that increases the likelihood that retail investors will be warned about using them improperly.
RELATED POSTS:
Exchange Traded Funds 101 – Part 1
Exchange Traded Funds 101 – Part 2
Leveraged/Inverse Exchange-Traded Funds Draw FINRA Warning
Leverage and Exchange-Traded Funds Don’t Necessarily Mix: The Leverage Trap
Brokerage Firms Distancing Themselves From Leveraged/Inverse ETFs
MA Secretary of State Investigating Leveraged Exchange-Traded Funds
SEC Adds Its Voice to Warnings About Leveraged and Inverse ETFs