Five months ago, Doug Morrow figured he could make money betting that oil prices would head north again from about $37 (U.S.) a barrel.
Using a discount broker, he invested more than $10,000 to buy a special exchange-traded fund that aims to double the daily return of crude futures. However much oil went up, he would make two times that. Or so he thought.
While his hunch on commodity's direction proved right – crude oil rose about 60 per cent in four months starting in mid-January – his investment languished in the red. He had bought a leveraged ETF called the Horizons BetaPro NYMEX Crude Oil Bull ETF HOU-T. But Mr. Morrow began to feel as if he'd signed up for a casino game.
“It's like heads you win, tails you lose,” lamented the 32-year-old investor. “If you hold these things for anything longer than a day, you have to be careful,” said Mr. Morrow, who lives in Toronto.
Mr. Morrow, a recent MBA graduate, hung in until the fund finally rose above his initial investment. He recently sold at $9.07 a unit – a mere 13.5 per cent higher than his average purchase price, while oil had doubled.
Welcome to the world of leveraged ETFs, an investment fund vehicle that seductively promises the potential of double or triple the returns of an index or commodity. While the “bull” and “bear” versions of these funds have been gaining popularity in North America, they have also come under increasing scrutiny by securities regulators and by investor advocacy groups as investor complaints rise.
“[These ETFs are] very hazardous for retail investors” because they don't understand that expectations about their performance should not exceed more than a day, said Ermanno Pascutto, executive director of the Canadian Foundation for the Advancement of Investor Rights [FAIR Canada].
“We are calling for better disclosure [in prospectuses] and warnings in the marketing. We have regulated plain-vanilla ETFs in a certain way, but [leveraged] ETFs have morphed into a completely different product.”
The longer investors hold them, and the more volatile the underlying index the ETF tracks, the further away the ETF can get from actually doubling or tripling the underlying index.
Horizon BetaPro ETFs are offered by BetaPro Management Inc., a unit of Jovian Capital Corp. It is currently the only player in Canada offering leveraged ETFs and maintains that its current disclosures about these investments are adequate.
It says that is why as many as 40 per cent of the users are retail investors.
“I am sure that some people didn't initially understand them, but I would suggest that given the popularity of these products … that the vast majority do understand them,” BetaPro president Howard Atkinson said.
There are 30 leveraged ETFs trading in Canada. They are different from conventional ETFS in that they attempt to give investors a turbo-charged return through the use of derivatives. They can work if investors hold them for a single day, and make a right bet.
But the longer investors hold them, and the more volatile the underlying index the ETF tracks, the further away the ETF can get from actually doubling or tripling the underlying index.
Canadians have made no small bet on these funds either. They hold close to $2.3-billion of leveraged ETFs now, all with BetaPro, up about 69 per cent in the past year.
It didn't matter if they were in a bull or bear ETF, they still lost. — Ken Kivenko, a Toronto-based investor advocate
While most retail investors are looking for these ETFs as a way to get a bigger bang for their buck, sophisticated investors like fund managers are using the “bear” ETFs to hedge portfolios – to have something that goes up when everything else is falling – in addition to making short-term speculative bets.
