Your ability to make money depends to a large extent on whether you correctly guess the short-term direction of the market and how long you stay invested. Morningstar’s Paul Justice cites four of nine pairs of leveraged ETFs that lost money over a 12-month period, whether bull or bear. “You would have met the same fate – losing money – no matter which side of the trade you took.”
Other risks include:
- These products trade on exchanges, so during periods of greater uncertainty, the bid-ask spread will often widen. Your order could go through at a different price than the net asset value (NAV).
- With funds that reflect the price of a commodity, there is also the risk that the price of the forward contract is not the same as the spot price.
- All leveraged ETFs require counter-parties to support them – typically big banks and brokerages. Yet after the recent financial meltdown, investors should be wary. Credit ratings and the size of a financial institution is no guarantee the counter party is financially sound.
Did you know?
In the year ended March 2009, the ishares i60 ETF fund – which tracks the TSX index – lost 31.7 percent. So if you had invested in the double bear version of that fund – Horizon 60 Bear – you would have expected to see a double profit of 63.4 percent. Instead, this leveraged ETF made only 20.2 percent.
Likewise, after the Canadian gold subindex gained 1 per cent for the 12 months ending March 31, you might have expected the HBP S&P/TSX Global Gold Bear Plus ETF to lose 2 percent. Instead, it dropped 87 percent. Likewise its pair, the HBP Global Gold Bull Plus ETF did not gain 2 percent. Instead, it lost 46 percent .
FAIR (the Foundation for Advancement of Investor Rights) says regulators should require sellers of leveraged and inverse ETFs to file a prospectus carrying a clear warning that they are not suitable for holding longer than a few days – especially in volatile markets.
“Despite recent warnings in the financial press on both sides of the border, many investors are unaware of the perils of holding leveraged or inverse ETFs for periods longer than a few days,” says FAIR Canada associate director Steve Garmaise.
“Retail investors don’t understand what the real risks are,” echoes Ermanno Pascutto, FAIR’s executive director.
Content in this section is provided in partnership with the Investor Education Fund, a non-profit organization promoting financial literacy to Canadians. To find out more go to GetSmarterAboutMoney.ca.