With the proliferation of exchange traded funds (ETFs), the average investor is capable of investing in a multitude of market themes. Though, some fund providers believe that sophisticated or complex ETFs should be limited to those who know how to use them correctly.

Specialty ETFs are strategy-based ETFs made to beat the underlying market benchmark, writes Johnathan Bernstein for ETFZone. As such, expense ratios are typically higher.

These niche ETFs focus on a small area of the market; some examples include:

  • The PowerShares S&P 500 BuyWrite (NYSEArca: PBP) tries to capitalize on market volatility by selling call options on underlying equity positions, and the fund receives the premium for selling the call options.
  • The First Trust U.S. IPO Index Fund (NYSEArca: FPX), which invests in new issues or IPOs. FPX invests in newly issued stocks by purchasing the stock after the first seven days of its initial IPO and then selling it after 1,000 days of trading.
  • Guggenheim Insider ETF (NYSEArca: NFO) tries to take advantage of company insider transactions. Company insiders publicly disclose when they buy/sell shares of their own stock, and the fund trades on the premise that insiders would be better suited to understand their products and markets better than others.
  • The SPDR Barclays Capital Convertible Bond ETF (NYSEArca: CWB) trade convertible bonds, or hybrids, that have characteristics of both debt and equity securities. Convertibles are bonds that pay interest coupons but can also be converted to new equity shares.

BlackRock Inc. and Invesco PowerShares executives are calling on regulators to address the suitability requirements of sophisticated ETFs, reports Jessica Toonkel for InvestmentNews. The observers are especially worried about potential problems arising from complicated ETF instruments, more notably leveraged and inverse funds, which use derivatives and debt instruments to achieve their goals. [Using ETFs to Access ‘Alternative’ Asset Classes.]

For now, FINRA has suitability requirements in place for both simple and sophisticated ETF products. ETF providers are concerned that the regulators have been too lax on the more sophisticated ETF instruments. BlackRock and Invesco PowerShares both voice the need to limit these complex ETF products to qualified investors who have suitable knowledge of the instruments.

Whatever your take on this is, one thing we can tell you for sure is: Never buy something you don’t understand. Always do your research first.

For more information on ETFs, visit our ETF 101 category.

Max Chen contributed to this article.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Mr. Lydon serves as an independent trustee of certain mutual funds and ETFs that are managed by Guggenheim Investments; however, any opinions or forecasts expressed herein are solely those of Mr. Lydon and not those of Guggenheim Funds, Guggenheim Investments, Guggenheim Specialized Products, LLC or any of their affiliates. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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