Although most exchange traded funds follow market indices and offer competitive fees, recent events have made investors more aware of the unique risks of leveraged ETFs, and exchange traded notes.
Regulators are “still coming up short on dealing with the risks of exchange traded funds,” writes Agnes Crane at the Reuters Breakingviews blog.
“Most of the $1.7 trillion ETF market remains relatively straightforward. They offer a simple solution to a simple problem, allowing retail investors who just want index returns a vehicle that can be traded just like any other stock,” Crane wrote.
“But not all ETFs are created equal. Their overwhelming popularity over the past decade has spawned a host of newer products that are neither simple nor safe – some are high-stakes trading vehicles designed to be bought and sold on the same day, for example,” she added, referring to leveraged and inverse ETFs.
The Financial Industry Regulatory Authority will bring enforcement cases against brokerage firms for selling complex ETFs that were not suitable for their clients, according to recent reports. [FINRA Prepping Cases Over Leveraged, Inverse ETFs]
Last month, FINRA permanently barred a former Morgan Keegan registered rep for putting some of his clients into leveraged ETFs that were unsuitable. [Broker Barred Over Leveraged ETF Investments]
Regulators are concerned brokers may be inappropriately putting their long-term clients into ETFs designed as trading vehicles.
“That’s akin to giving a circular saw to a toddler. These short-term, structured ETFs can make mincemeat of an unwitting buyer’s investment portfolio,” Crane wrote.
She said investors should also consider the risks of exchange traded notes, or ETNs.
With ETFs, investors are buying a slice of a portfolio managed by an investment firm. However, ETNs are credit instruments issued by financial institutions. Therefore, they are backed by the full faith and credit of an investment bank.
“So if the issuing lender goes bust, bye-bye ETN,” Crane said.
Exchange traded fund providers have been stepping up efforts to differentiate their products from ETNs. [ETF Providers Call for More Transparency]