By Ian Salisbury
Dow Jones Newswires
NEW YORK — Last year’s months-long controversy over exchange-traded funds that let investors magnify bets on the stock market may finally have taken a toll on these products’ huge popularity.
So-called leveraged ETFs, securities that promise to double, or sometimes triple, daily returns of the stock market, or alternatively to let investors make double- or triple-sized bets against market moves, were an immediate hit when they appeared in 2006. They garnered headlines during the financial crisis for their high trading volumes and big daily moves at a time when the stock market was gyrating wildly.
But critics, including regulators, began to suspect the funds’ complicated mechanics were tripping up investors who held onto these securities for periods longer than the single day designated in the funds’ prospectuses. Warnings and new restrictions issued by the Financial Industry Regulatory Authority and the Securities and Exchange Commission, as well as moves by several large brokerage firms to curtail use of the funds by small investors, appear to have crimped their appeal.
Assets in leveraged ETFS, which grew steadily through 2007 and 2008, peaked in the middle of last year at about $35 billion and since then have stalled, and even fallen slightly, according to data from fund researcher Morningstar Inc. The funds held about $30.5 billion in January, the latest date for which data are available.
To be sure, leveraged ETFs remain one of the most popular types of exchange-traded funds, with funds like the $740 million ProShares UltraShort Financials ETF (SKF) trading millions of shares a day. Moreover, the market climate may also have had an effect on the funds’ popularity. Declining volatility could mean fewer chances for traders to profit using funds to bet on sharp stock market moves.
Market returns also affect these and other funds’ assets under management by altering the value of funds’ holdings. It’s difficult to quickly gauge the affect of last year’s bull market on the leveraged funds, however, because some are designed to rise and others to fall when stocks appreciate.
Michael Sapir, chief executive of ProFunds Group, the largest leveraged ETF company, says the funds “continue to prove themselves as valuable tools that can help enhance returns or manage risk in sophisticated portfolios.”
He notes investors poured about $700 million into the funds in the fourth quarter of 2009 and says the funds have attracted another $1 billion in 2010. However, those strong figures contrast with outflows of $2.5 billion from the funds in the third quarter of 2009.
Some traders may have been scared off after realizing how complicated the ins and outs of leveraged ETFs can be, says William Ahmuty, head of U.S. ETF sales and trading at Newedge USA LLC in New York, a brokerage specializing in derivatives. Investors that hold the funds for weeks or months, rather than a single day, can post significant losses even if they correctly guess the direction of the market.
“There is an education process that occurs,” he says. “They’re not suitable for investors on a long-term basis.”
In recent months, fewer investors have been trading leveraged ETFs at TD Ameritrade Holding Corp. (AMTD), says Sandra Motusesky, director of mutual funds and ETFs there. The funds accounted for about 5% of overall trading volume at the discount brokerage in January, down from about 14% in March 2009, she says.
Volume began to slip last summer as stories about leveraged ETFs’ tricky mechanics hit the news and Finra and the SEC issued a joint alert warning of “extra risks for buy and hold investors.” Motusesky says a turning point came late last year when Finra changed rules to make it more difficult for investors to trade leveraged ETFs on margin, that is, using borrowed money to add even more oomph to the funds’ magnified returns. The new rules made leveraged ETFs less attractive to many investors who otherwise might continue to use them, she believes.
“It took the wind out of their sails,” she says.
–(Ian Salisbury is a Getting Personal columnist who writes about personal finance; he covers topics including exchange-traded funds and separately managed accounts. He can be reached at 212-416-2241 or firstname.lastname@example.org.)