3X Leveraged ETF’s Create Havoc For The Retail Investor (FAZ, FAS)

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July 20, 2009 10:17am ETF BASIC NEWS NYSE:FAS

leveragedBrenda Wenning, a financial adviser in Newton, Mass., has seen firsthand the damage leveraged exchange-traded funds can wreak in the portfolio of an unsophisticated investor. “A new client came in and had a leveraged ETF in his portfolio. He had an enormous loss, and he just sat with it

,” said Wenning, who launched Wenning Investments LLC in May 2008. “I’m like, ‘Oh, my goodness; you can’t do that.’ They can complement your strategy, but I don’t think they’re intended for retail investors.”

“Wenning says she employs leveraged ETFs – complex instruments that can magnify not only investors’ returns but their risks as well – very selectively, and plans to continue to do so, but does understand regulators’ concerns about the investments. Ian Naismith, a partner and mutual fund manager at Sarasota Capital Strategies in Osprey, Fla., regularly uses leveraged ETFs and leveraged mutual funds, mainly for hedging, but says they’re not right for many retail investors and most advisers. They’re a valuable tool if used prudently, but most advisors and retail investors won’t monitor them as diligently as they should, he said,” Reports the WSJ.

“Before you know it, it’s a nasty little downward movement in the market, and if they’re not paying attention, it can have a severe effect on the portfolio,” Naismith said. “They’re only right for the adviser who looks at these items on a daily basis.” At various conferences, a lot of advisers tell Naismith “they got beat up on these things and they don’t understand why,” he said. Nevertheless, that’s the fault of the adviser, not the ETFs, which are a useful tool in the right hands, he said,” WSJ Reports.

“ETFs trade daily on exchanges like stocks. Leveraged ETFs, sometimes labeled “ultra” or “2X,” use futures or derivatives to multiply the daily returns of an index, sometimes striving to double or triple the return. Lately they’ve come under the scrutiny of regulators. Whether that will put a chill on their use remains to be seen. The Financial Industry Regulatory Authority reminded brokers and registered investment advisers in a June notice about their fiduciary duties when selling ETFs that offer leverage, are designed to perform inversely to the index or benchmark they track, or both. Finra reminded brokers and advisers that the instruments are complex and typically unsuitable for retail investors who plan to hold them longer than one trading session,” WSJ Reports.  SEE OUR PREVIOUS FINRA STORY

Full Story: HERE


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