The Securities and Exchange Commission and the Financial Industry Regulatory Authority issued a joint investor alert today warning investors about the risks associated with leveraged and inverse exchange-traded funds.

Leveraged ETFs are funds that seek to deliver multiples of the performance of the index or benchmark that they track. Inverse ETFs, also called short funds, try to deliver the opposite of the performance of the index or benchmark to which they are pegged. The trouble with these products, says FINRA, is that they reset daily. Over longer periods, their performance can differ significantly from the performance of the related index.

“These products are complex and can be confusing,” according to the joint statement from the regulators. “Investors should consider seeking the advice of an investment professional who understands these products, can explain whether or how they fit with the individual investor’s objectives, and who is willing to monitor the specialized ETF’s performance for his or her customers.” 

Between Dec. 1, 2008 and April 30, 2009, for instance, a leveraged ETF that aimed to deliver three times the daily return of the Russell 1000 Financial Services Index actually fell 53%, even as the index gained 8%. The difference was caused by the compounded effect of daily resets during a volatile period. A leveraged inverse ETF that sought to get three times the inverse of the Russell 1000 Financial Services Index’s daily return over the same five-month period actually dropped by 90%.   

Investors should consider leveraged and inverse ETFs only if they are confident that the product can help meet their investment goals, and they are very comfortable with the risks associated with the products, the regulators said.

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