Morgan Stanley Smith Barney is examining how it sells leveraged exchange-traded funds, and Charles Schwab has posted a warning on its website that the products could exacerbate losses for investors who hold them for more than a day.
The Schwab notice, posted Tuesday, details how trades of both leveraged an inverse ETFs can compound losses if the underlying index moves direction frequently. “While there may be limited occasions where a leveraged or inverse ETF may be useful for some types of investors,” Schwab said, “it is extremely important to understand that, for holding periods longer than a day, these funds may not give you the returns you may be expecting.”
“If the index keeps moving in the same direction every single day,” Schwab explains, “this will result in better than expected returns for the longer period. But any reversals in the index direction will leave a leveraged ETF worse off than would be expected based on its multiple. Because of this phenomenon, investors who plan to hold their investment for longer than a day should be cautious when approaching this type of ETF.”