Why are Leverages and Inverse ETFs so Dangerous?

Leveraged exchange traded funds (ETFs) are designed to provide investors with an amplified return of the underlying index. For example, the popular ProShares Ultra S&P500 (NYSE: SSO) “seeks daily investment results, before fees and expenses, that correspond to two times the daily performance of the S&P 500.(see footnote 1 below)” However, there are significant risks associated with leveraged ETF investments and they are not suitable for many investors.

At the outset, it should be noted that the leveraged ETF return (2x for instance) is muted by fees and expenses (often around 1%) so the upside potential is less than the investor may perceive.

Next, and importantly, the ETFs only seek to provide a multiple of daily returns. Not two days, not two months or two years, just the one day returns. As a result, and due to compounding, the leveraged ETF returns of more than one day vary from the return of the underlying index. As noted in FINRA’s Regulatory Notice 09-31 (see footnote 2 below) between December 1, 2008 and April 30, 2009 for example:

“The Dow Jones U.S. Oil & Gas Index gained 2 percent, while an ETF seeking to deliver twice the index’s daily return fell 6 percent and the related ETF seeking to deliver twice the inverse of the index’s daily return fell 26 percent” [emphasis added].

These differing returns are amplified with increased market volatility. FINRA requires brokerage firms to analyze and understand the ETFs and to determine whether they are suitable for any investors. The firm must then determine if the product is suitable for the investor that it is being recommended to. FINRA definitively states “[w]hile the customer-specific suitability analysis depends on the investor’s particular circumstances, inverse and leveraged ETFs typically are not suitable for retail investors who plan to hold them for more than one trading session, particularly in volatile markets.”

If an investor has substantial losses as the result of a broker placing them in a leveraged or inverse ETF, they may have a securities arbitration claim against the broker and/or their brokerage firm for unsuitability among other claims. Each situation is unique and only a qualified securities attorney can evaluate the investor’s claim.