Leveraged and inverse single-stock exchange traded funds are the latest complex investment products to be given the green light by regulators, but the Securities and Exchange Commission has issued a warning ahead of the new tools’ approaching launch.
Lori Schock, director of the Securities and Exchange Commission’s office of investor education and advocacy, cautioned that the new leveraged and inverse single-stock fund strategies are even riskier than existing leveraged and inverse ETFs, which provide daily amplified losses and gains on the securities they track, the Financial Times reported.
Schock stated that in addition to the risks posed by other leveraged products, especially during volatile market conditions, the single-stock versions also lacked the benefits of diversification given their targeted focus.
“Investors holding these funds will experience even greater volatility and risk than investors who hold the underlying stock itself,” Schock said.
SEC commissioner Caroline Crenshaw revealed that while regulatory changes adopted in 2019 helped streamline the approval process for new ETFs to hit the markets, policymakers did not anticipate the updated rules would open the way for leveraged single-stock ETFs.
“I am disappointed that, months after [former commissioner Allison] Lee and I called for improvements to the rules for complex exchange traded products, we have not updated our regulatory framework to better address the risks these products pose to investors and the markets,” Crenshaw said.
These geared ETF products can provide two or three times the daily returns or the opposite daily returns of the underlying benchmark. However, traders should note that these leveraged or inverse products typically reset daily, so long-term investors could suffer magnified losses beyond the 2x or 3x when the underlying securities lose their value in extended trades.
“Investors should be aware that if they were to hold these funds for longer than a day, the performance of these funds may differ significantly from the levered and/or inverse performance of the underlying stock during the same period of time,” Schock added.
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