More reasons to worry about ETFs

Good post on Zero Hedge about leveraged ETFs with two major conclusions: 1. They are being used by retail investors; and 2. At least some of these investors are using them as buy and hold investments as if they were index funds, which they most certainly aren’t- this makes me wonder if they are being mis-sold.

http://www.zerohedge.com/news/leveraged-etfs-why-do-we-have-them

It is worth quoting a couple of conclusions:

1. ‘If investors hold the leveraged ETF for extended periods (and it seems that this is more common than I previously thought) their returns may not be what they expect. The total return of a leveraged ETF may differ significantly from what a typical investor might expect based on the movement of the underlying asset.’

You do not have double the return over the period, you get double the daily return, which can be very different. If you don’t immediately understand that point and you are invested in leveraged or inverse ETFs you are playing with fire.

2. ‘Ignoring the costs, which are higher than other investments (leverage has a cost as does the more frequent rebalancing).’

So much for ETFs as low cost transparent investments.

Comments

[Rix]

You seem to have taken an article which provides a reasoned argument against leveraged ETFs and applied the argument to all ETFs.

You gave a more detailed critique of ETFs on 16/09/11 but even that left me uncertain whether ALL ETFs (ie. including those which hold and track the underlying asset rather than messing about with derivatives) should be avoided.

Any chance you could clarify?

[prohyp]

Thanks for that valuable insight Terry.

Some time ago, before gold took off I bought ETFs in that commodity believing that it tracked the price. When it became apparent there was a considerable discrepancy between the value of my ETFs and the price of gold I unloaded them gradually. Fortunately, I made a worthwhile profit.