Regulators are re-evaluating complex exchange trade fund tools that allow sophisticated traders to better weave in and out of markets to capitalize on more volatile conditions.
The Securities and Exchange Commission will vote Wednesday on a rule change to ease the approval of leveraged and inverse ETFs, which incorporate derivatives to boost gains in both up and down markets, Bloomberg reports. The final change could eliminate the need for issuers to seek a special order from the SEC to allow these types of funds to operate, providing a more streamlined vetting process available to other standard products.
“I would encourage investors to really understand what they are getting when they are purchasing such products, but leveling the playing field for all issuers is certainly in my mind a positive thing,” Jillian DelSignore, principal at Lakefront Advisory, told Bloomberg.
While leveraged and inverse ETFS have helped investors capitalize on wild market swings, with the category attracting $9.7 billion and on pace for its biggest annual inflows, some warn about the risks of these ETFs that use derivatives, especially to retail investors whom don't fully understand the products.
“Leveraged and inverse funds pose substantial risks to investors, but if the SEC is going to allow them, there should be consistency in the product approval process - which this proposal would help achieve,” Nate Geraci, president of the ETF Store, told Bloomberg.
The Leveraged & Inverse Space
ProShares and Direxion, with $44.8 billion and $15.5 billion in ETF assets under management, respectively, dominate the space, but they could see increased competition under the SEC proposal as new issuers enter the market.
More traders are looking into leveraged and inverse products, which now comprise 13% of all ETF trading but make up only around 1% of total assets, as many try to capitalize on the wide swings this year.
“These products have found their natural investment base, people who know them, understand them and can use them well,” Ben Johnson, Morningstar’s global director of ETF research, told Bloomberg.
However, the new SEC ruling could tack on additional reporting requirements, which could discourage brokerages from offering these types of products. Brokerage firms would have to determine if clients fully understand the risks involved with these more complex ETF strategies and formally approve requests to purchase them, which could translate to more information about the investor’s experience, employment status, annual income and net worth.
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