Investors Fled out of Leveraged ETFs at Exactly the Wrong Time

Saturday's Wall Street Journal has an article titled "Investors Pull $2.1 Billion out of Leveraged ETFs." What's going on?

The article says assets in ETFs increased by $20.1 billion in August but declined in only two asset classes: leveraged and inverse ETFs.

The article goes on to discuss how the Securities and Exchange Commission and the Financial Industry Regulatory Authority have issued warnings that leveraged ETFs may not be suitable for all investors. These warnings have been especially targeted at retail investors.

The SEC and FINRA, however, aren't the only ones pointing fingers at leveraged ETFs. Let's see how many ambulance chasers have initiated class action lawsuits against the ProShares company:

• Gilman and Pastor LLP Files Class Action Lawsuit Against ProShares' UltraShort MSCI Emerging Markets ProShares Fund on Behalf of UltraShort Fund Investors
• Labaton Sucharow LLP Files Class Action Lawsuit Against ProShares' UltraShort Real Estate ProShares Fund -- SRS
• Law Offices of Howard G. Smith Announces Class Action Lawsuit Against Proshares’ UltraShort Financials ProShares Fund
• Law Offices of Howard G. Smith Announces Class Action Lawsuit Against ProShares' UltraShort Real Estate ProShares Fund.
• Shalov Stone Bonner & Rocco LLP Announces Class Action Against ProShares' UltraShort MSCI Emerging Markets Fund - EEV
• BERNSTEIN LIEBHARD LLP FILES CLASS ACTION LAWSUIT ON BEHALF OF INVESTORS IN PROSHARES ULTRASHORT REAL ESTATE PROSHARES FUND (SYMBOL: SRS)

This list is the result of a quick search on Google and doesn't include any litigation against the folks who bring you the Direxion 3X leveraged ETFs. There are probably more lawsuits in the works out there.

With lawyers and government agencies ganging up on the providers of leveraged ETFs it's no wonder that many investors are pulling back from using these funds.

Unfortunately, this has been exactly the wrong time. As we discussed in earlier posts (here, here and here), 2X leveraged ETFs work quite well in strongly trending markets. Since the March lows, we have indeed had strongly trending markets in the bullish direction and the benefits have accrued to almost every sector. This scenario is the best time to be in leveraged long ETFs yet the frenzy around the warnings and lawsuits has driven many investors away from these vehicles.

As we have written before (here and here), taking a few simple precautions and riding a trend can lead to superior results using the 2X leveraged ETFs. It is unfortunate that "educating investors" doesn't extend beyond scare tactics.

Disclosure: Long ROM and USD

Comments

[Gary Gallo:]

They would rather have had you buy the now worthless GM.

Sep 13 06:42 AM

[Brian O'Fla...:]

in the long run, the value of all leveraged ETFs will go to zero. They are never an appropriate investment for anybody with a holding period longer than 1 day.

Sep 13 08:34 AM

[Baboon:]

If this is the case then one needs just to take short positions of their reverse counterparts and avoid using excessively high leverage.


On Sep 13 08:34 AM Brian O'Flanagan wrote:

> in the long run, the value of all leveraged ETFs will go to zero.
> They are never an appropriate investment for anybody with a holding
> period longer than 1 day.

Sep 13 09:25 AM

[optionsgirl:]

I don't trust the SEC and CFTC. Who knows what they will do to hamstring the etf's further (both equity and commodity based).

You'd think they'd leave the retail investors to draw their own conclusions and purchase what they see fit.

In the back of my mind, I will always remember that when the banks melted down last year, the SEC responded by disallowing short selling and widening the list of companies to include their favorite sons.
Anything is possible when it comes to governmental control.

Sep 13 09:44 AM

[Analyste de...:]

This is nonsense, propaganda from the managers, shills, salesguys for NON-leveraged products. And the ignorant.

Agree with the author's premise that 'we have had a strongly trending bull market' and leveraged Bullish ETFs were an excellent tool for savvy investors in the past 4 months. However, practically ALL the money in leveraged ETFs is INSTITUTIONAL - professionals.

Another way to see the big players bailing on these 2x-3x bull ETFs? The great Bull run may be slow, halting, or reversing : is this the point or pivot, the moment to reduce risk? Time will tell if that's correct, premature or simply wrong.

The next wave of deleveraging will probably witness 'bank holiday' restrictions, and wouldn't you imagine leveraged short ETFs will be closed to retail investors then?


On Sep 13 08:34 AM Brian O'Flanagan wrote:

> in the long run, the value of all leveraged ETFs will go to zero.
> They are never an appropriate investment for anybody with a holding
> period longer than 1 day.

Sep 13 12:28 PM

[lo maximo:]

Brokers discourage the use of leveraged ETF's...they l advise to get out... How many times have I promised myself I'd never again get conned into selling UYG...and then sold, only to see it go up again. The fact that it is not marginable is another problem. It's as though no one wants the retail investor to make a living. For some reason, I
have a very good feeling about Michael Johnson....he makes so much sense...his advise is excellent in my view.

Sep 13 06:54 PM

[Whitehawk:]

These products are being killed by the likes of Jim Cramer, et al. You'd think these folks would be free market capitalists, but they are not - they are establishment shills that, like our crony socialist government, try to control what people buy and sell, not to mention prices and wages, and the redistribution pipeline. The products will get killed and the lawyers will make a killing.

Sep 14 01:04 PM

[CARL IN NC:]

I'm up 35% in a leveraged ETF in a very short time. Obviously, these are not something you hold forever or get too attached to, or put all your money in. Just protect yourself with a trailing stop loss and relax. When it sells, sit back and wait for a dip to buy back in.


On Sep 13 08:34 AM Brian O'Flanagan wrote:

> in the long run, the value of all leveraged ETFs will go to zero.
> They are never an appropriate investment for anybody with a holding
> period longer than 1 day.

Sep 14 04:59 PM

[Brian O'Fla...:]

man, 6 thumbs down on my comment? Tough crowd. I still leveraged ETFs are toxic.

Sep 17 07:36 PM

[Greg-In-Mid-Mo:]

I'm not an expert but I do know that all ETFs trend down over time so they're not meant for the long haul. But I'm not a day trader either. I usually trade them on major swings every 3-5 days (currently on a 10 day run, thank you very much) and do just fine. Can a pro do a lot better? Absolutely. Am I happy with my 2-3 points per week average? You bet your retirement.

Sep 18 02:13 PM

[Jonathan Swift:]

Anyone who bought $10K of BGU (2X leveraged high cap ETF) in March is sitting on about $30K profit now about 6 months later. I did that with about $15K. Six months is just a little bit longer than 1 day.


On Sep 13 08:34 AM Brian O'Flanagan wrote:

> in the long run, the value of all leveraged ETFs will go to zero.
> They are never an appropriate investment for anybody with a holding
> period longer than 1 day.

Sep 21 06:08 PM

[six:]

The drive to regulate leveraged ETFs is all about the short funds not the long funds. The Gov is trying deparately to control the market. They do want to see a repeat of last winter/spring of 08 market declines. The Gov has done EVERYTHING within it's grasp to get control of the market. This rally has been a complete farce and now the Gov wants to curtail short selling to keep the market from tanking too fast. Leveraged ETFs are fine, never been marketed to the average investor. This is bunch of crap brought to you by the Gov.

Oct 02 11:27 AM

[Peter Cooper:]

Could not agree more, I have gone into the scale of this opportunity in more detail on my website, which also has some interesting comments from those who disagree:
arabianmoney.net/2009/.../

Nov 02 01:31 AM