Synthetic ETFs are complex, very risky, require active analysis and monitoring and are not suitable for the average long-term "buy and hold" retail investor. A synthetic ETF can be a basket of investments involving stocks, bonds, commodities, currencies, options, swap contracts, swaptions, commodities futures contracts and other derivative instruments that track the performance of an underlying Index or market sector. The synthetic ETFs du jour fall in three categories: Leveraged ETFs, Inverse ETFs and Leveraged Inverse ETFs.
Leveraged ETFs use financial derivatives and debt to multiply the returns of an underlying Index. The managers of Leveraged ETFs attempt to maintain a constant amount of leverage throughout the investment at a 2:1 or 3:1 ratio. The manager's goal is to enhance the returns; if the underlying index returns 1%, the fund should theoretically return 2%. However, the leverage ratio increases the losses in a similar manner, a drop of 1% in the index would result in a 2% loss in the ETF managed on a 2:1 leverage ratio.
Inverse ETFs, also called "short" funds, use various financial derivatives to profit from a decline in the value of an underlying index. Investing in an Inverse ETF is similar to holding various short positions in order to profit from falling prices. An Inverse ETF that tracks a particular index seeks to deliver the inverse of the performance of that index. Inverse ETFs are often marketed as a way for investors to hedge their exposure in rapidly moving markets.
Leveraged Inverse ETFs, also called "ultra short" funds, seek to deliver return that is a multiple of the inverse performance of the underlying index. For example, a 2:1 leveraged inverse ETF attracts a particular index seeks to deliver double the inverse of that index's performance.
Leveraged and Inverse ETFs are intended as short-term investments. They are not meant to be held for longer periods of time. If held for more than one day, their performance can differ significantly from their stated objectives due to liquidity and other management performance issues. Leveraged and Inverse ETFs have also become the new tool of brokers seeking to turn clients' accounts to maximize their commissions. Leveraged inverse ETFs also require daily resets internally that make them less tax efficient than traditional ETFs.
Synthetic ETFs are unsuitable for most retail investors. The mantra for the long term "buy and hold" investor should be ET-Synthetic ETF-go home! If you have suffered losses investing in any Synthetic ETF then you should call the Law Offices of Robert Wayne Pearce P.A. for a free consultation.
The most important of investors' rights is the right to be informed! This Investors' Rights blog post is by the Law Offices of Robert Wayne Pearce, P.A., located in Boca Raton, Florida. For over 30 years, Attorney Pearce has tried, arbitrated, and mediated hundreds of disputes involving complex securities, commodities and investment law issues. The lawyers at our law firm are devoted to protecting investors' rights throughout the United States and internationally! Please visit our website, www.secatty.com, post a comment, call (800) 732-2889, or email Mr. Pearce at email@example.com for answers to any of your questions about this blog post and/or any related matter.