Investor Alert - Leveraged, Inverse, and Leveraged-Inverse ETFs May Facilitate Outsized Losses
Investors in leveraged, inverse, and leveraged-inverse exchange traded funds may be able to recover their investment losses, provided the investment was recommended by a financial advisor without a reasonable basis, or if the investment was sold through a misleading sales presentation. Over the past quarter-century, investors have been increasingly investing in financial products beyond the traditional universe of stocks, bonds, and bank-deposit products. One such non-traditional product is the well-known exchange traded fund (ETF).
In 1993, the first U.S. ETF was launched, which tracks the S&P 500 Index. Since then, both investors and their advisors have demonstrated significant appetite for ETFs. In fact, since the Great Recession of 2008 until 2019, ETFs have experienced exponential growth from about $500 billion to more than $4 trillion in assets under management. This growth is not surprising when considering the benefits offered by ETFs, including their characteristic low costs, liquidity, tax efficiency, and diversification. In many cases, ETFs offer an avenue allowing for passive investment in broad market indices, as many ETFs are designed to track the performance of an underlying benchmark, usually an index such as the S&P 500 or, in some cases, a certain sector such as utilities.
Not all ETFs, however, are structured as low-cost, passive investment vehicles. Rather, there exists an extreme pocket of risk within the ETF universe, namely leveraged, inverse, and leveraged-inverse ETFs. Leveraged ETFs, as their name implies, are financial products designed to replicate the performance of an underlying benchmark (typically, an index) by earning multiples on the underlying index. And inverse ETFs are bearish financial instruments, structured to replicate a short position by seeking to deliver the opposite performance of the underlying benchmark. Leveraged-inverse ETFs, sometimes referred to as ultra-short funds, combine these two strategies and seek to deliver a multiple return against an index through a bearish short position.
In certain instances, investors may be inappropriately steered into leveraged-inverse ETFs by their financial advisors, when such risky and complex investments are not necessarily in keeping with those investors’ objectives and risk profiles. To begin, leveraged-inverse ETFs rely on debt and the use of complicated and risky financial derivatives in their construction, in order to seek multiples on the returns of an underlying index. Moreover, these leveraged-inverse ETFs are only designed to be held for the short-term, typically less than a trading session. Accordingly, many industry insiders concede that these products are intended for sophisticated traders, rather than the average buy-and-hold retail investor.
In recent months, amidst the market turmoil brought about by the COVID-19 pandemic, many investors have experienced outsized losses on their positions in certain leveraged, inverse, and leveraged-inverse ETFs. Notably, the following ETFs (and exchange traded notes, or ETNs) have suffered extremely poor performance:
GUSH Direxion Daily S&P Oil & Gas Exploration & Production Bull 2X Shares -98.15%
JDST Direxion Daily Junior Gold Miners Index Bear 2X Shares -95.02%
UCO ProShares Ultra Bloomberg Crude Oil -94.26%
ERX Direxion Daily Energy Bull 2X Shares -93.20%
FNGD MicroSectors FANG+ Index -3X Inverse Leveraged ETN -91.12%
DPST Direxion Daily Regional Banks Bull 3X Shares -88.47%
DUST Direxion Daily Gold Miners Index Bear 2X Shares -86.45%
SOXS Direxion Daily Semiconductor Bear 3x Shares -83.18%
BNKU MicroSectors U.S. Big Banks Index 3X Leveraged ETN -83.08%
TECS Direxion Daily Technology Bear 3X Shares -79.82%
Financial advisors are legally obligated and have an affirmative duty to inform their clients of the risks involved with investment products. Advisors also should not place their customers in investments that are unsuitable based on their age, risk tolerance, investment objectives, and other factors. Failure to handle customers in a forthright manner may violate various industry rules such as FINRA Rule 2111 (Suitability), FINRA Rule 2210 (Communications with the Public), and FINRA Rule 3110 (Supervision). Moreover, firms are required to oversee and supervise the activities of their brokers, and in instances where a financial advisor unsuitably recommends risky and complicated leveraged-inverse ETFs to clients, then the brokerage firm may be held liable for failure to supervise potential misconduct.
Investors who have suffered losses in risky and complex leveraged, inverse, or leveraged-inverse ETFs may be able to recover their losses through FINRA arbitration, or in some instances, litigation. The attorneys at Giarrusso Law Group LLC have extensive experience representing investors unsuitably allocated to risky and complicated investment products, including leveraged-inverse ETFs. Investors are invited to contact our office by telephone at (201) 771-1115 or by email at info@gialawgroup.com for a no-cost, confidential consultation to learn more about their legal rights.