As recently reported in the Wall Street Journal, investors are increasingly turning to “volatile and sometimes dangerous” exchange-traded fund (ETF) products known as leveraged, inverse, or leveraged-inverse ETFs. These risky and complicated investment products, with near-record year-to-date flows reaching $16.3 billion, utilize leverage to double or even triple daily returns, or profit off the opposite of the underlying index’s price movement. Also referred to as “geared” ETFs, these leveraged and inverse products are not appropriate for many investors. In certain instances, investors may have been inappropriately steered into these complex products by their financial advisors, and if so, may be able to recover their investment losses through FINRA arbitration.  

The first U.S. ETF, the well-known SPDR S&P 500 ETF Trust (NYSE: SPY), which is benchmarked to the Standard & Poor’s 500 Index, launched in 1993. ETFs tracking other indexes such as the Dow Jones Industrial Average (NYSE: DIA) and the NASDAQ-100 (NASDAQ: QQQ) followed. Since then, both investors and their advisors have demonstrated significant appetite for ETFs. From 2008 until 2019, ETFs experienced exponential growth from about $500 billion to more than $4 trillion in assets under management. This growth is not surprising considering ETFs’ characteristic low costs, liquidity, tax efficiency, and diversification, typically achieved through passive investment in broad market indexes or certain sectors, such as utilities.

Not all ETFs, however, are structured as low-cost, passive investment vehicles. Rather, leveraged, inverse, and leveraged-inverse ETFs represent an extreme pocket of risk, intended for sophisticated traders and not the average buy-and-hold retail investor. Leveraged ETFs, as their name implies, are financial products designed to replicate the performance of an underlying benchmark (typically, an index) by earning multiples (such as 2X or 3X) 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 (such as -1X). Leveraged-inverse ETFs, sometimes referred to as ultra-short funds, combine these two strategies to deliver a multiple return against an index through a bearish short position (such as -2X or -3X).

These funds use financial derivatives and debt in their construction in order to amplify returns. Moreover, these products are only designed to be held for the short-term, typically over the course of a single trading session, and not for longer periods due to the effects of daily rebalancing and compounding. Potential losses can be enhanced during volatile markets because of these characteristics. In recent months, amidst the market turmoil brought about by the COVID-19 pandemic, investors have experienced outsized losses on their positions in certain leveraged, inverse, and leveraged-inverse ETFs. Funds experiencing the greatest declines year-to-date include:

GUSH Direxion Daily S&P Oil & Gas Exploration & Production Bull 2X Shares -97.41%

JDST Direxion Daily Junior Gold Miners Index Bear 2X Shares -94.74%

FNGD MicroSectors FANG+ Index -3X Inverse Leveraged ETN -94.07%

UCO ProShares Ultra Bloomberg Crude Oil -93.54%

ERX Direxion Daily Energy Bull 2X Shares -91.29%

SOXS Direxion Daily Semiconductor Bear 3x Shares -91.25%

TECS Direxion Daily Technology Bear 3X Shares -85.17%

DUST Direxion Daily Gold Miners Index Bear 2X Shares -83.59%

DPST Direxion Daily Regional Banks Bull 3X Shares -79.99%

BNKU MicroSectors U.S. Big Banks Index 3X Leveraged ETN -72.96%

In certain instances, investors may be unsuitably steered into leveraged, inverse, and leveraged-inverse ETFs by their financial advisor, when such risky and complex investments are not necessarily in keeping with those investors’ objectives and risk profiles. Financial advisors are required 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 the customer’s 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) and FINRA Rule 2210 (Communications with the Public). Moreover, firms are required to oversee and supervise the activities of their brokers, and in some cases may run afoul of FINRA Rule 3110 (Supervision), meaning the firm may also be held liable for investment losses.

Investors who have lost money 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.