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A New SEC Proposal Would Open the Door for More Leveraged ETFs

We still think they are a uniquely confusing and unsuitable investment for most investors.

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A new SEC proposal could lead to a proliferation of an exotic type of exchange-traded fund: the leveraged ETF. Right now, only two fund companies offer these products--ProShares and Direxion--but that could change if the proposed rule is adopted. Fortunately for investors, it would also add safeguards to ensure that investors who purchase them have been evaluated for suitability of the product. These are confusing products with risks that investors do not usually understand, and we think if the SEC permits more of them, investors should demonstrate sufficient familiarity and understanding before making a purchase. We do appreciate the compromise the SEC is making--leveling the playing field by allowing competition in the product space and simultaneously adding safeguards so that retail investors, even in self-directed brokerage accounts, have to jump through some hoops before purchasing these products.

As we warned in 2016 and even earlier in 2009, it is hard to overstate the risks of owning leveraged and inverse exchange-traded funds. These funds are designed for a one-day holding period, a horizon over which price movements are unpredictable. In general, leveraged ETFs amplify those movements. Over holding periods longer than one day, the funds’ performance can diverge sharply from what many investors might expect.

Jasmin Sethi does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.