Sell Block: The 3 Most Dangerous ETFs
If the FDA can protect consumers against poisonous food and drugs, then certainly the SEC can protect investors from poisonous financial products. Unfortunately, though, that hasn’t been the case, especially when it comes to highly leveraged exchange-traded funds. But Cramer has promised to crusade against them so Mad Money viewers would know just how toxic they really are.
The problem with these ETFs is that they don’t operate the way you’d expect. One would assume that an ultra-short fund focused on the financial sector would have generated big returns during the credit crisis, but that wasn’t a given. Such a fund would offer double or triple the return of the underlying index, but only on a daily basis. Each day the fund would reset, meaning that investors started from scratch, and any volatility would eat into their returns.
This is exactly how both the Direxion Daily Financial Bull 3X Shares and Direxion Daily Financial Bear 3X Shares worked, though the former was an ultra-long fund rather than short. These two tied for third most dangerous ETF, on a list of 10 compiled by TheStreet.com’s Don Dion. Their prices sunk so low, even though financials had been a leader in the rally since early March, that they had to do a reverse split. So even playing a long and a short ETF on the same sector didn’t guarantee that you’d see profits.
Number two on the list of worst ETFs was one that Cramer warned against just two short weeks ago: the US Natural Gas Fund . This fund has “done nothing,” Cramer said, even though nat gas has jumped to a seven-week high. Why? Because the UNG doesn’t buy natural gas, it buys the futures. And each month it rolls over its contracts, selling the old and buying the new. The fund loses money anytime the upcoming month’s futures cost more than the previous month.
The other problem with the UNG is that it stopped issuing new shares, which caused it to trade at a premium to its net-asset value. That premium disappeared as soon as the ETF began to issue new shares, and that’s why it missed the latest natural-gas rally. Cramer urged viewers to stay away from the UNG, directing them instead to buy stocks like Apache , Linn Energy , Anadarko Petroleum , XTO Energy and EQT .
Beyond the troubles that come with all ultra-short ETFs, Cramer didn’t like the DTO’s potential for regulatory crackdown. The fund tracks a basket of futures contracts to bet against oil prices, and regulators might decide to increase position limits or impose restrictions on the number of futures contracts a fund can own. Also, the Financial Industry Regulatory Authority, an independent regulator, announced it would up the margin requirements for ETFs on Dec. 1. Any of these initiatives would hurt the DTO.
There’s another problem here, too. The DTO has a twin, so to speak, on the long side, the PowerShares DB Crude Oil Double Long ETN . But the fund’s managers shut down the DXO earlier this month after getting so big that it bumped up against regulatory limits.
“When one half of the pair goes down,” Cramer said, “I’d start worrying about the other half.”
The bottom line here is that there are a lot of bad ETFs out there – “toxic financial products that could blow up in your face,” Cramer said – and now you know the worst of them: the FAS and FAZ, the UNG and the DTO.
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