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Are Leveraged ETFs Getting a Bad Rap?

This post is part of a regular series written by ETF Trends editor Tom Lydon, special for CNBC.com.

Leveraged and inverse ETFs have worked exactly as they should since they’ve been in existence, and have helped investors, but in the last year, they’ve been getting a bad rap.

Last month, FINRA issued a warning about leveraged ETFs and stated that they were typically unsuitable for most investors. The Investment Company Institute (ICI) quickly responded and asked FINRA to withdraw its warning because it robs member brokers of their discretion in using the funds.

On Tuesday, FINRA took a step back from its warning and noted that they can be appropriate as part of sophisticated trading strategies by professionals.

But that wasn’t before some major names announced they would ban sales of leveraged ETFs, including Edward Jones, LPL Financial, Ameriprise and UBS. However, these announcements might seem a little self-serving because these companies tend to focus more on asset allocation models — instead of sophisticated hedging strategies.

Counterpoints:

  • Bob Pisani dissects ETFs with Lydon. Watch the full interview

For their part, leveraged and inverse providers such as Direxion, ProShares and Rydex have been very forthcoming about the risks, who they’re for and they’ve also mounted big education campaigns aimed at investors:

- They maximize the daily movements of their underlying index by 200% or 300% in either direction on a daily basis – in an ultra fund, if the index gains 8%, the ETF would gain 16%

- On a daily basis, they work as promised

- For longer holding periods in non-volatile funds, they can also be rebalanced to approximate long-term returns; keep in mind the trading costs, though

- They are not intended for buy-and-hold use; because of daily rebalancing to bring the funds back in line, they tend to stray from their benchmarks over longer periods of time

- This effect is heightened in volatile markets

- Investors who want to use them need to be prepared to actively watch them and understand how they work

- Above all, they are not for everyone — and no one has ever claimed that they are

Disclosures:

Tom Lydon is a board member of Rydex Funds.

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Tom Lydon is the editor of ETF Trends and author of iMoney: Profitable ETF Strategies for Every Investor.

Disclaimer