The ETF Gold Standard

From Markets Media Magazine's November/December 2009 issue:

Regulators spooked by the volatility of leveraged ETFs are reining in the popular vehicles.

The Financial Industry Regulatory Authority is implementing increased margin requirements for leveraged ETFs and uncovered options overlying leveraged ETFs. Finra says higher margin levels are necessary in view of the volatility of leveraged ETFs compared to their nonleveraged counterparts.

Effective Dec. 1, margin requirements will increase by a percentage commensurate with the leverage of the ETF. For example, the current margin requirement for any long ETF is 25 percent of the market value; thus, for an ETF with 200 percent leverage, the margin requirement would double to 50 percent. Asset managers believe the higher margin requirements are justified because of the risks the products pose for retail investors.

“There's nothing inherently wrong with leveraged ETFs, but they may not work well for investors with long time horizons, which make up the vast majority of investors,” says Tim Clift, chief investment officer at FundQuest. “They're most appropriate for single day trading and hedging strategies.

FundQuest doesn't offer leveraged ETFs. Leveraged ETFs are designed to generate multiples (e.g., 200 percent or greater) of the performance of the underlying index or benchmark they track. Some leveraged ETFs are inverse or short funds, meaning they seek to deliver the opposite of the performance of the index or benchmark.

Leveraged ETFs may include among their holdings derivatives such as options, futures or swaps. They are inherently more volatile than their underlying benchmark or index.

This article in its entirety includes the following commentary:

The new curbs are ultimately in the best interest of the market, says George Simon, chair of the Securities, Commodities and Exchange Regulation practice at law firm Foley & Lardner.

“The most significant aspect of the rule is that day traders will no longer be able to get 4-to-1 buying power on leveraged ETFs,” says Simon. “Instead, for an ETF with 200 percent leverage, the buying power would be reduced to 2-to-1 and for a 300 percent leveraged product, 1.33 to one. This will significantly curtail the interday trading of these products.”

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Posted on Nov. 30, 2009