Certain ETFs May Not be Appropriate for Long-term Investors
Exchange-traded funds (ETFs) have grown increasingly popular with retail investors during the last decade. Securities regulators are concerned that investors may not understand how these complex investment products work or the potential risks they may face.
The Pennsylvania Securities Commission (PSC) today cautioned investors to make sure they understand ETFs before they invest and consider whether these investments are right for them. The PSC’s ETF advisory is available at www.psc.state.pa.us.
“As with any investment, investors should know what they are investing in. They should understand the risks, costs and tax consequences before investing in ETFs. Check under the hood,” said Chairman Robert Lam.
Exchange-traded funds are baskets of investments such as stocks, bonds, commodities, currencies, options, swaps, futures contracts and other derivative instruments that are created to mimic the performance of an underlying index or sector.
While ETFs are often compared to mutual funds and marketed to investors seeking safe, stable investments, not all ETFs are the same. The PSC’s advisory notes that some traditional ETFs may be appropriate for long-term holders, but others, including exotic leveraged and inverse ETFs, may require daily monitoring.
Two years ago, the association of state securities regulators, the North American Securities Administrators Association (NASAA), identified unsuitable ETF sales as a top threat to Main Street investors. “We continue to actively scrutinize a variety of issues related to ETF sales practices, such as point of sale disclosures, and the suitability of these products, particularly inverse and leveraged ETFs for long-term investors,” Commissioner Tom Michlovic said.
The ETF advisory outlines several risks associated with ETFs, including:
- Liquidation. The number of ETFs that are shut down or liquidated, while previously a rare occurrence, is on the rise, up 500 percent in each of the last three years over 2007 levels (which equates to one ETF each week).
- Fees. Leveraged and inverse ETFs must be traded all the time, therefore incurring substantial brokerage fees and commissions.
- Tax Consequences. Leveraged and inverse ETFs may be less tax efficient due to daily resets that can result in significant short-term capital gains that may not be offset by a loss.
“Before you invest, you should contact the PSC to determine if the ETF and the person recommending the investment are properly registered with Pennsylvania,” Commissioner Steven Irwin said. Contact the PSC at 1-800-600-0007.
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