Sponsored Research by HBP Makes Some Good Points…
Horizons BetaPro, the sole provider of leveraged and inverse ETFs in Canada, sponsored a 31-page detailed analysis by independent funds analyst Dan Hallett, published on September 9, 2009.
FAIR Canada staff consulted Mr. Hallett in our original research on ETFs. He is a well-regarded analyst who has remained consistent in his views. He states up front that his research was sponsored and addresses head-on the possibility of a conflict of interest. We have the utmost respect for his professionalism.
We agree with many of the statements and explanations in Mr. Hallett’s report. He provides a good explanation of the mathematics of leveraged ETFs, and their record of tracking daily returns. Compared to “naked” shorting or other uses of leverage, leveraged and inverse ETFs offer certain advantages – including limiting potential losses to 100% of the original investment.
… But We Disagree with Some of the Conclusions.
We agree with Mr. Hallett’s main conclusion that BetaPro double ETFs “should normally be held for shorter periods of time.”
However, we do not agree with Mr. Hallett’s claim that “many BetaPro ETFs have closely tracked holding period return benchmarks over longer periods.” We do not believe it is “cherry-picking bad results” to point out that 5 of the 9 pairs of HBP leveraged funds in existence for a year or more lost money for the year ended March – and June. Mr. Hallett acknowledges that “ultimately, underlying index volatility will determine the appropriateness of any holding period.” Unfortunately, investors have no way of knowing in advance what the upcoming volatility or return path will be.
Several studies of U.S. and Canadian leveraged ETFs have demonstrated that the impact of daily rebalancing, leverage, and high fees make it highly unlikely that these vehicles can match their benchmark performance over time. See our earlier reports on leveraged ETFs from May and July, 2009.
Advertising is a Huge Issue
Mr. Hallett asserts that leveraged and inverse ETFs do not require “cigarette style warnings,” that its prospectus disclosure and education campaigns are sufficient to bring investors up to speed. Mr. Hallett’s report does not address the issue of Horizon BetaPro’s advertising at all – and we believe that advertising is the crucial issue.
It is widely acknowledged that most investors do not rely on prospectuses – in fact, the great majority do not read them at all. Despite recent improvements (including front-page disclosure about daily rebalancing), most such prospectuses are still tedious and unclear. Investors have to plow through pages and pages of risk factors to understand the impact.
Like many financial service products, leveraged ETFs are sold, not purchased – through targeted advertising in the business media.
Product Sponsors – and Regulators – Have a Duty to Protect Investors. Mr. Hallett concludes that “expecting regulators and product sponsors to save investors from themselves is beyond the duty owed to investors.” We strongly disagree. Product sponsors do not discharge their responsibility through education and disclosure if their products cannot be easily understood and can be easily misused by investors. An important duty of regulators is to protect investors from misleading disclosure, whether through advertising, biased advice, or other reasons.
The Solution: Advertising Warnings, More Knowledgeable Use. In our previous reports, we proposed specific solutions to the problems of individual investor misperceptions of leveraged and inverse ETFs. They include:
- Plain language prospectus disclosure that leveraged ETFs and other derivatives-based products are day trading products for sophisticated investors, not intended to be held for longer periods.
- “Cigarette style” warnings on all advertising and on web sites.
- Risk disclosure and acknowledgment requirements, including “options-style” documents that all individual investors must sign in advance.
- “Pop-up warnings” or other similar protections for the large and growing ranks of do-it-yourself investors at the online investment dealers.
- A comprehensive study by regulators about leveraged ETFs and other derivatives-based products targeted at individual investors.
