Kid Dynamite and The Analyst have taken issue with my post about levered ETFs. We’re all in agreement that they shouldn’t be held for a period of longer than 1 day. But their argument is basically that the SEC can’t and shouldn’t protect people from their own stupidity. Here’s the Analyst:
As should be extremely obvious at this point, understanding how these ETF’s work is not rocket science, and it does not take much time/effort to do. If you do a quick google search for “how do leveraged etfs work” returns a large number of posts, most of which answer the question with little ambiguity.
Let me put this as nicely as possible: You have to be self-defeatingly ignorant/naive/lazy to trade these things without learning about them. If you have an internet connection, you’d actually have to go out of your way not to pick-up some basic knowledge about how leveraged ETF’s work just by sheer happenstance. The information is EVERYWHERE, easy to find, and just as easy to understand for anyone capable of opening a brokerage account.
Except, if you go back a month to when KD last wrote about these things, you’ll find him linking to a column by Dave Kansas — the founding editor of thestreet.com, and about as veteran and admired a markets journalist as it’s possible to find. And he got it wrong, as the correction at the bottom of the column attests.
My point here is that if you want to find out how easy and obvious something is, you don’t first look for someone who understands it and then ask them whether understanding it is easy. Instead, you look at a broad audience of people who ought to understand it, and look to see what percentage of them actually do.
And if you look at the people who are investing in TBT, it’s clear that the vast majority of them do not understand how it works. For all that there are prominent disclaimers in the abbreviated summary prospectus about such things, those disclaimers are not preventing people from making long-term investments in a security which should never be held for longer than one day. They’re not working.
What worries me here is that we’re taking rules which apply to stocks and applying them to levered ETFs, even when levered ETFs are very different creatures from stocks. Stocks are permanent long-term stores of value — ownership stakes in something real in the world. Levered ETFs, by contrast, are pretty much guaranteed to go to zero eventually; the only question is how long they will take to get there. That’s not a problem for people who hold them on an intraday basis, as trading vehicles. But they trade on the stock exchange with a stock-like ticker symbol, and they look similar to unlevered ETFs which do things like replicate the S&P 500, and which really are long-term investments. So it’s easy to see where the confusion arises.
What I’m not getting from KD or the Analyst is any good reason why levered ETFs should exist. What purpose do they serve? If you want to make a leveraged bet on a certain asset, you can buy it or short it using borrowed money. These things are obviously harming a lot of people — the investors wielding billions of dollars who are holding them for long periods of times. Who are they benefiting? It seems to me that the cost of leveraged ETFs is greater than the benefit; that’s why I think the SEC should look into them.
It’s one thing allowing people to invest in individual stocks which can be highly risky investments — that’s fine, because there’s a strong social upside to allowing companies to raise capital on the stock market and allowing individuals to buy those stocks. But there’s no such social upside to levered ETFs, and if they disappeared tomorrow, anybody using them the right way could very easily put on the same trades just by using their margin account. So if there’s good reason to believe they’re causing harm, and no reason to believe they’re causing any good, why keep them?