If you owned an inverse ETF that, for example, guaranteed you twice the inverse of the S&P, you might think you would be down 2.6 percent. But the ProShares UltraShort S&P 500, which guaranteed you twice the inverse of the S&P 500, was down 9.6 percent.
What happened? Just what the funds advertised: They only guarantee you the return on a daily basis. Once you’re past that, the returns will vary.
Because of this, these types of investments should only be used by sophisticated investors who understand what the funds are promising.
And that’s why the SEC is looking into this. Regulators want to make sure no one is surprised.
Past the suitability issue, I have doubts that regulating them out of existence is the right way to go.
First, they are a tiny part of the market. ETFs are a $2 trillion market. Leveraged and inverse ETFs probably account for $30 billion of that, less than 2 percent.
Second, for the most part these instruments consist of a pile of cash and a swap agreement with a counterparty, usually a big bank. The funds go to the bank and say, “If the S&P is up 1 percent, you will pay us 2 percent today. If the S&P is down 1 percent, we will pay you 2 percent.” It’s a swap agreement that is collateralized. Money changes hands.