Securities Lawyers Blog
The attorneys at Gana Weinstein LLP have been receiving investor complaints concerning advisors recommending what the advisors call hedge or bear market products to the investors causing large investor losses. These complaints often involve large holdings in derivative, leveraged, or inverse investment vehicles that are extraordinarily risky. Further, such investments are not bear market investments or account protection investments. These investments are usually leveraged bets against general market indices that have long time history of growth.
Two favorite advisor bets against the general market are leveraged ETFs and VIX related investments. An ETF is a registered investment trust whose shares represent an interest in a portfolio of securities that track an underlying benchmark or index. Leveraged ETFs differ from other ETFs in that they seek to return a multiple of the performance of the underlying index or benchmark or the inverse or opposite performance.
To accomplish their objectives non-traditional and leveraged ETFs typically contain very complex investment products, including interest rate swap agreements, futures contracts, and other derivative instruments. Moreover, leveraged or non-traditional ETFs are designed to achieve their stated objectives only over the course of one trading session, i.e., in one day. This is because between trading sessions the fund manager for the ETF generally will rebalance the fund’s holdings in order to meet the fund’s objectives and is known as the “daily reset.” As a result of the daily reset the correlation between the performance of a leveraged ETF and its linked index or benchmark is inexact and “tracking error” occurs. Over longer periods of time or pronounced during periods of volatility, this “tracking error” between a non-traditional ETF and its benchmark becomes compounded significantly.
FINRA has advised members for years about the dangers of recommending these toxic products to retail investors. In June 2009 FINRA issued NTM: 09-31 concerning non-traditional ETFs stating that “[d]ue to the effect of compounding, [non-traditional ETFs’] performance over longer periods of time can differ significantly from the performance…of their underlying index or benchmark during the same period of time.” Because of these risks NTM: 09-31 advised broker-dealers that non-traditional ETFs “are typically not suitable for retail investors who plan to hold them for more than one trading session, particularly in volatile markets.” The SEC has provided similar guidance.
Another investment commonly recommended as a market hedge are VIX related ETNs. The VIX index is commonly referred to as the “fear” index which increases with volatility and decreases in calm markets. However, the ETN which seeks to replicate the index “rolls” futures over in the portfolio from the one month to the other which has the effect of causing the VIX ETNs to always lose money over prolonged holding periods. As explained by FINRA:
Because of the negative roll yield, many volatility-linked ETPs that seek to maintain a continuous, targeted maturity exposure to VIX futures, particularly to shorter maturities, have lost a significant amount of value over time; some have lost more than 90 percent of their value since they launched. And, such products will likely continue to lose value over longer periods of time. Moreover, the performance of VIX futures can diverge from that of the VIX, and in general, movements in the futures are smaller in magnitude than those of the VIX. For these reasons, the performance of volatility-linked ETPs that seek to maintain a continuous, targeted maturity exposure to VIX futures may also be less correlated to that of the VIX than investors might expect.
Finally, advisors who recommend long-term holdings of these investments have no basis for the belief that the stock market will produce prolonged negative returns. A historically analysis of the stock market from 1916 through 2019 reveals that only 1 in 3 years does the market produce a negative return. What’s more, if the stock market is negative usually such results are relatively minor or less than -10%. Only less than 1 in 5 years is the market down more than 10%. Conversely 50% of the time the market is up more than 10%. On average the Dow Jones returns 7.27% a year since 1916.
Reading one prospectus of a leveraged ETF illustrates the extreme damage such investments – even in relatively small amounts – can do to a portfolio. As the UltraShort Russell 2000 fund prospectus shows on average an investor will lose 30% every year based on 10 years of historical returns. Accordingly, if the stock market returns on average 7.5% in the past 100 years it could take $4 dollars invested in the stock market to counter every $1 invested in a leveraged inverse ETF producing similar historical annual losses.
The SEC has repeatedly warned investors about these risks. Recently, the SEC alleged that several broker-dealers had clients holding VIX related investments such as VXX or VIXY for months or even years. To settle these allegations the firms paid fines such as:
Benjamin F. Edwards agreed to pay $716,000 in disgorgement and a $650,000 fine;
Royal Alliance agreed to pay $502,000;
American Portfolios Financial Services agreed to pay $653,000;
Securities America agreed to pay $603,000; and
Summit Financial Group agreed to pay $606,000 in disgorgement and a $600,000 fine.
Investors who have suffered losses on leveraged ETFs or VIX investments are encouraged to contact us at (800) 810-4262 for consultation. At Gana Weinstein LLP, our attorneys are experienced representing investors who have suffered securities losses due to the mishandling of their accounts. Claims may be brought in securities arbitration before FINRA. Our consultations are free of charge and the firm is only compensated if you recover.