Leveraged and Inverse Exchange Traded Funds (ETFs) risks by mercy2beans117

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                     Leveraged and Inverse Exchange Traded Funds (“ETFs”) risks

Overview

Exchange Traded Funds (“ETFs”) are investment vehicles that have grown in popularity since their launch in the
1990s. These instruments allow investors to obtain investable exposure to an underlying index, a basket of
securities or to the price of an underlying commodity among other possibilities.

Among the potential benefits of ETFs are:
  • The ability to gain exposure to investments that were previously not available to relatively smaller
      investors;
  • Their generally high liquidity, especially for the larger well known ETFs;
  • The ability of investors to trade the securities intra-day on exchanges; and
  • The relatively low expense ratios compared to similar managed mutual funds.

As ETFs have become an accepted part of most retail and institutional investment portfolios, some of the inherent
risks of ETFs that offer leverage or that are designed to inversely track certain benchmarks have not been
adequately explained to the investing public. Financial Industry Regulatory Authority (FINRA) has recently issued
a notice warning its member firms regarding the risks of these non-traditional ETFs. Several larger broker-dealers
have taken steps to provide additional guidance to their customers and certain broker-dealers have even take the
step of banning solicitation of these investment products to their clients.

Leveraged and Inverse ETFs

Leveraged ETFs are investment instruments that aim to deliver a multiple of the return of an underlying index.
Generally, their name indicates “2x”, “3x” or “ultra”. For instance, a “2x S&P500” ETF aims to deliver twice the
return of the Standard & Poor’s 500 Index. If the Standard & Poor’s Index increases by 5% then the price of this
ETF should increase by 10% and vice versa.

Inverse and Inverse Leveraged ETFs are investment instruments that aim to deliver the inverse or a multiple of the
inverse of the return of an underlying index. Generally, their name indicates “short”, “ultrashort”. For instance, a
“short S&P500” ETF should deliver the opposite of the return of the Standard & Poor’s 500 Index. If the Standard
& Poor’s 500 Index decreases by 5% then the price of the ETF should increase by 5% and vice versa.

Risks

Due to the more complicated nature of non-traditional ETFs, holding these investments for longer than one day can
give rise to unexpected investment returns. For this reason, these non-traditional ETFs may not be appropriate for
long-term investors. Although the stated objective of non-traditional ETFs is to track an index on a leveraged or
inverse leveraged manner, they do not necessarily track the indices very closely because of (a) the rebalancing
method utilized and (b) compounding effects that magnify small discrepancies over time.

For example, suppose that a hypothetical ETF priced at $10 aims to deliver twice the return on an index that is at
100. If the index on day 1 increases by 10% and goes from 100 to 110, then the ETF will increase on day 1 by 20%
from $10 to $12. At the end of day 1, the firm that manages the ETF will rebalance its positions and adjust and


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increase its exposure to reflect the new level of the index, now at 110. If the underlying index on day 2 drops by
10% the index will fall from 110 to 99, but if the ETF drops by 20%, its prices will fall from $12 to $9.6. The two
days’ performance of the index will be (99-100)/100 = -1% whereas for the ETF it will be ($9.6 - $10)/$10 = -4%.

This example makes clear that an ETF investor over the two days will not receive twice the performance of the
underlying index, but rather four times the performance of the index. This type of discrepancy magnified over time
can cause significant variation in return compared to the stated investment objective of the ETF. A very similar case
can be made for inverse and inverse leveraged ETFs. The intended leveraged and inverse performance hold true
only for the day the investment is made. For longer time periods, the rebalancing and compounding effects may
distort the expected performance for the investor.

Caution Required

While these leveraged and inverse ETFs may be appropriate for some investors, it is important to be mindful of the
significant risks involved with these investment products, especially if they are held for periods longer than a day.
Each investor should proceed with caution when contemplating investments in these types of non-traditional ETFs.

Please contact your registered representative if you have any questions or require assistance.




Important Disclosures:

This material has been prepared by SAFDIÉ Investment Services Corp. (“SAFDIÉ ISC”), a U.S. registered investment adviser and broker dealer.
This material is provided for informational purposes and is not a solicitation of an offer to buy or sell any financial instruments. The information
provided here is for general informational purposes only and should not be considered an individualized recommendation or personal investment
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consequential losses arising from the use of information contained in this material. SAFDIÉ ISC does not represent that it will advise the client as
to the changes in the information contained herein or its views in connection therewith. The opinions, estimates, and projections in this material
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important disclosures regarding risks, fees, and expenses. The financial instruments discussed in this material may not be suitable for all
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