As sales of exchange-traded funds boom, the Securities and Exchange Commission’s Office of Investor Education and Advocacy has released an investor bulletin on the investment vehicle that highlights the view that not all ETFs are created equal.
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"Certain ETFs can be relatively easy to understand. Other ETFs may have unusual investment objectives or use complex investment strategies that may be more difficult to understand and fit into an investor's investment portfolio," the bulletin says. "For example, leveraged ETFs seek to achieve performance equal to a multiple of an index after fees and expenses. These ETFs seek to achieve their investment objective on a daily basis only, potentially making them unsuitable for long-term investors."
The bulletin refers to an investor alert issued by the SEC in August 2009 that warns about the risks of leveraged and inverse ETFs for buy-and-hold investors.
The bulletin concludes with the advice that investors should "not invest in something that you do not understand. If you cannot explain the investment opportunity in a few words and in an understandable way, you may need to reconsider the potential investment."
The bulletin notes that even ETFs that would appear to be identical, such as ETFs based on the same benchmark, can "be quite different and can deliver very different returns. For example, the S&P 500 is capitalization-weighted, meaning the larger companies make up a much higher percentage of the index than the smaller companies. However, some ETFs will track an S&P 500-styled index that is equal-weighted, meaning all the companies have equal representation on the index, irrespective of the size of the company. Although these two benchmarks may seem similar, they provide very different returns."
The bulletin also describes the differences between ETFs and mutual funds.
The SEC's Office of Investor Education and Advocacy publishes about two dozen investor bulletins a year. The agency also publishes investor alerts, which are designed to spotlight an issue that the SEC is concerned about.
Mary Schroeder writes for Securities Technology Monitor.