January 15, 2016
I am writing to you in support of the proposed limits on derivative use as it applies to Leveraged ETFs. As a retail investor who has lost and learned through the years, I have become seasoned in what works for my portfolio and what does not. Ive done well with these products when Ive used them and have been burned on some bad trades but I have witnessed, firsthand, close friends lose their shirts entirely. With these new products there is simply too much juice for the average investor to successfully use them without risking greater portions of their portfolio and simply holding them as you would with a stock just does not apply.
The compounding involved with holding leveraged ETFs magnify the losses (or gains). Simple mathematics can suddenly turn on an investor due to the length of time that one holds it. View the countless examples of the effects of compounding and holding period where both the Leveraged (3x) and Inverse Leveraged (-3X) pair have both produced losses when the tracked index declines despite the inverse ETF intending to produce gains when the index drops. On the flip side, there are many examples where the holding period has provided an investor much greater leverage (5X+) due to the length of holding it. These very real scenarios give an investor conflicting support for holding an ETF. While these ETFs are meant to be held for 1 day or less, the possibility of greater leverage is too powerful of an incentive to hold while losses greater than the described leverage is experienced by investors decimating their portfolios.
Dan ONeill, the CEO of Direxion, was quoted in a Moneyshow.com 2012 article as saying I think that most market participants should not use these productsand Im not sure what the proper number is, but lets just say 95% of market participants should not use these sorts of products. Because theyre looking to invest for longer than the timeframe for these sorts of products. Here, we have the head of a leveraged ETF provider discouraging the use of his own product yet the only difference between my access to this product vs a stock or unleveraged etf is that Im greeted with a small red box reminding me that it may not be suitable for me. If these products are not suitable for most then they should not be available to all. Many platforms have gone so far as to ban the use of them by licensed professional money managers yet allow them for use by the average retail investor. I have seen no breakdowns on who exactly is holding Proshares or Direxion ETFs. If Mr. ONeills assumption is correct then all 5% of suitable investors are somehow the only ones purchasing leveraged ETFs without any restrictions in place to ensure this. Without restrictions, it is more reasonable to assume that the same ratio of market participants quoted exists in the same degree as who currently holds leveraged ETFs- investors who do not know how to use these products.
Laurence Fink of BlackRock has consistently warned and criticized the use of leveraged ETFs. Blackrocks assets tower over the entire leveraged ETF spaces assets. Why are more dominant firms like BlackRock not looking to participate in the leveraged space? Certainly firms like BlackRock can back the use of derivatives with enough liquid assets with no problem. But large firms are not looking to jump into the space because of the inherent risk it poses to the market as a whole. We have seen with the Nomura 225 leveraged ETF how quickly a leveraged ETFs assets and flows can grow exponentially in a matter of weeks if not days. We have seen a market frenzied enough to all pile onto the leverage game all at once. We have seen this affecting prices of stocks needed to create the underlying index and the futures markets.
I believe the SEC will do what is right and limit derivative use by issuers to protect the market and investors. The time for the commission to act is now before it runs away from all of us.