Mass. Inquiry on Leveraged ETF’s (FAS, FAZ, UYG, SKF, SDS, SSO)

There may be some misconceptions out in the market over an inquiry into the leveraged ETF universe.  The Massachusetts Secretary of State has inquired into the sales, marketing, and disclosure practices of leveraged ETF’s.  This issue will bring more attentionon some top volume leveraged-ETFs.  The two most active before the reverse splits were the Direxion Daily Financial Bull 3X Shares (NYSE: FAS) and the Direxion Daily Financial Bear 3X Shares (NYSE: FAZ) in the triple-leverage.  Others are as follows:

Ultra Financials ProShares (NYSE: UYG) seeks twice the daily performance of the Dow Jones U.S. Financials index.  UltraShort Financials ProShares (NYSE: SKF) seeks twice the inverse of the daily performance of the Dow Jones U.S. Financials index. UltraShort S&P500 ProShares (NYSE: SDS) seeks twice the inverse of the daily performance of the S&P 500 index. Ultra S&P500 ProShares (NYSE: SSO) twice the daily performance of the S&P 500 index.

There are many other issues from leveraged ETF families out there.  These are just some of the top leveraged exchange traded funds by trading volume.  But there are some considerations here that are a part of the Mass. Secretary of State inquiry.

As we noted before, Direxion specifically addressed several focal issues.  It has shown how returns differ from the target index and even went as far as saying these are not suitable investments for long-term investments.

We have confirmed with Direxion that Secretary Galvin has made an inquiry, but our contact also noted that the firm is cooperating with the inquiry and is very comfortable with all of their practices.  More specific details from the office of the Secretary of State have not been given to us as of yet.

What Secretary Galvin is probably looking to make sure of is that investors know what they are getting into, and that these funds are not being held by many widow and orphan funds.

We have essentially zero reason to expect any closure of these ETFs over this inquiry.  Nor do we expect these issues to have any bearing over the operations of these leveraged ETFs.  If anything, the inquiry would seem to lead to even more disclosure practices, and in the most extreme case it could possible create some ‘suitability issues’ that could make these exclusionary for certain types of investors and/or for certain retirement funds.

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Update… CNBC has an interview with Secretary Galvin on this matter.
JON C. OGG
July 15, 2009