Exotic ETFs Going Mainstream

Leveraged and inverse exchange-traded funds received a lot of scrutiny during the volatility of last year. But now that volatility is down and equities are on the rise, investors are more and more viewing these once exotic products as just another way to take positions on the direction of the markets.

That was the opinion of ETF insiders speaking on the panel “Volatility and Leveraged ETFs” at the Security Traders Association of New York conference on Thursday. ETFs that are leveraged two, three times, or even more, or that move in an inverse relationship to indexes like the S&P 500, are slowly becoming more accepted.

Stephen Sachs, head of capital markets for ProShares, said that while ETFs drew a lot of attention during high-volatility periods last year, the actual evidence suggests those instruments did not cause the volatility. Leveraged and inverse products were only a small part of trading during those periods, and important macro events were also very much in play, he said.

“At the end of the day, volatility is not an asset,” Sachs said. He added that unlike actual asset classes, investors don’t take buy and hold positions on the VIX. Investors in VIX ETFs need to understand that the product exists for taking positions on risk, not for long-term investments.

Chris Hempstead, director of ETF execution at WallachBeth Capital, said inverse and leveraged products have gotten more than their fair share of press. However, they too serve a specific purpose, and the investment community needs to learn more about them.  “If you trade anything, you should be paying attention to the ETF market,” Hempstead said. “It [the market] is a lot harder [to understand] than it was five years ago.”

Inverse and leveraged ETFs are still only a small part of the total ETF universe. However, new types of ETFs are being launched all the time, and Hempstead said we have only scratched the surface in terms of the number and variety of exchange-traded products available.

Lately, much of the criticism of ETFs has been dampened by the positive performance of the markets in general. Paul Weisbruch, vice president of ETF/index sales and trading at Street One Financial, said the general investing public is not concerned about the use of ETFs now that stocks are on the rise.

“The trading volumes are astounding in 2012,” Weisbruch said. “These leveraged products are being traded more than ever, but nobody’s complaining.”

Weisbruch noted that the average portfolio has a higher turnover rate today, and with increased turnover, it just makes sense that more investors are using ETFs.

Many of those investors are mutual fund managers, said Nick Cherney, chief investment officer of VelocityShares. He said ETFs shouldn’t be seen as a competitor of mutual funds, but rather as just another tool that all managers should have in their toolkits.