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Exchange-Traded Funds (ETFs)

What is an ETF?

An exchange-traded fund (ETF) is a type of exchange-traded product (ETP). Like other ETPs, it is a security that tracks a financial instrument, such as a security or index (i.e.: the S&P 500 or Dow Jones), trades on exchanges, and has a price that fluctuates and comes from the investment it is tracking.

An ETF can also track a sector, industry, currency, or commodity. It usually holds a basket of investments, which may include stocks and bonds.

Created in the 1990s, exchange-traded funds have grown in popularity with both individual investors and institutional investors. These days, there are ETFs with assets under management in the billions of dollars.

While investing in exchange-traded funds can garner significant profits, it can also lead to huge losses. This was evident in 2020 when COVID-19 led to market volatility that caused leveraged ETFs to stop trading or become delisted, resulting in major losses for investors.

Our securities lawyers at Shepherd Smith Edwards and Kantas (SSEK Law Firm at investorlawyers.com) represent ETF investors in recouping their investment losses caused by broker negligence or fraud. Contact us at (800) 259-9010 today.

What are Some of the Benefits of ETFs?

Exchange-traded funds give investors a chance to get involved in different indices and securities, which provides diversification. They are a less costly option than mutual funds. As a matter of fact, ETFs are often promoted as a more beneficial choice than the latter. A lot of investors like ETFs because they can be actively traded.

Kinds of Exchange-Traded Funds
  • Sector ETFs: This type of exchange-traded fund invests in the securities or stocks of a certain sector.
  • Stock ETFs: This exchange-traded fund tracks certain equities sets, whether the stocks from one industry or a whole index of equities.
  • Bond ETFs: This exchange-traded fund invests in bonds, such as corporate bonds, floating-rate bonds, and convertibles.
  • Commodity ETFs: This type of exchange-traded fund gives investors a chance to invest in the commodities markets.
  • Currency ETFs: These pooled investments track the value of a currency or a basket of them, giving investors exposure to currencies or foreign exchanges.
  • International ETFs: Investing in foreign-based securities, this kind of ETF can hold fixed-income securities or equities with a focus that can be global, regional, or on one specific country.

The risks involving an exchange-traded fund will depend on the type of ETF involved, how it is managed, its investment objectives, and the indices that it is tracking.

What are Leveraged ETFs and Inverse ETFs?

Leveraged exchange-traded funds use debt and financial derivatives to enhance an underlying index’s returns. A leveraged ETF usually seeks to track the securities in the underlying index on a 3:1 or 2:1 basis. (Traditional ETFs track their underlying financial instrument on a 1:1 basis.)

A leveraged exchange-traded fund can lead to greater investment gains or losses. The majority of leveraged ETFs reset on a daily basis, which makes them suitable for short-term investing.

On the other hand, an inverse exchange-traded fund utilizes derivatives to make money from an underlying benchmark’s drop in value. This gives investors a chance to profit during a decline in the market or underlying index without needing to make a short sale.

An inverse ETF is also called a Bear ETF or a Short ETF. This kind of investment is most suitable for sophisticated investors that can deal with a lot of risk. Like with leveraged ETFs, investing in inverse ETFs can lead to substantially greater losses for investors than when they invest in more traditional ETFs.

Lastly, a leveraged inverse exchange-traded fund is a kind of ETF that will try to enhance the performance of the index it is tracking when the market is declining.

ETFs are usually promoted as low-cost, low-risk, and tax-efficient. However, that has become less true over the years as the number of exchange-traded funds has grown and many of them have become more complex. One reason for this is that there are more ETFs that use leverage and tend to be concentrated on more narrow market sectors.

When Brokers Recommend Exchange-Traded Funds

A broker must make sure that any exchange-traded fund that they recommend is suitable given a customer’s investing profile, goals, and risk tolerance level. They also need to ensure that the investor knows and understands the risks involved.

Because an ETF is a traded security, financial advisors will usually earn a commission for any purchase or sale. This can pose a conflict of interest that could prove detrimental to the customer if the broker chooses their own profit over whether an ETF is, in fact, the right fit for a customer.

Knowledgeable ETF Fraud Attorneys

Our exchange-traded fund fraud attorneys have helped thousands to recoup their losses. SSEK Law Firm represents new investors, retail investors, high-net-worth individual investors, and institutional investors.

To determine whether you have grounds for an ETF fraud case against your broker-dealer and financial advisor, call (800) 259-9010 today or contact us online.

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