Leveraged ETFs, Inverse ETFs, and ETNs
An exchange traded fund (ETF) is a security that tracks an underlying index, such as the S&P 500, by holding the same securities as the index. Traditional ETFs track their indexes on a one-to-one basis, so that if the index increases by 1%, the ETF also increases by 1%.
A leveraged ETF uses derivatives and debt to multiply the returns on the index it tracks, so that a 1% increase in the index causes a 2% or 3% increase in the ETF.
Of course, leverage can be positive or negative. When an underlying index in a leveraged ETF declines, the losses are also multiplied by the leverage.
There are also leveraged inverse ETFs (also called “bear ETFs” or “short ETFs”), which use derivatives to earn a return when an underlying index declines.
Exchange traded notes (ETNs) are securities that are issued as a senior debt note. They are not secured and are not a stake in the underlying commodity.
Massive Losses In Exchange-Traded Products
With the coronavirus-related market losses and volatility starting in February, 2020, leveraged exchange-traded products (ETPs) have been suffering what some have called a bloodbath. Dozens have stopped trading, been delisted, redeemed, or accelerated.
Because leveraged and inverse exchange-traded products return is based on the daily performance of their index, they are especially vulnerable to wild high market volatility. When things go bad for an ETP, there are several things that can happen.
Mandatory Redemptions
ETNs can have clauses in their prospectus that state the note must be redeemed early in some circumstances to prevent further losses. This mandatory redemption occurs when the ETN’s price falls to a certain level called a “minimum indicative value”. That value can be relative to the previous closing price or the last month’s valuation, or a certain share price.
When a minimum indicative value is reached, the issuer accelerates the ETN and pays investors an acceleration amount, which is based on the reduced value of the note. Investors can suffer huge losses when their ETN is accelerated. It can come as a surprise when this happens because many investors don’t read their prospectus and don’t know this is a possibility.
Elective Redemptions
Issuers may also choose to redeem ETNs even if a clause in the prospectus doesn’t require it. Citigroup’s VelocityShares 3x Long Crude Oil ETN (UWT) and Inverse Crude Oil ETN (DWT) were recently electively redeemed after suffering large losses.
Delisting
ETFs and ETNs can also be delisted, which is when the share price falls below the minimum price required by the exchange it trades on. Though the fund isn’t closed when it’s delisted, investors are stuck holding a security that’s hard to liquidate and significant paper losses.
Do You Have Losses Related To A Leveraged ETF Or ETN?
Leveraged ETFs and ETNs carry significant risk and are not suitable for all investors. If your broker or financial advisor sold you a leveraged ETF or ETN, you may be able to recover losses through a FINRA arbitration claim. Contact us to discuss your rights and potential options to recover losses.
Silver Law Group’s nationally-recognized attorneys represent investors in class actions against issuers in state or federal court and investors in securities arbitration claims against Wall Street firms for stockbroker misconduct.
Scott Silver, Silver Law Group’s managing partner, is the chairman of the Securities and Financial Fraud Group of the American Association of Justice. Silver Law Group represents investors nationwide in securities investment fraud cases. Please contact Scott Silver for a free consultation at ssilver@silverlaw.com or toll free at (800) 975-4345.