Some financial products are so risky that big firms sometimes decide not to sell them despite their popularity — out of fear that customers will end up with such devastating losses that refunds are sought, lawsuits are filed or tales of woe are peddled to a sympathetic news reporter.
That appears to be the case with “triple-X” exchange-traded funds, which offer investors the ability to triple gains on stock-market movements, but also the potential for triple losses.
Vanguard Group, the $5.1 trillion money manager, said this week that starting on Jan. 22 it will stop selling the ETFs, which use complex financial engineering to amplify market returns, using a concept known as “leverage.” In addition to banning the the so-called leveraged ETFs, Vanguard will also halt sales of “inverse ETFs,” which use similar financial-engineering techniques to provide investors with fat gains whenever stocks fall.
“This change is part of an ongoing effort to align the products and services we offer with our investors’ focus on the long term,” according to a notice posted on the Malvern, Pennsylvania-based company’s website on Jan. 8. “These investments, which are generally incompatible with a buy-and-hold strategy, run counter to this long-term focus.”
Three years ago, U.S. regulators tagged the leveraged and inverse ETFs as among the riskiest Wall Street inventions to emerge as part of the rapid growth in the ETF industry as a whole, where total assets globally have swelled sixfold over the past decade to $4.79 trillion, based on the latest count by the research firm ETFGI.com.
The vast majority of ETFs are far simpler in construction, allowing investors to make bets on things like the Standard & Poor’s 500 Index of large U.S. stocks via easy, low-commission trades on an exchange.
Mary Jo White, former chairwoman of the Securities and Exchange Commission, led a push in 2015 to ban triple-leveraged, or “3x,” funds — on the grounds that they were too risky.
Yet White was replaced at the SEC after President Donald Trump was elected in 2016 amid promises of loosening regulations on the financial industry. Her successor, Jay Clayton, has taken no action on the proposal, instead offering to require better labeling of exchange-traded products.
In May 2017, the SEC even approved one firm’s proposal to offer a “4x” ETF, offering quadruple the returns of the S&P 500.
Vanguard revealed its distaste for the investment vehicles in mid-2018, when it announced plans to provide commission-free online trading in almost 1,800 of competitors’ ETFs in addition to its own 77 ETFs. Leveraged and inverse ETFs were specifically excluded from the offer.
In this week’s announcement, the firm said that the leveraged and inverse ETFs’ “extremely short-term, speculative nature is contrary to the long-term focus shared by most Vanguard investors.”
Ben Johnson, director of global ETF research at Morningstar, said in a phone interview that a growing number of Wall Street firms have been taking extra steps to make sure customers are fully informed about the risks of leveraged and inverse ETFs, though usually stopping short of banning them outright.
“There’s more gating and red-taping in place so as to immunize these firms from any of the potential negative ramifications and blowback” that might occur if customers suffered devastating losses en masse, Johnson said. He added that he assumes Vanguard wasn’t making enough profit off of selling the leveraged and inverse ETFs to justify the ongoing business risk.
Yet Daniel Wiener, editor of the newsletter Independent Adviser for Vanguard Investors, says the firm still sells plenty of other investments that, in his opinion, are just as risky.
“I agree with Vanguard that these leveraged ETFs are dangerous when used by people who don’t understand how they work,” Wiener said in a phone interview. “But it’s a little bit of nanny-stateness to actually be telling investors what they can and can’t invest in.”
Of course, when things go badly, it can be nice to have a nanny.
