SEC warning on leveraged ETF [Proposed rule]

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SEC warning on leveraged ETF [Proposed rule]

Post by cfs » Mon Dec 14, 2015 11:51 pm

SEC warning on leveraged ETF

This is related to the conversation of "Third Avenue liquidates its high-yield bond fund" where Larry mentioned the leverage loans.

Today leveraged ETFs were in the news. Article from Bloomberg: Leveraged ETFs Face SEC Squeeze in Plan to Rein in Derivatives

This is an OLD warning, nothing new, here is this from 2009: Leveraged and Inverse ETF-Specialized Products with Extra Risks for Buy-and-Hold Investors

So, high yield bonds is not the only issue out there, but if you are a "Three Funder" relax and enjoy the ride.
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Re: SEC warning on leveraged ETF

Post by Clive » Tue Dec 15, 2015 10:53 am

What's risker, 50/50 SSO (2x long stock) and SHY (STT) or 100% long stock ? ... ount=10000

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Re: SEC warning on leveraged ETF

Post by Johno » Tue Dec 15, 2015 10:56 am

Actually this is new. It's not 'warning', it's a proposed rule change that might prohibit certain existing ETF's. I guess as proposed rule it might be dicey to debate but to summarize registered investment co's (MF, ETF) would be limited to 150% 'exposure' as notional amount of derivatives divided by net assets, except if they passed a risk test which would allow 300%. The general presumption would be that long or short only levered ETF's would have to meet the 150%, long/short funds using derivatives would have to meet the 300%. The SEC chair said it's 'possible' 2X ETF's could meet the new rule which the leveraged fund provider Proshares says it definitely can. Say if 50% long the underlying index and set aside the other 50% as margin/collateral on a derivative that pays 150% of the return, that's 2X total though only 150% derivatives. Proshares says they are 'exploring' whether 3X's could meet the rule but it would seem the idea of the rule is to extinguish those funds for retail investors. There are also secondary restrictions which might affect the attractiveness of a fund even if it basically meets the headline requirement.

On long/short, the often discussed QSPIX would apparently be prohibited as a regular mutual fund for individual investors, it's 6-7 or so leveraged, long/short across various asset classes, presumably fails the 300% test for that case. This might be related to the somewhat obscure situation of QSPIX's availability in retail size only through certain brokers. It hasn't been clear whether individual brokers are driving that or AQR doesn't want brokers offering the fund to true retail and just a couple (maybe only one now, Scotttrade) haven't complied. It might have been in anticipation of such a rule, if the final rule allowed registered investment companies this much leverage, as long as not available to all investors.

Among possible evolutions to a final rule might be whether anything is 'grandfathered' in, or whether some kind of 'gating' for investors might be implemented as an alternative. For example options trading is potentially much more leveraged than any ETF but is allowed for investors who apply for options trading permission with their broker and meet certain, pretty nominal, requirements. Or the more rigorous standard of 'accredited investor' might come into play. Or funds might change their legal form from 1940 Act registered investment co's to something else.

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Re: SEC warning on leveraged ETF

Post by LadyGeek » Tue Dec 15, 2015 3:59 pm

I retitled the thread. Investing related proposed regulations published for public comment may be discussed. See: Unacceptable Topics

From: SEC Proposed Rules

The proposed rule: Use of Derivatives by Registered Investment Companies and Business Development Companies Dec. 11, 2015

File No.: S7-24-15

DERA White Paper: Use of Derivatives by Registered Investment Companies

Received comments are available, you may also submit comments at the above site.
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