Edward Jones Puts Brakes on Leveraged ETFs

As the sale of leveraged exchange-traded funds (ETFs) comes under scrutiny from regulators, Edward Jones & Co. is nixing the sale of the products.

Edward Jones decided the instruments are not suitable for long-term investors. A spokeswoman told the Wall Street Journal that the company decided in June, during a regular review of the investment products it offers, to drop them.

In a report titled “Not All ETFs are Created Equal,” Edward Jones mutual fund research analyst Katie Martin wrote that leveraged ETFs are “one of the most misunderstood and potentially dangerous types of ETFs,” according to the news report. She also noted the dangers in exchange-traded notes and structured products.

Regulators have warned recently that leveraged ETFs can lead to long-term results that differ significantly from the underlying index, therefore producing different results than expected. Massachusetts authorities announced this month that they are conducting an inquiry into the sales practices of leveraged ETFs (see “Mass. Regulators Look at Leveraged ETFs”).

The Financial Industry Regulatory Authority (FINRA) has also warned about the products. In Regulatory Notice 09-31 it notes that leveraged ETFs “typically are unsuitable for retail investors who plan to hold them for longer than one trading session, particularly in volatile markets.” It also reminds firms of their obligations that recommendations to customers be suitable.

A recent report by State Street Global Advisors, a provider of ETFs, found that leveraged ETF products are becoming more popular. At the beginning of 2008, the inverse/leveraged category had just $11 billion in assets, but by the end of June 2009, that number had swelled to more than $32 billion, alongside an 86% increase in the number of products. Moreover, in June, three of the top 10 ETFs in terms of notional dollar volume were leveraged or inverse products, trading north of $1.5 billion per day, according to the report (see “Investors Change ETF Investing Strategies”).