Beginning January 22, 2019, Vanguard will no longer accept purchases in leveraged or inverse mutual funds, ETFs (exchange-traded funds), or ETNs (exchange-traded notes). If you already own these investments, you can continue to hold them or choose to sell them. You’ll simply pay the same commission you would to trade individual stocks. You can also transfer them in kind from or to other institutions.
Leveraged and inverse ETFs and ETNs
Leveraged and inverse ETFs and ETNs are unique and involve additional risks and considerations not present in traditional products. Leveraged products are often identified with a multiplier in their names, such as “2x” or “3x,” or may have a fund-specific description such as “ultra.” These funds are designed to double or triple the performance of a particular index over a stated period of time. Similarly, “inverse” or “short” products are designed to deliver the opposite return of an index, or, in the case of a leveraged inverse fund, a multiple of the opposite return of the index. Because the products reset over short periods, they’re designed to deliver their stated returns only for the length of their reset periods. Most leveraged and inverse ETFs and ETNs currently reset on a daily or monthly basis and are therefore designed to deliver their stated returns for the reset period only (i.e., one day or one month).
What does this mean? On any given day, if you use a leveraged or inverse product, you can expect a return similar to the stated objective. However, because of the structure of these products, their rebalancing methodologies, and the compounding math, extended holdings beyond one day or one month, depending on the investment objective, can lead to results different from a simple doubling, tripling, or inverse of the benchmark’s average return over the same period. This difference in results can be magnified in volatile markets. As a result, these types of investments aren’t generally designed for a buy-and-hold strategy, even if the “hold” period covers only several days. Such funds aren’t intended for investors who don’t intend to actively monitor and manage their portfolios. These funds are riskier than alternatives that don’t use leverage.
For additional information, please see this Investor Alert issued by the SEC and FINRA related to leveraged and inverse ETFs.
In general, ETFs are investments whose shares represent an interest in a portfolio of securities that track an underlying benchmark or index. Unlike traditional mutual funds, ETF prices change throughout the day, similar to stocks. All ETFs are subject to trading risks similar to those of stocks. ETFs can entail market, sector, or industry risks similar to direct stock ownership.
ETNs are senior, unsecured, unsubordinated debt securities issued by a bank or financial institution that have a maturity date and seek to mimic the return of certain equity, commodity, and currency indexes. ETNs offer returns linked to the performance of a particular market index, but they represent no ownership interest in a pool of securities, pay no periodic coupon interest, and offer no principal protection. When you buy an ETN, you’re buying a debt instrument backed only by the creditworthiness of the issuer. Therefore, the performance of an ETN may be affected by both the performance of the particular index as well as the credit rating of the issuer.
Commodity and volatility futures-linked ETFs and ETNs
Commodity and volatility futures-linked exchange-traded products (ETPs) are investments that are traded on an exchange, similar to individual stocks. The price and value of the product may be affected by changes in overall market movements, commodity index volatility, changes in interest rates, or factors affecting a particular industry or commodity.
Commodity and volatility futures-linked ETPs may be subject to greater volatility than securities ETPs and may not be appropriate for all investors. Unique risk factors of a commodity product may include, but are not limited to, the product’s use of aggressive investment techniques, which can include the use of options, futures, forwards, or other derivatives; correlation or inverse correlation; market price variance risk; and leverage.
Understanding commodity ETFs and ETNs
The performance of commodity-linked products may deviate significantly from the performance of the actual referenced commodity. This is because many of these products don’t physically hold commodities, but instead hold or track indexes based on futures or other derivative products.
A futures contract is an agreement to buy or sell at a certain date for a predetermined price, so its value generally moves along with spot prices of the commodity or index. However, this correlation is imperfect. To avoid taking physical possession of the underlying commodities, commodity products conduct a regular “roll” process, selling contracts nearing expiration and using the proceeds to purchase longer-dated futures contracts. This process of buying longer-dated futures contracts can sometimes be more expensive than simply buying and holding the underlying commodity because of changes in the spot price of the commodity and the amount of time value in the futures contract—a situation known as “contango.” Therefore, if the market for a particular commodity is subject to contango, the performance of a commodity-linked product will deviate from the spot-price change of the commodity over the same period.
Before investing in a commodity or volatility futures-linked ETP—or any ETP—you should carefully read the prospectus and consider the product’s objectives, risks, charges, and expenses.
For additional information, please see this Investor Alert issued by the SEC and FINRA related to volatility-linked products.