It is imperative that investors gain an understanding of how inverse and leveraged exchange-traded funds (ETF) work before implementing them in portfolios, according to BlackRock.
The firm's global head of ETF research and implementation Deborah Fuhr said that while inverse and leveraged ETFs can be useful, they are not 'buy and hold' products and have caused disappointment because have been misunderstood.
It's also an area that regulators globally have become increasingly concerned about, she said at the Australian Securities Exchange institutional ETF conference in Sydney yesterday.
"People who were buying these were thinking 'what a great idea, I want to hedge against market falls, I'll just buy an inverse ETF'. They buy and hold, watch the market fall, come back and sell thinking they have made money," she said.
"But instead they were surprised and, more importantly, disappointed because the returns that they achieved were not what they expected."
Fuhr said that these types of products are designed to rebalance daily, which means that investors can only expect the ETF to achieve its stated performance each day.
"Beyond a day based on rebalancing, compounding, volatility and path dependency, you cannot predict performance for any period greater than one trading day," she said.
"So please if you are going to use these products monitor the performance on a daily basis, it is very important. Many people use them and find them helpful but if you don't do your homework you can be surprised and that's not a good thing in industry or life."
While there are no leveraged and inverse ETFs in Australia, BlackRock expected providers to issue them here eventually, so it was important that investors understood them, she said.
Morningstar Australasia's co-head of fund research Tim Murphy agreed that investor education was important.
He gave an example of when the US Dow Jones Real Estate Investment Trust market tumbled 40 per cent in 2008. But a double-leveraged inverse ETF tracking the index - which some investors assumed should have risen 80 per cent - actually lost 50 per cent over the period.
"That ETF actually performed exactly how it was designed to. But if you didn't understand that structure and jumped into that as an investor then you really lost out," he said.
"You might have made a really great call to double-short the US REIT markets but implementation would have been terrible because you didn't understand the structure you were executing on."
A leveraged ETF is often designed to create two or three times the return of an underlying index on a daily basis. An inverse ETF is designed to rise when an index falls.
BlackRock owns ETF provider iShares.
