In March 2010, the Securities and Exchange Commission (SEC) began a review of the use of derivatives by ETFs, specifically actively-managed and leveraged funds. That announcement seemed to suggest that the SEC recognized that the public's perception of ETFs as low costs ways to track a particular market sector did not account for a large portion of ETFs that achieve results through the use of complex and high risk derivatives trading.
Unfortunately the SEC recently announced that fund companies can seek regulatory permission to include derivatives in actively-managed ETFs, provided that they adhere to the following requirements:
1. The ETF's board must periodically review and approve the ETF's use of derivatives and how the ETF's investment advisor assesses and manages risk with respect to the ETF's use of derivatives.
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2. The ETF's disclosure of its use of derivatives in its offering documents and periodic reports is consistent with relevant Commission and staff guidance.
This appears to be another win for Wall Street at the expense of retail investors. Derivative use has been a touchy subject for many investors, as these powerful instruments have led to some huge financial disasters. That risk will not continue to exist the ETF sector, a sector that the majority of investors believe is primarily low risk.