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Exchange-Traded Products Warning

An exchange-traded product (ETP) is a derivative priced security which trades intra-day on a national stock exchange.  ETPs are typically benchmarked to indices, stocks, bonds, or commodities.  There are several different types of ETPs, two of the more popular ones include:

  • Exchange-traded funds (ETFs)
  • Exchange-traded noted (ETNs)

Both ETFs and ETNs have some additional risks that all investors should consider before they make their investment decision.  Some of the following risks may relate to either one or both of the above mentioned ETP products:

1.  Some ETPs may have "leverage" , "compounding", and "tracking" risk

Some leveraged ETPs are designed to achieve a particular investment objective.   Many leverage ETPs may be designed to track a multiple of the "daily percentage change" rather than a total period change.   This is generally referred to as a 2x or 3x ETF.   The ETF basis may not be designed to, and will not necessarily track the underlying index or benchmark over a longer period of time in this situation.  Due to the effects of compounding, their performance over longer periods of time can differ significantly.   In addition, ETFs may be considered "inverse" or "short" and may also have leverage, compounding and a tracking risk

2.  Counterparty Risk

All ETFs have a sponsor, or a financial institution which created and administers the ETF.  ETFs may have counterparty risk in situations where the sponsor becomes insolvent.  In addition the ETF may be involved with swap transactions with multiple financial institutions thus subjecting the ETF owner's to 3rd party risk.

3.  Hidden Cost and Net Asset Value

Many ETPs may have significant management fees, which are charged directly by the sponsoring financial institution.   These fees may be deducted directly from the ETPs net asset value.   Investors are encouraged to thoroughly review each ETPs prospectus and other official filing statements before making an investment decisions.   These documents can generally be found at the sponsoring financial institution's website or with the appropriate regulatory agency.   In addition, since the current price of the ETF is determined on an exchange through supply and demand, it is possible for the ETP to trade at a value that is significantly different from its NAV, either at a premium or a discount.

Additional Information can be found at:

http://sec.gov/investor/pubs/leveragedetfs-alert.htm
http://www.finra.org/Industry/Regulation/Notices/2009/P118953