ETFs: Cry Transparency

A common thread runs through the Wall Street disasters that occurred at financial institutions like Goldman Sachs(GS Quote), AIG(AIG Quote) and funds championed by crooks like Bernie Madoff. Lack of transparency, combined by momentarily stellar returns, has caused otherwise-savvy investors throughout time to look the other way while stepping into the pit of despair.

The unsustainable institutions often use derivatives and leverage to achieve returns. Investors doing their homework may feel overwhelmed by the "It's too complicated for you to understand" explanation and placated as their returns reach higher.

As ETF strategies become increasingly foggy, there is cause for concern. In the triple-down world of leveraged funds like Direxion's Daily Financial Bull 3X(FAS Quote) and derivatives doused arena of commodity products like U.S. Natural Gas(UNG Quote), ETFs are getting more complicated as regulation looms. What makes this phenomenon particularly frightening is the yawning gap between investor expectations and reality.

Both leveraged and futures-based commodity ETFs have been under attack, largely for the strategies that these funds employ. To be sure, these funds actually execute these strategies but they are probably inappropriate for the bulk of investors.

UNG and U.S. Oil(USO Quote) use a combination of futures and swaps to synthetically track the spot price of oil. As regulations loom on the horizon, UNG has been selling futures and buying swaps. Both UNG and USO have complex strategies and the CFTC investigation may force these funds to add more layers of complexity in a move to survive.

ProShares UltraShort Real Estate(SRS Quote) has been sued by a customer who believes that the company was not forthcoming about its strategy. Before, if you read the fine print, this strategy may become obvious but it is couched in language that an average investor may not understand. Recently leveraged fund issuers like ProShares, Direxion and Rydex have added more explicit warnings to their websites.