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10 Most Dangerous ETFs (Part 2)

Editor's note: This is the second part of a three-part series on the 10 most dangerous ETFs. To read "ETFs: 10 Most Dangerous (Part I)," click here.

NEW YORK ( TheStreet) -- Non-traditional ETF funds that invest in derivative contracts like futures have been the subject of regulatory scrutiny in recent months.

Rather than simply tracking a basket of equities like their predecessors, non-traditional ETFs use futures contracts, swaps and other complex financial instruments to meet their investment objectives. Often, the uses of these contracts make non-traditional funds riskier than their passive, equity-tracking peers.

In this second installment of our countdown of the 10 Most Dangerous ETFs, all three of the funds discussed use leverage to achieve their goals. Leveraged ETFs are inherently more volatile than unleveraged ETFs and are designed with sophisticated investors in mind.

Leveraged ETFs can be caustic in the hands of long-term, buy-and-hold investors who do not understand their strategies completely. The three ETFs listed below are some of the more dangerous of the bunch.

5. MacroShares Major Metro Housing Up (UMM) and MacroShares Major Metro Housing Down (DMM).

After the failure of two sets of leveraged oil funds, MacroShares has set its sights on the housing market, as measured by the S&P/Case-Shiller Composite-10 Home Price Index. This pair of funds is designed to provide the investor with three times the exposure of this index for both bullish and bearish bets.

Rather than investing in stocks or bonds, like other ETFs, UMM and DMM use short-term Treasury securities and overnight repurchase agreements to track their underlying indexes.

Perhaps the most dangerous aspect of the funds is that they are designed as paired trusts and pledge assets to each other over time. Generally, fund issuers create additional shares of a fund if investor demand peaks and assets pour in.

Since UMM and DMM are tied financially, a creation in one of these funds will spark a creation in the other. Investors can get burned when fund managers take money from one pocket and put it in the other.
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