NEW YORK (TheStreet) -- Although the public is focused on Washington's assault on Goldman Sachs (GS) - Get Report and the Congressional debate over financial reform, these are not the only situations where the regulatory hammer has been brandished.
Prior to these headline grabbing events, the SEC began to actively examine the use of derivatives in leveraged and active ETFs.
As the ETF industry has grown and evolved over the years, products have become more and more advanced. Today, while the vast majority of funds like the
SPDR S&P 500 ETF
passively track a broad index, investors can target increasingly complex slices of the market or magnify their returns using leveraged and alternative products.
Investors can also now choose from the growing collection of actively managed ETFs which promise stronger returns than a traditional index ETF.
While these new classes of exchange traded funds make promises of market beating returns, their use of derivatives make them increasingly risky. The dangers of holding these products have drawn the attention of the SEC which, in an effort to better grasp the use of derivatives in these products, placed a freeze on any new ETF which employs these instruments to achieve their goals.
The companies most affected by this freeze include
: the three firms leading the leveraged ETF revolution.
While it may not have much to do directly with this regulatory development, since the SEC started its investigation, two of these providers have announced dramatic changes to their current and forecast leveraged ETF line-ups.
On Monday, investors learned that Rydex is planning to close nearly every leveraged exchange product in its lineup. Though well known for its leveraged mutual funds like the
Rydex Dow 2X Strategy Fund
, traditional ETFs like the
Rydex S&P Equal Weight Index ETF
, and CurrencyShares ETFs like the
CurrencyShares Euro Trust
, Rydex also commands a suite of fourteen 2X leveraged products that allow investors to take bullish and bearish bets a number of indexes and sectors.
For 12 of these products, May 21 will mark their final day of trading.
Products scheduled for execution include the
Rydex 2X Russell 2000
Rydex Inverse 2X S&P Midcap 400
and the Rydex
2X S&P Select Sector Health Care
. While these funds have been available for over two years, they have failed to gain much of a following.
The two funds that will survive the onslaught are the
Rydex 2X S&P 500 ETF
Rydex Inverse 2X S&P 500 ETF
, which each have about 100k in average volume and about $190 million in combined assets. The twelve closing funds have $130 million in assets.
The Rydex news follows Direxion's unveiled plans for a collection of 36
. Similar to Direxion's current line-up, the vast majority of these funds will offer triple the performance, up or down, of market slices such as gold, Brazil and water. However, two additional products will allow investors to take unleveraged bullish bets on the performance of the automotive and airline industry.
Although uncharacteristic, these two funds may end up being blockbuster products from the firm. The Direxion Auto Shares and the Direxion Airline Shares will not only be immune from the regulatory assault but also, given the performance of these two specific market slices throughout the economic recovery, the popularity of these funds could set the stage for even more unleveraged products from Direxion.
As the ETF industry has expanded and become more commonplace among investors, it has gone through a number of transformations. While many of these developments have been beneficial for retail investors, others have made this industry a riskier place.
The SEC's investigation appears to be ushering the next step in this industry's evolutionary process. During this time, investors will want to stay on top of this development or risk being left behind.
At the time of publication, Dion owned QQQQ.
Don Dion is president and founder of
, a fee-based investment advisory firm to affluent individuals, families and nonprofit organizations, where he is responsible for setting investment policy, creating custom portfolios and overseeing the performance of client accounts. Founded in 1996 and based in Williamstown, Mass., Dion Money Management manages assets for clients in 49 states and 11 countries. Dion is a licensed attorney in Massachusetts and Maine and has more than 25 years' experience working in the financial markets, having founded and run two publicly traded companies before establishing Dion Money Management.
Dion also is publisher of the Fidelity Independent Adviser family of newsletters, which provides to a broad range of investors his commentary on the financial markets, with a specific emphasis on mutual funds and exchange-traded funds. With more than 100,000 subscribers in the U.S. and 29 other countries, Fidelity Independent Adviser publishes six monthly newsletters and three weekly newsletters. Its flagship publication, Fidelity Independent Adviser, has been published monthly for 11 years and reaches 40,000 subscribers.