Leaving aside the oxymoronic concept of aggressively shorting a passive basket of stocks -- I mean, c'mon, if you are so convicted that you want to lever a short, how about a little selectivity? -- let's see if they could have figured this out, and indeed whether an ordinary retail investor could have figured out the dramatic failure of these instruments in advance.

My guess is, unfortunately, they must not have read the offering docs; it just viscerally sounds so good -- "Wow, a product that easily allows me to be 2 times short an index!" Yes, even the "sophisticates" can fall prey to gimmicks. But even still, what if they had read the offering docs?

I have just finished rereading the 165-page prospectus for one of these funds. It is my opinion that in no way, shape or form have they adequately disclosed the volatility risk -- in fact, they have a longer passage for risk associated with foreign investments than they do this concept of volatility eating away at returns outlined in my prior pieces. The "Statement of Additional Information" goes into a little more detail, but is still insufficient to explain the miserable failure of these as a term trade or hedge.

I believe the purveyors of these products were careless, reckless and perhaps even grossly negligent in disclosing the risks. Either they were a) completely clueless as to how dramatically these could underperform due to volatility (in the prospectus, they use 15% volatility and show underperformance of 70 to 220 basis points ... in the 68-page "Statement of Additional Information," they show volatility of up to 40% and underperformance of ~900bps, with the index down 40% ... nowhere remotely close to the underperformance we have seen), or b) they knew that performance looked horrendous at high volatilities but chose not to disclose. Given they show the tremendous potential outperformance of these if volatility is very low, my guess is they knew exactly what it would look like in the type of volatility environment we have seen, thus making "b)" more likely ... but, then again, if they knew of this risk, they'd disclose it more thoroughly, right? To be fair, I have no idea which is the case, but this raises my eyebrows a bit.

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