ProShare Advisors to offer 48 leveraged ETFs

In a move criticized by some industry experts, ProShare Advisors LLC plans to introduce 48 exchange traded funds that use leverage to provide short or magnified exposure to commodities and currencies. "I'm not a big fan of narrow commodity or currency ETFs to start with," said Sonya Morris, editor of Morningstar ETFInvestor, a newsletter published by Morningstar Inc. of Chicago. "They can be extremely volatile to begin with. Add shorting and leverage, and that only adds to the turbulence." ProShare declined to comment on its proposed ETFs, because the funds are in registration. The company filed papers with the Securities and Exchange Commission on Oct. 18 to offer the ETFs. Bethesda, Md.-based ProShare has faced criticism that its products are too dangerous. It currently offers 58 ETFs, all of which offer short or magnified exposure to a variety of indexes. In response to past criticism, of ProShare has maintained that its ETFs are appropriate "tools" for sophisticated investors. It appears that investors agree. The company broke though $9 billion in assets under management last month, an impressive feat given that its first ETFs weren't launched until 2006. At least one financial adviser said he thinks that the ProShare ETFs in registration could be useful. "As trend followers ourselves, we are looking at areas to provide extra alpha," said Tom Lydon, president of Global Trends Investments of Newport Beach, Calif. "If the bloom falls off the rose with commodities, might we consider going short? We wouldn't sell short, but we would consider a short ETF." The reason is that it can be a logistical nightmare to sell an ETF short, but it's simple to buy a short ETF, Mr. Lydon said, adding that the fact that the investment is structured as an ETF is a big plus. Many exchange traded commodity and currency products are not actually ETFs but ETF-like products known as exchange traded notes that track the same Dow Jones-AIG Commodities indexes, albeit without leverage. Some of the most popular of these are the iPath exchange traded notes, which are issued by Barclays Bank PLC of London and sold through Barclays Global Investors of San Francisco. Launched in 2006, they have amassed more than $2.6 billion in assets. ETNs are debt securities backed only by the credit of the issuer. ETFs typically are registered investment companies and are collateralized by an underlying portfolio of securities. One nagging question concerning ETNs is taxation. The Internal Revenue Service and the Department of the Treasury currently are reviewing their favorable tax treatment of the product. That uncertainty gives an edge to commodities ETFs. ETNs, because of their structure, also require investors to fill out a few extra forms at tax time, which investors don't like, said Marvin Appel, chief executive of Appel Asset Management Corp. in Great Neck, N.Y. But the possible negatives of ETNs do not mean that he would recommend commodities ETFs. Mr. Appel explained that because ETFs invest in commodities via futures, investors may experience performance at odds with general market trends. For example, when the futures markets are in "contango" — that is, when the price of a commodity for future delivery exceeds the spot price — funds that invest in commodities via futures can underperform. That's exactly what happened this year to the United States Oil Fund LP, a Denver-based ETF-like product from Victoria Bay Asset Management LLC in Alameda, Calif. The fund drastically lagged the run-up in oil prices, much to the disappointment of its investors. In its filing, ProShare said its proposed commodities ETFs will be subject to contango. Contango isn't currently a problem, but it could easily crop up if market conditions are right, said Jim Lowell, Needham, Mass.-based editor of Forbes ETF Advisor, a monthly newsletter. He said investors should consider the possibility of contango before investing in a vehicle that has the potential to be as volatile as ProShare's proposed ETFs. "We're still in the Wild West of ETFs' coming to market," Mr. Lowell said. "We will need to see how everything performs over rolling time periods." Given that, if investors are still interested in a commodities ETF, they may want to consider an existing commodities ETF that follows a broad commodities index, and doesn't employ leverage, Ms. Morris said. "I think there is an argument to be made to include them in a small portion in your portfolio," she said. David Hoffman can be reached at dhoffman@crain.com.