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Compliance Concepts

Non-Traditional ETFs: A Primer

November 21, 2017



by Howard Haykin


In October, FINRA reported on disciplinary sanctions against one firm and two brokers for unsuitable sales of Non-Traditional ETFs to retail customers. So, it's time for a brief primer on these speculative securities products. [Click on today's WWW post  ... "Firm Prohibited Sales of the Most Volatile Non-Traditional ETFs – But It Wasn’t Enough"]


Exchange Tarded Funds (ETFs) are typically registered investment trusts (UITs) or open-end investment companies whose shares represent an interest in a portfolio of securities that track an underlying benchmark or index. Shares of ETFs typically are listed on national securities exchanges and trade throughout the day at prices established by the market.


Leveraged ETFs are different from other ETFs in that they seek to deliver multiples of the performance of the index or benchmark they track. Some Non-Traditional ETFs are "inverse" or "short" funds, meaning that they seek to deliver the opposite of the performance of the index or benchmark they track. 


  • Some funds are both inverse and leveraged, meaning that they seek to achieve a return that is a multiple of the inverse performance of the underlying index or benchmark.
  • To accomplish their objectives, Non-Traditional ETFs use swaps, futures contracts and other derivative instruments.
  • Most Non-Traditional ETFs "reset" daily, meaning that they are designed to achieve their stated objectives on only a daily basis.
  • On a particular day, a Non-Traditional ETF may come close to achieving its intended return.
  • But the correlation between a Non-Traditional ETF and its linked index or benchmark is inexact, and there is typically at least a small difference or "tracking error," between a fund and its benchmark, which may compound over longer periods of time.
  • This effect becomes more pronounced during periods of volatility in the underlying index or benchmark.


FINRA RESPONDS TO POPULARITY   By January 2009, Non-Traditional ETFs had grown in popularity and their unique features and risks were prominently discussed in Non-Traditional ETF prospectuses and industry articles. FINRA noted in its June 2009 Regulatory Notice 09-31 about Non-Traditional ETFs that "[d]ue to the effect of compounding, their performance over longer periods of time can differ significantly from the performance ... of the underlying index or benchmark during the same period of time.” Because of the risks and the inherent complexity of the products, FINRA advised broker-dealers and their registered reps that Non-Traditional ETFs "are typically not suitable for retail investors who plan to hold them for more than one trading session, particularly involatile markets.”


FINRA NON-TRADITIONAL ETFS FAQ.    Visit FINRA's FAQ page for answers to these questions:

  • What are leveraged or inverse ETFs?

  • How can the "reset" feature of a leveraged or inverse ETF affect suitability?

  • What does the suitability analysis require?
  • Can leveraged and inverse ETFs be suitable for a retail investor?
  • What should firms do as new types of complex or non-traditional ETFs are introduced to the market?
  • What about leveraged or inverse mutual funds?