It's not often a fund company declines to take investors' money. But in a surprisingly bold move last week, asset manager UBS did everything but, using all capital letters on the front page of a prospectus to steer mom and pop investors away from its new volatility-linked exchange-traded notes. "YOU SHOULD NOT INVEST IN THE ETNs," the Swiss bank shouted at regular investors. "THE ETNS ARE NOT INTENDED TO BE A 'BUY AND HOLD' INVESTMENT."
Such strong pronouncements are rare among companies offering exchange-traded funds and notes. Risk disclosures are rarely read, usually boilerplate and easily dismissed -- much to the frustration of investor advocates. But as ETFs and other investment products become increasingly complicated and risky, more firms may follow UBS' lead. Bold risk warnings have become standard for complex products, but few firms have been so obvious or blunt.
It remains to be seen whether such strong warnings will curb investors' temptation to bite on the latest offerings. While the first ETFs were low-cost mutual funds based on stock indexes from Standard & Poor's, MSCI or Dow Jones Indexes, investors can now choose from more than 1,000 products, including those based on fairly sophisticated strategies such as spread betting or currency hedging. Commenting on the proliferation of such risky products last week, Vanguard found John C. Bogle told the Wall Street Journal: "Some kind of monster was built out of what I created."
Short of a loud warning from the fund firm, here are three signs an ETF or ETN may not be right for you.
YOU'VE NEVER HEARD OF THE INDEX Most exchange-traded funds and notes follow a passive index to select stocks or bonds. While some funds slice up or refigure widely-used benchmarks, like the S&P 500 Growth ETF (SPYG)
YOU DON'T UNDERSTAND THE TERMS OR STRATEG Y If the name of the fund doesn't throw you, make sure you can follow the investment strategy. Dig into the fact sheet or the prospectus (not always available at your broker, but always available from the issuer). Not all ETFs and ETNs follow a benchmark index. Many take a predetermined set of stocks or bonds, then filter the holdings and weightings based on a proprietary set of rules. The strategy is verified by looking at theoretical past performance, but it may not necessarily work for your holding period or risk profile.
YOU'VE NEVER SOLD SHORT OR BOUGHT ON MARGIN Many ETFs zip to the top (and bottom) of the performance charts because they hit the very specific cycle (or day) they were designed for. For example, during the 2008 financial crisis, Direxion's pair of triple financial sector funds -- FAS (FAS)