Leveraged and inverse exchange-traded funds endanger the health of investment portfolios if held for periods longer than a few days, a new report by FAIR Canada warns.

The nine-page report, called “Heads You Lose, Tails You Lose: The Strange Case of Leveraged ETFs,” says these types of funds have a high probability of losing money if they are held longer term.

“The longer you hold a leveraged or inverse ETF, the greater the likelihood that you will lose money, regardless of which direction you bet,” commented FAIR Canada executive director Ermanno Pascutto.

He pointed out that for the 12 months ending March 31, the S&P/TSX index of gold-mining stocks was up 1%, while the Horizons BetaPro Bear+ ETF lost 87%, and the Bull+ fund lost 46%.

“These were not anomalies. Four of the nine pairs of Horizons BetaPro’s leveraged ETFs with at least a year-long track record lost money in both their bull and bear versions for the 12 months ended March,” Pascutto said.

The ideas presented in the report are not new, according to Howard Atkinson, president of BetaPro Management Inc.

“These are nuances of how our products work,” he said.

The BetaPro leveraged and inverse leveraged ETFs seek to offer either two times or minus two times the daily return of the underlying index. It is inaccurate to compare the returns of a leveraged ETF to its corresponding index over a period longer than a day, Atkinson said.

“The investment objective is on a daily basis,” he said. “We meet that objective with almost perfect correlation.”

For periods longer than a day, Atkinson explained, “its mathematically incorrect to assume you will earn two times or minus two times whatever any period return is, because everyday we rebalance the portfolio.”

Leveraged and inverse ETFs are the most rapidly growing segment of the market, according to the report. Horizons BetaPro’s 32 funds in Canada have pulled in $2.1 billion in investor dollars in the past 26 months, with roughly 40% of these investors on the retail side. Canadian investors are also purchasing U.S. leveraged ETF products.

FAIR Canada expresses concern over the rapidly growing popularity of these types of ETFs, since many investors may be buying the products without realizing the risks involved.

“Despite recent warnings in the financial press on both sides of the border, many investors are unaware of the perils of holding leveraged or inverse ETFs for periods longer than a few days,” said FAIR Canada associate director Steve Garmaise. “Less sophisticated investors must be protected from financial ‘innovations’ that pose excessive risks to their savings while generating handsome returns for their sponsors. Just because something can be sold doesn’t mean that it should be sold – at least not without appropriate safeguards and warnings.”

The report argues that ETF marketing materials and prospectuses fail to convey the risks associated with the investments. It calls for regulatory action to protect investors, including a requirement for all leveraged and inverse ETF products offered in Canada to file a new prospectus with bold front page disclosure of the risks of holding these products for longer than a few days, particularly in volatile markets.

On Thursday, BetaPro filed a new preliminary prospectus that features this type of disclosure in bold print, Atkinson said.

“Any investor who either reads our prospectus and/or looks at some of the material on our website would very quickly have a good grasp of how these products work,” he said.

Atkinson added that BetaPro has been actively educating investors on its ETFs all along. “From day one, we’ve put out disclosure front and centre,” he said. “Every month we come out with more and more ways to educate the public on how our products work.”

Still, FAIR Canada calls for more prominent disclosure of the risks. It urges regulators to require prominent disclaimers on all print and broadcast advertising for these types of ETFs, as well as warnings to registrants of the need to consider the suitability of these products for clients.

IE