This disclosure statement explains certain options and features which are common to most ETPs. Of course, we cannot cover everything about ETPs. The best source of information about a specific ETP is the investor prospectus prepared by
the fund manager which your Janney Financial Advisor can provide upon request. If you have questions about an investment, you should discuss them with your Financial Advisor before you invest.
EXCHANGE TRADED PRODUCTS (“ETPs”)
Exchange Traded Products (ETPs) include Exchange Traded Funds (ETFs) and Exchange Traded Notes (ETNs). ETPs are designed to track an underlying asset, such has stocks, bonds, commodities or index and trade on a stock exchange. All ETPs have risks including
market, liquidity, and pricing tracking risk.
Exchange Traded Fund (“ETFs”)
ETFs are registered investment companies that offer investors a way to pool their money in a fund that makes market investments in stocks, bonds, other assets, or some combination of these investments and, in return, you receive an interest in that investment
pool. ETFs hold the assets they invest in, are traded throughout the day, and can be purchased with relatively low dollar amounts by purchasing as little as one share at the fund’s market price.
Exchange Traded Notes (“ETNs”)
ETNs are senior unsecured debt obligations issued by financial institutions and designed to track the total return of an underlying market index or other benchmark, minus investor fees. The issuer promises to pay ETN holders the return on the underlying
asset or index over a certain period of time and return the principal of the investment at maturity and therefore ETNs are subject to credit risk of the issuer. ETNs can be held to maturity or bought and sold at will.
RISKS OF INVESTING IN ETPs
The risks associated with purchasing ETPs are important considerations in making a purchase decision. Such risks include, but are not limited to, credit risk, market risk, management risk, liquidity risk, interest payment risk, price tracking risk, and
redemption risk. This list is not exhaustive. Before investing, carefully consider all risks and read the prospectus for the specific ETP which is available on the investment company website. ETFs involve price tracking risk, which is the risk that
the performance of the ETF may diverge from that of its underlying index. Tracking error may occur because of imperfect correlation between the ETF’s holdings of portfolio securities and those in the underlying index, pricing differences, the
ETF’s holding of cash, differences in timing of the accrual of dividends, changes to the underlying index or the need to meet various regulatory requirements. This risk may be heightened during times of increased market volatility or other unusual
market conditions. Tracking error may also result because the ETF incurs fees and expenses, while the underlying index does not.
An ETNs repayment of the principal, interest (if any), and any returns at maturity or upon redemption are dependent on that issuer’s ability to pay. Thus, the issuer’s potential to default is an important consideration for ETN investors. ETNs
do not generally offer principal protection unless specifically stated in the prospectus. Some ETNs are callable or redeemable by the issuer before their stated maturity date. Furthermore, the trading price of an ETN in the secondary market may be
adversely impacted if the issuer’s credit rating is downgraded.
Actively-managed ETPs do not seek to replicate the performance of a specified passive index of securities. Instead, they use an active investment strategy to attempt to meet their investment objective. An investor’s decision would usually be based
on their assessment as to whether the ETP investment manager can select securities that will lead to outperformance versus the benchmark, net of the ETPs fees, over a given market cycle or longer period of time. Actively-managed ETPs are therefore
exposed to management risk and typically charge higher fees than ETPs that passively track an index.
INVERSE OR LEVERAGED ETFs
Inverse or Leveraged ETFs are non-traditional ETPs and include leveraged, indexed and volatility funds that are more complex than traditional ETPs and may not be appropriate for all investors. Many of these instruments are specifically designed for short-term
trading. In some instances, due to a daily reset function, a holding period of longer than one trading day creates potential tracking errors versus the long term performance of the underlying index.
What is a Leveraged ETF?
Leveraged ETFs employ financial derivatives and debt to try to achieve a multiple (for example two or three times) of the return or inverse return of a stated index or benchmark over the course of a single day.
Are Leveraged ETFs risky investments?
The use of leverage typically increases risk for an investor. The more leverage is used (e.g., 150% versus 100%), the greater the potential magnification of gains or losses on those investments. However, unlike utilizing margin or shorting securities
in your own account, you cannot lose more than your original investment.
What is an Inverse ETF?
An inverse ETF is designed to track, on a daily basis, the inverse of its benchmark. Inverse ETFs utilize short selling, derivatives trading, and other leveraged investment techniques, such as futures trading, to achieve their objectives.
In attempting to provide performance opposite to its benchmark over short investing horizons, and excluding the impact of fees and other costs, an inverse ETF attempts to provide a result similar to short selling the stocks in the benchmark index. For
example, an inverse S&P 500 ETF seeks a daily percentage movement opposite that of the S&P 500. If the S&P 500 index rises by 1%, the inverse ETF is designed to fall by 1%, and if the S&P falls by 1%, the inverse ETF is designed to
rise by 1%. Because it is assumed that their value will rise in a declining market environment, inverse ETFs are of interest to some investors during bear markets.
Are Inverse ETFs a risky investment?
Purchasing an Inverse ETF is not the same as holding short positions in securities that make up the underlying index or benchmark. That is, if one enters into a simple short position on one day, and after some number of days the price of the underlying
security has changed in value by X%, then one's payoff is -X%, regardless of what has happened in the meantime. However, the performance of an inverse ETF, being the compound of daily returns, will likely differ in comparison with the simple short
position.
Inverse ETFs carry liquidity risks and are speculative investments. Inverse ETFs are not designed to be used as long-term investment vehicles. Due to rebalancing methods, and compounding, extended holding periods beyond one day can lead to results that
vary from just an inverse of the index or benchmark the investment tracks over the same time frame. In addition, gains or losses can be magnified in volatile markets.
Inverse ETFs are not suited for long-term investment strategies. These funds tend to carry higher fees, due to active management, that can also affect performance.
Why are Inverse and Leveraged ETFs susceptible to market volatility?
Most Inverse or Leveraged ETFs get their leverage by using derivatives. The prices of derivative contracts do not necessarily move in tandem with the underlying securities. As a result, Inverse or Leveraged ETFs can have volatile price movements
and race ahead or fall behind their stated index over long and short periods. Costs of borrowing to implement leverage as well as any efforts to insure counterparty risk are borne by the fund, creating a potential drag on returns.
Example: If a target index is up 10% for a month, will a Leveraged ETF that utilizes 3 times leverage have a 30% gain?
Probably not. Leveraged ETFs seek to amplify investment results, before fees and expenses, of the price performance of its benchmark index, based on a daily objective.
Indeed, long-term performance (when held beyond a day) will almost certainly vary, depending on market movements and portfolio adjustments required to pursue the daily investment targets set by the Leveraged ETF. For example, it is not unheard of for
two Leveraged ETFs - with completely opposite strategies (one with a bullish strategy, the other with a bearish one) - to BOTH show sizeable declines. Remember, most Leveraged ETFs (as are most Inverse ETFs) are considered short-term trading vehicles.
Holding a Leveraged ETF for a period longer than one day may create returns that differ - sometimes greatly - from the stated multiple of the benchmark index.
Are Inverse and Leverage ETFs for short-term or long-term investing?
Inverse and Leveraged ETFs are designed to be used for short-term investing as part of a market timing strategy and do not appear appropriate for the buy-and-hold or conservative investor. Leveraged ETFs “reset” daily, meaning that they
are designed to achieve their stated objectives on a daily basis. For this reason, if they are held for a period longer than one day, their performance can differ significantly from the stated performance of their underlying benchmark. Returns over
longer periods of time can differ significantly in both amount and direction from the target return of the same period. ETFs tracking the movement of non-appreciating assets such as the volatility based indexes carry significant risks and long-term
hold periods are likely to result in a complete loss of invested principal. The effects of compounding, aggressive techniques, and correlation errors may cause the ETFs to experience greater losses than expected and therefore are considered
a complex product. This is especially true in volatile markets. Compounding may also cause the performance disparity to widen between the investment and its underlying benchmark. These investments may experience losses even in situations where the
underlying benchmark has performed as desired. Investments in leveraged and/ or inverse ETPs must be monitored on a daily basis and are typically not appropriate for a buy-and-hold strategy
Inverse and Leveraged ETFs are generally most suitable for sophisticated investors who understand leverage and are willing to assume the risk of magnified potential losses. Given the risk/ return trade-offs, these types of ETFs are unlikely to be appropriate
for long-term investors who typically subscribe to “buy and hold” investment strategies. Suitability may also depend on the degree to which the Inverse or Leveraged ETF represents a proportion of an individual’s investment portfolio.
Investors must take special care to make sure they understand the investment theory around owning these instruments, and due to the volatile nature of the investments, watch them closely.
The Financial Industry Regulatory Authority (FINRA) and the Securities and Exchange Commission (SEC) have issued warnings to retail investors of the risks associated with investing in leveraged or inverse ETFs and issued an Investor Alert entitled "Leveraged and Inverse ETFs: Specialized Products With Extra Risks for Buy-and-Hold Investors," which is available on both FINRA's and the SEC's web sites.
COSTS OF INVESTING IN ETPs
Investors will pay a commission when purchasing or selling an ETP in a brokerage account but are not subject to the same type of loads as mutual funds. In addition to the advisor’s commission, investors will pay fees and expenses, commonly referred
to as “operating expenses” or “investor fees”, which are paid indirectly by a deduction in the value of the security. These fees may be charged for management of ETP assets, ETP trust operating expenses, distribution, and other
expenses. Fees vary depending on the type of ETP. In addition to the internal fees associated with ETPs, ordinary equity trading commission generally apply unless purchased in a fee-based program, where an asset-based fee would apply. These fees are
in addition to any internal costs of the ETP.
UNDERSTANDING HOW JANNEY AND YOUR FINANCIAL ADVISOR ARE COMPENSATED
Janney and our Financial Advisors receive compensation when clients purchase or sell an ETP. The compensation may be in the form of a transaction-based commission or an advisory fee which is a percentage of assets under management.
Through our relationship with ETP managers, Janney and our Financial Advisors also receive other forms of compensation that do not directly affect the amounts our clients are charged, such as promotional assistance. These forms of compensation are meant
to cover a variety of initiatives and expenses incurred by Janney, including expenses associated with marketing ETPs to investors, educating Financial Advisors, and performing administrative services for clients.
Janney Financial Advisors, consistent with the firm’s practices, may also receive non-cash compensation and other benefits from ETPs. Such non-cash compensation includes invitations to attend conferences or educational seminars sponsored by ETP
mangers or their advisers or distributors, payment of related travel, lodging and meal expenses, and receipt of gifts and entertainment. Acceptance of these benefits is in accordance with industry regulations and Janney’s policies. Clients should
review all ETP prospectuses and other offering documents for further explanation.
Receiving non-cash compensation presents a conflict of interest and gives Janney and its Financial Advisors an incentive to recommend investment products based on the compensation received, rather than based on a client’s needs. We address this
conflict by maintaining policies limiting gifts and gratuities and disclosing this conflict to clients.
Additional Information Is Available at:
https://www.finra.org/rules-guidance/key-topics/etf/non-traditional-etf-faq
https://www.sec.gov/investor/pubs/leveragedetfs-alert.htm
http://www.sec.gov/investor/alerts/etfs.pdf
http://www.sec.gov/answers/etf.htm