Exchange Traded Funds (ETFs) & Leveraged ETFs

1. Exchange Traded Funds (ETFs) & Leveraged ETFs Chad Hartwick State of Michigan NASAA 2010 Investment Adviser Training

2. These views are my own views and not necessarily those of NASAA or the State of Michigan NASAA 2010 Investment Adviser Training

3. ETFs in General • Definition – Security that tracks an index much like a index mutual fund but is traded like a stock on an exchange. • ETFs hold assets such as stocks and bonds. • Legally classified as: • Open-end investment companies • Unit Investment Trusts (UITs) • First ETFs were created by SSgA (1993) • Spiders (SPDR) – S&P 500 – SPY on AMEX • Approximately 1000 ETFs NASAA 2010 Investment Adviser Training

4. Trading ETFs • Trade intraday just like stocks • Can sell short, limit orders, stop-loss orders, and buy on margin • No minimums • Many have the ability for options to be written against them • Very small deviation between market price and net asset value NASAA 2010 Investment Adviser Training

5. ETFs Types • Index ETFs – most popular • Sector ETFs – more expensive • Commodity ETFs – not regulated as investment companies under the 40 act • Fixed-Income ETFs – Bond, Treasuries • Currency ETFs – generally not long term • Actively Managed ETFs – started in 2008 • Inverse ETFs – moves opposite of benchmark • Leveraged ETFs – greater volatility NASAA 2010 Investment Adviser Training

6. ETFs vs Mutual Fund • Costs • ETFs would pay brokerage commissions, where MFs may be purchased direct with no load • ETFs have a lower expense ratio (not actively managed) • Most ETFs do not have 12b-1 fees • Taxation • ETFs are generally more tax-efficient • ETFs investors only realize capital gains when they sell their own shares or when the ETF trades to reflect a change in the index • Trading • MFs end of the day pricing • Rebalancing and Dollar-Cost Averaging easier with MFs NASAA 2010 Investment Adviser Training

7. ETFs vs Mutual Funds • Dividends • ETFs distribute quarterly • MFs immediately • Liquidity • Some ETFs are not as liquid and may have high bid-ask spreads • MFs always get NAV at the end of the day • Transparency • ETFs have transparent portfolios NASAA 2010 Investment Adviser Training

8. Leveraged ETFs • Exposure to indexes with greater volatility • If S&P 500 rises by 1% the LETF would rise by 2% • If S&P 500 falls by 1% the LETF would fall by 2% • Leveraged ETFs typically uses options and futures • May be purchased in retirement accounts • Usually has higher expense ratios • Daily rebalancing, maintaining ratio • Low liquidity • Short Term NASAA 2010 Investment Adviser Training

9. Inverse ETFs • Moves in opposite direction of benchmark • If S&P 500 rises by 1% the IETF fall by 1% • If S&P 500 falls by 1% the IETF would rise by 1% • Uses short positions on underlying stocks • Hedge for bearish markets when you don’t want to sell or can’t • May be purchased in retirement accounts • Daily basis investment objective • Leveraged Inverse ETFs NASAA 2010 Investment Adviser Training

10. Leveraged Returns • Day 1 – Market -10% • Index $100 - $10 = $90 • LETF(2) $100 - $20 = $80 • Day 2 – Market +10% • Index $90 + $9 = $99 • LETF(2) $80 + $16 = $96 • Index Return of -1% • LETF(2) Return of -4% NASAA 2010 Investment Adviser Training

11. Resources • NYSE – Informed Investor – What should you know about exchanged traded funds • SEC – Exchange-Traded Funds • SEC/FINRA Investor Alert – Leveraged & Inverse ETFs • FINRA – Non Traditional ETFs – FAQ • FINRA – Notice to Members 09-31 NASAA 2010 Investment Adviser Training

12. Thank you! Have a nice day J NASAA 2010 Investment Adviser Training