A Fraud By Any Other Name Is ...

A Fraud.

That is the character of the latest recognized Wall Street "product" sold to the public, viz. the leveraged and short ETFs. THe WSJ and Barron's have had articles in the past week showing how those ETFs are simply bunco scams sold under misleading names to the public.

Here's an example from this week's Barron's -

"SUPPOSE YOU HAD PREDICTED -- correctly, as it turned out -- that the Chinese economy would slow following last summer's Beijing Olympics, causing China's stock markets to tumble. Also suppose that, to profit from your insight, you had invested in the ProShares UltraShort FTSE/Xinhua China 25 , a leveraged exchange-traded fund (ticker: FXP) designed to go up by as much as twice the percentage that the FTSE/Xinhua China 25 Index falls on a given day.

When Chinese stocks crashed by 34% over the following four months, shouldn't you have reaped a gaudy return around 68%? Not exactly. In fact, you would have lost 56%. How can this be?"

Easy. The mountebanks at Proshares, Rydex and others created a product to make themselves and their Street market maker pals money at the public's expense. And the SEC, as usual, played along. All these ETFs that are based on derivatives and not actually holding the true assets are simply casino games. No assets are owned or investments made. The fund has a deal with the Street derivative desks who buy and sell it derivatives to meet the technical fine print "performance" in the fund's prospectus. Never mind that the title of the "fund" is grossly misleading. And to even call these "investments" is a lie. These are no more "investments" than the racing bet slips one gets at the track.

At least at Las Vegas one can know the true odds of a bet. In casino craps - my preferred game - the house take is 1.41% on a pass line bet. If you leverage that with the free odds, you can reduce it to 0.374% at most Las Vegas tables where 3-4-5x free odds bets are allowed. Not bad. But over time you'll lose everything. We all know that.

That principal applies to these derivative-based ETFs. As these "funds" churn up and down, the Street 'vig" is extracted over and over as money flows into and out of these "funds". Don't "invest" in them or use them to "hedge". The Street "vig" will bleed you to death over time.

They are suitable only for day traders to speculate.

Other factors cause large changes, too. The amount of leverage in the fund DOES NOT match the leverage of an actual short or leveraged positions. Any investor on margin knows his leverage changes as the price of the asset changes: the amount of debt is fixed but the net equity moves up and down, changing the leverage ratio. The Street products don't do that as they are based on "notional" derivatives. So these "funds" are not suitable for hedgers, either.

"Investors" in the oil ETF know this by now. When the USO was created, its price was about equal to the price of a barrel of oil. Now it's price is about $31, but the price of a barrel of oil is about $39. So "investors" in oil have lost about 20% of their "investment" more that the actual value of a barrel of oil have fallen. Nice.

Thanks, SEC, for letting these bunco artists loose on the public.

Speaking of frauds ...

Another hedge fund bites the dust.

"Harbinger Capital, the activist US hedge fund headed by Philip Falcone that shot to fame in 2007 with a lucrative bet against subprime mortgages, joined the list of funds restricting withdrawals for investors a day before the end of last year, according to two investors.
Harbinger’s main fund rose almost 43 per cent in the first six months of last year but lost all its profits and ended the year down 27.1 per cent. After redemptions and losses, the fund now manages about $6bn, one investor said, down from a peak of almost $20bn last summer."

Aw, shucks ...

Word of the Day

"Pulchritude" - noun [$10] literary; "Pulchritudinous" - adjective. A Mencken word.
Pulchritude means beauty.
Pulchritudinous means possessing or relating to beauty.
Sentence: The pulchritudinous schemes of the creators of the leveraged and short ETFs would be deeply appreciated by Dutch Shultz, who loved the numbers racket in old New York City. Over time, he got it all.