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

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

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

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

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

NASAA 2010 Investment Adviser Training ETFs vs Mutual Fund Costs Costs ETFs would pay brokerage commissions, where MFs may be purchased direct with no load ETFs would pay brokerage commissions, where MFs may be purchased direct with no load ETFs have a lower expense ratio (not actively managed) ETFs have a lower expense ratio (not actively managed) Most ETFs do not have 12b-1 fees Most ETFs do not have 12b-1 fees Taxation Taxation ETFs are generally more tax-efficient 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 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 Trading MFs end of the day pricing MFs end of the day pricing Rebalancing and Dollar-Cost Averaging easier with MFs Rebalancing and Dollar-Cost Averaging easier with MFs

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

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

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

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

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

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