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Beware of Exotic ETFs Bearing Credit-Default Swaps

If you’ve always wanted to bet your savings on risky credit derivatives, now’s the time. In May regulators signed off on a plan to allow trading in eight exchange-traded funds (ETFs) created by ProShares that will hold credit-default swaps—the derivatives that helped bring on the global credit crisis in 2008.


Swaps for amateurs

Credit-default swaps are investment contracts that function like insurance: One party makes payments to another in exchange for a guarantee to be made whole if a borrower defaults. The eight ProShares funds allow investors to bet on or against indexes of investment-grade and junk bonds in North America and Europe.


Alternative universe

Calling itself the “alternative ETF company,” ProShares operates funds that track the stock market, government and corporate bond indexes, volatility, inflation, and commodities. It offers leveraged funds that use borrowed money to amplify returns, rising or falling twice or three times as much as a specified index each day.


Just like the pros

ProShares funds are primarily aimed at professional investors, who find ETFs to be an uncomplicated, inexpensive way to put money into specialized markets. About two-thirds of money managers who focus on debt are using ETFs this year, up from 55 percent in 2013, according to a Greenwich Associates survey. The new ProShares ETFs join more than 250 others that are based on derivatives. “ETFs are gaining traction in asset classes outside equities, especially in fixed income,” says the study.


Or maybe not

The universe of ETFs, where the plain-vanilla, stock-market-tracking SPDR S&P 500 ETF remains the biggest fund by far, is increasingly becoming home to exotic portfolios. ETFs trade on exchanges like stocks, and there are no restrictions on who can buy them and no minimum investment. So if you have an irresistible urge to make a bet that junk-rated companies are going to struggle to pay their bills in the near future, ProShares CDS Short North American HY Credit ETF may be just for you. Otherwise, perhaps this and similar investments are better left to the professionals.

Abramowicz is a reporter for Bloomberg News in New York.

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