This disclosure statement is in place to provide you with information regarding the risks associated with purchasing leveraged or inverse products.
Leveraged products seek to deliver multiples of the performance of the index or benchmark they track. Inverse products seek to deliver the opposite of the performance of the index or benchmark they track. Some leveraged and inverse products track broad indices, some are sector-specific, and others are linked to commodities, currencies, or some other benchmark. Inverse products often are marketed as a way for investors to profit from, or at least hedge their exposure to, downward moving markets.
Leveraged inverse products seek to achieve a return that is a multiple of the inverse performance of the underlying index. An inverse product that tracks a particular index, for example, seeks to deliver the inverse of the performance of that index, while a 2x (two times) leveraged inverse product seeks to deliver double the opposite of that index's performance. To accomplish their objectives, leveraged and inverse products pursue a range of investment strategies through the use of swaps, futures contracts, and other derivative instruments.
Most leveraged and inverse products "reset" daily and are designed to achieve their stated objectives on a daily basis. Their performance over longer periods of time—over weeks or months or years—can differ significantly from the performance (or inverse of the performance) of their underlying index or benchmark during the same period of time. This effect can be magnified in volatile markets. As the examples below demonstrate, an Exchange Traded Fund (ETF), which is a product that may utilize leverage or inverse objectives, is set up to deliver twice the performance of a benchmark from the close of trading on Day 1 to the close of trading on Day 2 and will not necessarily achieve that goal over weeks, months, or years.
The following two real-life examples illustrate how returns on a leveraged or inverse products over longer periods can differ significantly from the performance (or inverse of the performance) of their underlying index or benchmark during the same period of time.
How can this apparent breakdown between longer term index returns and product returns happen? Here's a hypothetical example: let's say that on Day 1, an index starts with a value of 100 and a leveraged product that seeks to double the return of the index starts at $100. If the index drops by 10 points on Day 1, it has a 10 percent loss and a resulting value of 90. Assuming it achieved its stated objective, the leveraged product would therefore drop 20 percent on that day and have an ending value of $80. On Day 2, if the index rises 10 percent, the index value increases to 99. For the leveraged product, its value for Day 2 would rise by 20 percent, which means the ETF would have a value of $96. On both days, the leveraged product did exactly what it was supposed to do—it produced daily returns that were two times the daily index returns. But let's look at the results over the 2 day period: the index lost 1 percent (it fell from 100 to 99) while the 2x leveraged product lost 4 percent (it fell from $100 to $96). That means that over the two day period, the leveraged product's negative returns were 4 times as much as the two-day return of the index instead of 2 times the return.
The best form of investor protection is to clearly understand leveraged or inverse products before investing in them. No matter how you initially hear about them, it's important to read the prospectus, which provides detailed information related to the product's investment objectives, principal investment strategies, risks, and costs. The SEC's EDGAR system, as well as search engines, can help you locate a specific prospectus. You can also find the prospectuses on the websites of the financial firms that issue a given product, as well as through your Financial Advisor. Before investing in these instruments, you should consider the following:
Only invest if you are confident the product can help you meet your investment objectives and you are knowledgeable and comfortable with the risks associated.
Non-deposit investment products offered through RBC Wealth Management are not FDIC insured, are not a deposit or other obligation of, or guaranteed by, a bank, and are subject to investment risks, including possible loss of the principal amount invested.