Canada Markets close in 3 hrs 42 mins

An Insidious New Class of Investment Instruments That You Should Steer Clear of

Joey Frenette

You’ve likely heard of ETFs. They’re a terrific instrument that many investors use to invest in a basket of hand-picked stocks. These days, there are a tonne of options to choose from when it comes to ETFs. With more of them flooding into the Canadian and U.S. exchanges, many passive investors may be overwhelmed with the ridiculous amount of choices they have.

Weren’t ETFs supposed to simplify the experience for passive investors?

Yes, ETFs (and index funds) are fantastic instruments that make the lives of passive investors easy. Is there a dark side to the rise of passive investment instruments?

There are, and such new investment instruments should come with warning labels.

Consider ETNs, which are like ETFs, but with one major caveat — they’ve got no real underlying assets. An ETN is an unsecured note issued by an institution, and the risk placed on the investor is elevated substantially versus your typical ETF, which is backed by real assets, like gold. Many ETNs can be instruments used for gambling on speculative events, and unfortunately, those who touch these toxic securities without truly understanding them could stand to lose their shirt.

I’m not sure why any trader would dare touch such securities, as many of them could end up blowing up suddenly, wiping out a tonne of wealth in what would seem like an instant.

Consider the VelocityShares Daily Inverse VIX ETN (NASDAQ:XIV), which absolutely nosedived, shedding ~93% of its value in just a day, crushing many traders who dared to dabble in the toxic security. XIV held no assets that acted as an index to show the inverse of the VIX volatility index (or fear gauge). For many traders, the ETN was a “free ride up,” until it wasn’t after the markets plunged earlier this week. The XIV ETN is now a getting its plug pulled, and unfortunately, many traders are in financial ruin.

Bottom line

Just when you thought Bitcoin-associated stocks like Hive Blockchain Technologies Ltd. (TSXV:HIVE) or cannabis stocks like Aurora Cannabis Inc. (TSX:ACB) were the most dangerous publicly traded securities, some toxic ETNs are rearing their ugly heads, making cryptocurrencies and cannabis stocks look like a safe preservation of wealth in comparison.

Stay hungry. Stay Foolish.

More reading

Fool contributor Joey Frenette has no position in any of the stocks mentioned.