BlackRock, Inc. (NYSE:BLK)’s Larry Fink issued a stern warning regarding leveraged ETFs yesterday, saying the investment vehicles have the potential to “blow up.”

BlackRock

Fink asking to shift focus away from assets under management to individual products

“BlackRock, Inc. (NYSE:BLK) would never do a leveraged ETF,” Fink was quoted as saying in a Bloomberg article, asking regulators to shift their focus from the assets under management to the danger and leverage within each product.  Blackstone is currently under consideration as a potentially “systemically important financial institution” (SIFI), a designation that the firm wishes not to add. By focusing on product risk and not assets under management the focus could move away from Blackrock.

Leveraged products should be carefully supervised

Fink advocated products with embedded leverage be supervised. “We still need a safer and sounder market,” he said.  The Securities and Exchange Commission typically regulates ETFs but has little experience in regulating leveraged products that use derivatives, which are most commonly found in managed futures, which is primarily regulated by the CFTC.  In supervision of such products, care to recognize the margin to equity ratios and leverage usage relative to each strategy has been a critical point for professional investors to consider.

BlackRock, Inc. (NYSE:BLK) is the world’s largest investment firm with $4.4 trillion under management in both passively managed and actively managed funds and accounts. In ETFs, the firm’s iShares product is an industry leader. Actively managed funds, not normally associated with ETFs, generate higher fees.  The leveraged ETF essentially uses derivatives to amplify performance both positive and negative. Fink is concerned that investment managers would misuse their leverage allocation and could generate a negative balance under the wrong circumstances. With derivatives, unlike stock investments, the loss potential is not limited to the amount invested, making trading in such products highly risky if not properly supervised. Fink said he doesn’t understand why the SEC allows the leveraged ETFs to operate.

Blackrock’s competition leads list of largest leveraged ETFs

The largest leveraged ETFs are offered by Blackrock’s competition and include primarily ProShares and Direxion funds.  The top funds relative to assets under management include the ProShares Ultra S&P 500, with over $2 billion under management, the ProShares UltraShort S&P 500 with $1.6 billion and the Direxion Binancial Bull 3X Shares, with $1.2 billion under management.  These funds essentially take an index approach to investing and utilize leverage to boost returns. Managed futures, by contrast, takes a more actively managed approach utilizing quantitative formulas to capture market trends, volatility and relative value opportunities in the market.

Fink isn’t a big fan of undisclosed leverage.  In 2011, the report noted, Fink compared the development of complex ETFs to the financial engineering in the 2008 opaque mortgage-backed securities and related derivatives implosion that sent the economy spiraling into recession.