Exchange traded funds, the miracle of modern investing, offer incredible diversity for institutional and individual investors. Last week a new set of exchange traded funds, or ETFs, debuted from ProShares. The new investments let investors dabble in the market for credit default swaps. You remember those, right? They were largely responsible for the 2008 financial crisis and nearly sunk AIG.
Credit default swaps are similar to insurance or gambling. One party to the transaction buys default protection from the other party. If the loan is repaid (in this case bonds from corporations) with no problems, only one party to the transaction comes out ahead: the one selling the default protection.
The two new ETFs offer investors exposure and inverse exposure to the credit of high yield debt issuers.
Here's a cogent explanation from Dave Nadig on ETF.com of the ProShares CDS North American HY Credit ETF (TYTE) and the inverse version, the ProShares CDS Short North American HY Credit ETF (WYDE):
TYTE is selling insurance to nervous nellies. It will generate income (currently around 3.45 percent), and if credit conditions get even better in the high-yield space (in other words, if the spread between junk bonds and investment-grade bonds gets narrower), then the net asset value of TYTE should go up as well.
WYDE is just the opposite -- it will pay out that yield over time (like a short-equity seller owing dividend payments), and will go up in NAV should spreads widen, or should there be some sort of crazy rash of defaults.
These are not investments for the unwary or unsophisticated. It should go without saying, but you never know. Case in point: This guy, who blundered into an exchange traded note linked to the volatility index, is now part of a class-action lawsuit alleging that the issuer understated the risks associated with the investment.
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Senior investing reporter Sheyna Steiner is a co-author of "Future Millionaires' Guidebook," an e-book written by Bankrate editors and reporters. It's available at all the major e-book retailers.