This guy had a great year betting against ETFs

NEW YORK - In a town of financial wizards, David Miller stood out this year.

The Michigan-native is betting against one of the most popular investment vehicles for mom-and-pop investors: exchange-traded funds. The bets have paid off, turning Miller's little known Catalyst Mutual Funds into one of Wall Street's most successful players in 2015.

Over the past decade, these funds, known commonly as ETFs, have become an $3 trillion market behemoth. The typical ETF tracks a basket of stocks, allowing the investor to follow their ups and downs without buying each stock individually.

But as the ETF market has grown so has this tool's complexity. An increasingly popular form, a leveraged ETF, is designed to secure a bigger profit. Such a fund may use leverage, or debt, to guarantee bigger profits if the ETF's basket of stocks goes up, but even greater losses if it falls.

Regulators have become increasingly concerned that average investors may not be fully aware of the risks posed by these funds.

Miller's Catalyst Macro Strategies Funds began making complicated bets against some leveraged ETFs earlier this year. The fund has since grown from $500,000 in assets at the start of the year to about $168 million. It achieved a more than 50 percent return this year, placing it far ahead of its competitors.

"Our goal is to identify poorly designed financial vehicles," said Miller, Catalyst's senior portfolio manager. "The strategy has certainly worked out well for us."

While still a tiny part of the market, the growth of leveraged ETFs has been explosive. Nearly nonexistent in 2005, the market has grown to more than $20 billion this year, according to data from Lipper. The market has doubled since 2011.

But even as the industry has grown, so have concerns around whether investors understand the risks. The Securities and Exchange Commission proposed rules in December to rein in these type of funds. And the Financial Industry Regulatory Authority, also known as FINRA, has cracked down on brokers who have sold complicated ETFs they didn't understand.

"The SEC and FINRA have been coming down on them, and they still have not gone away," Miller said. "Money keeps coming into them despite their poor performance."

Of course, Wall Street is riddled with risks. Some investors are still digging out from the 2008 financial crisis. Even a brand-name stock can suddenly stumble. And as the market ebbs and flows are increasingly directed by computers rather than humans, retail investors can feel unfairly outwitted.

Even traditional ETFs aren't immune from market volatility. Over the summer, the price of some ETFs dropped off a cliff, then bounced back within minutes. Investors who automatically sold as their value plunged, faced heavy losses.

And Catalyst isn't the only fund looking to profit from problematic ETFs. New York hedge fund Hilltop Park has employed complicated trades to bet against some ETFs, according to The Wall Street Journal.

This comes amid a particularly rough year for Main Street investors, who may be most attracted to leveraged ETFs as they look to boost stagnate returns before retirement. With just a few days left in the year, the Dow Jones industrial average and the Standard & Poor's 500-stock index are both headed to a money-losing or flat 2015.

"There has been a push on leveraged ETFs, but I would leave that to the realm of sophisticated day traders not your mom-and-pop [investors]," said Michael Mullaney, chief investment officer at Fiduciary Trust Company, a wealth management firm. "They are just too risky for the average investor."

Among the biggest critics of these leveraged funds is BlackRock, the largest producer of ETFs. Last year, BlackRock CEO Larry Fink warned: "They have a structural problem that could blow up the whole industry one day."

Leveraged ETFs are a small "niche" part of the overall market, which is expected to triple to $9 trillion in assets within 10 years, said Martin Small, the head of BlackRock's U.S. iShares. BlackRock has recommended that regulators require that these type of ETFs be more clearly labeled.

"We just don't want investors to be confused about what the risks are for leveraged" and other nontraditional ETFs, Small said.