First Trust Advisors Highlights Key Investment Risks, Distribution Policies, and Fund Characteristics for Exchange-Traded Funds
First Trust Advisors L.P. (FTA), the investment adviser to the First Trust funds, has outlined important investment considerations, risk factors, distribution policies, and regulatory disclosures applicable to its exchange-traded funds (ETFs). The disclosures provide investors and financial professionals with information about the potential risks associated with investing in the funds, including market volatility, changes in investment values, liquidity conditions, derivatives exposure, and the possibility of losing invested capital.
The information emphasizes that past investment performance does not guarantee future results and that the value of ETF shares can fluctuate depending on market conditions and the performance of the underlying investments. Investors are encouraged to review the relevant fund prospectuses, shareholder reports, and regulatory filings before making investment decisions.
Investment Performance and Market Value Considerations
First Trust emphasizes that historical investment performance should not be considered an assurance of future returns. The investment return and market value of an investment in a fund may change over time, and investors could receive more or less than their original investment when selling their shares.
ETF investments are exposed to market movements that can affect the value of individual securities and the overall portfolio. Changes in economic conditions, interest rates, government policies, geopolitical developments, and investor sentiment may influence the performance of the funds.
The company also highlights that investing in its funds involves risks similar to those associated with investing in portfolios of exchange-traded equity securities. Although ETFs provide access to diversified or specialized investment strategies, they do not eliminate the possibility of financial losses.
An investment in a First Trust fund is not equivalent to placing money in a bank deposit account. Fund shares are not insured or guaranteed by the Federal Deposit Insurance Corporation (FDIC) or any other government agency. There is also no assurance that a fund will achieve its stated investment objective.
Investors should therefore consider their financial objectives, investment time horizons, and tolerance for risk before purchasing fund shares.
ETF Trading, Redemption, and Liquidity Risks
Exchange-traded funds have specific trading and redemption structures that distinguish them from traditional mutual funds.
According to First Trust’s disclosures, ETF shares can generally be redeemed directly with a fund only by authorized participants, and such transactions must occur in large creation or redemption units. Individual investors typically buy and sell ETF shares through the secondary market on stock exchanges.
This structure means that the market price of ETF shares may differ from their net asset value (NAV). Depending on market conditions, shares may trade at a premium or discount to the value of the underlying portfolio.
Liquidity conditions can also affect the ability of investors to purchase or sell shares at favorable prices. During periods of market stress, trading activity may decline, bid-ask spreads may widen, and the difference between market price and NAV may increase.
First Trust also notes that ETF shares may face delisting risks under certain circumstances. A delisting could affect the availability and trading conditions of fund shares, potentially creating additional challenges for investors seeking to sell their holdings.
These considerations make it important for investors to understand how ETF trading operates and recognize that exchange-traded products may experience pricing and liquidity risks.
Risks Associated With Different Company Sizes
The investment characteristics of companies included in a fund’s portfolio can influence its risk and return profile.
Small- and mid-capitalization companies may experience greater share price volatility than larger, more established businesses. Their securities may also be less liquid, which can make it more difficult to purchase or sell shares without affecting market prices.
Smaller companies may have limited financial resources, narrower business operations, and greater sensitivity to economic changes. These characteristics can create additional uncertainty during periods of financial market volatility.
Large-capitalization companies, meanwhile, may have more established business operations and greater access to financial resources. However, they may experience slower growth compared with the broader market or smaller companies during certain economic cycles.
Consequently, funds investing in different market capitalization categories may perform differently depending on prevailing market conditions and broader economic developments.
Distribution Policies and Return of Capital Considerations
First Trust also provides information about fund distribution policies and the circumstances under which distributions may be reduced or classified as a return of capital.
Funds generally distribute income earned through their investment activities. However, the amount distributed depends on the income generated by the portfolio and the fund’s applicable distribution policies.
If a fund does not generate sufficient income to support its distributions, it may be required to reduce the amount distributed to shareholders.
The company explains that distributions exceeding a fund’s current and accumulated earnings and profits may be treated as a return of capital. In certain situations, a portion of a distribution may also be classified as a return of capital even when the fund has generated investment income.
For example, a fund may sell securities to cover a derivative position that generated all or part of a distribution. Depending on the circumstances, this transaction could result in a distribution being classified partly or entirely as a return of capital.
A return of capital generally represents a return of a portion of an investor’s original investment rather than income generated by the fund. It may also reduce the investor’s adjusted cost basis in the fund shares, potentially affecting the tax consequences when those shares are eventually sold.
Investors should review distribution notices and applicable tax information to understand the composition of payments received from a fund.
Current Market Conditions and Economic Uncertainty
Current market conditions represent another significant risk factor for First Trust funds.
Changes in economic activity, government fiscal policies, regulatory developments, and financial market conditions may influence the value of securities held by a fund. These developments can affect individual investments as well as the broader financial markets.
First Trust identifies several factors that could materially affect investment values, including disruptions in banking and real estate markets, changes in governmental policies, and actual or threatened international armed conflicts and hostilities.
Public health crises and other significant global events may also create uncertainty across financial markets.
For example, disruptions in banking markets could affect financial institutions, lending conditions, and the availability of credit. Changes in real estate markets may influence property-related securities and investments connected to commercial or residential property activity.
International conflicts can create uncertainty in commodity markets, foreign exchange markets, and global supply chains. These developments may also affect investor confidence and lead to increased volatility across different asset classes.
Because market conditions can change rapidly, investors may experience fluctuations in the value of their ETF holdings even when the underlying fund strategy remains unchanged.
Cybersecurity and Operational Risks
Cybersecurity represents an increasingly important consideration for investment funds and financial services organizations.
First Trust notes that funds may be exposed to operational risks arising from cybersecurity breaches, including unauthorized access to systems, disruptions to technology infrastructure, and other security incidents.
Such events could result in financial losses, regulatory penalties, reputational damage, and additional compliance expenses associated with corrective measures.
Investment funds also depend on a range of third-party service providers to support their operations. These providers may perform activities involving custody, administration, transaction processing, technology infrastructure, and other essential services.
Although funds and their advisers may establish internal controls and procedures designed to reduce operational risks, it is not possible to eliminate every potential threat.
A delay, interruption, or failure involving a third-party provider could affect a fund’s operations and its ability to achieve its investment objectives.
These risks highlight the importance of operational oversight, cybersecurity controls, and effective relationships with service providers.
Risks Associated With FLEX Options and Target Outcome Funds
Certain First Trust funds use Flexible Exchange Options, commonly referred to as FLEX Options, as part of their investment strategies.
These options are designed to provide customized investment exposures and are traded through options exchanges. However, investing in FLEX Options involves risks that differ from those associated with direct investments in securities.
First Trust explains that Target Outcome funds may experience substantial losses associated with their FLEX Option positions. Certain options may also expire worthless, depending on market movements and the structure of the positions.
There is no guarantee that a liquid secondary market will exist for FLEX Options. These instruments may be less liquid than conventional exchange-traded options, potentially making it more difficult for a fund to adjust or close positions under certain market conditions.
Target Outcome strategies are designed to provide specific investment results over a predetermined period, subject to defined upside caps and downside protection features.
For certain funds, the strategy seeks to deliver returns that match the performance of a reference asset. Funds in the X series are designed to provide approximately twice the returns of the reference asset, subject to the applicable strategy limitations and upside cap.
These outcomes are generally designed around a specific Target Outcome Period, which begins when the fund establishes its FLEX Option positions and ends when those options expire.
The intended investment results are generally applicable to investors who purchase fund shares on the first day of the Target Outcome Period and maintain their investments until the end of that period.
Investors who purchase shares after the beginning of the period or sell before its expiration may experience returns that differ significantly from the fund’s stated target outcomes.
In such circumstances, the investor may not receive the intended downside buffer against declines in the reference asset. The investor may also fail to participate in potential gains up to the fund’s stated upside cap.
Furthermore, although these strategies are designed to limit certain downside losses under specified conditions, shareholders may lose their entire investment.
The disclosures emphasize that investors should understand the timing requirements, upside limitations, and potential downside exposure before investing in Target Outcome funds.
Market Risk and Broader Economic Developments
Market risk applies to individual securities and investment funds more broadly. The value of a particular security or the shares of a fund may decline because of changes in general economic conditions, political developments, regulatory policies, interest rates, and market sentiment.
Changes in perceived investment trends can also influence securities prices and create volatility across different market segments.
A fund may underperform other investments or experience a decline in value even when its investment strategy is implemented as intended.
First Trust also identifies local, regional, and global developments as potential sources of market disruption. These include wars, terrorism, infectious disease outbreaks, public health emergencies, recessions, natural disasters, and other unexpected events.
Such developments may affect business activity, financial markets, consumer confidence, and the financial condition of companies included in fund portfolios.
Because these factors are often outside the control of fund managers, investors should recognize that market risk remains an inherent part of investing.
Non-Diversified Funds and Concentration Exposure
Certain First Trust funds are classified as non-diversified under applicable investment company regulations.
A non-diversified fund may invest a relatively large percentage of its assets in a limited number of companies or issuers. This structure can increase exposure to developments affecting individual portfolio holdings.
If a significant investment experiences financial difficulties, regulatory challenges, or other adverse developments, the impact on a non-diversified fund may be greater than it would be on a broadly diversified portfolio.
Concentrated exposure can also increase share price volatility and make fund performance more dependent on the financial results of a smaller group of companies.
Additionally, funds with substantial investments in a particular asset class, country, geographical region, industry, or sector may be more vulnerable to adverse developments affecting those specific markets.
For example, a fund concentrated in a particular industry may experience significant losses if that sector faces declining demand, regulatory changes, or unfavorable economic conditions.
These characteristics mean that specialized funds may behave differently from broader market benchmarks and may not be suitable for every investor.
Commodity and Derivatives Investment Risks
Funds with exposure to commodities may experience significant fluctuations in value because commodity prices can change rapidly and unpredictably.
Commodity markets are influenced by supply and demand, geopolitical developments, weather conditions, economic activity, transportation disruptions, and other factors.
Changes in these conditions can affect the value of commodity-related investments and cause fund shares to rise or decline substantially.
First Trust also highlights risks associated with the use of derivatives, including futures contracts, options, swap agreements, and forward contracts.
Derivatives allow investment managers to obtain exposure to underlying assets, indexes, or interest rates without necessarily purchasing the underlying securities directly.
However, these instruments can also magnify investment losses when the underlying asset, index, or rate moves in an unfavorable direction.
The performance of derivative positions may be affected by market volatility, liquidity conditions, counterparty risks, pricing differences, and contractual terms.
Certain fixed-income securities also carry additional risks, including call, credit, extension, income, inflation, interest rate, prepayment, and zero-coupon risks.
Changes in interest rates may influence the market value of fixed-income investments, while credit deterioration could affect an issuer’s ability to meet its financial obligations.
Prepayment and extension risks may change the timing of expected cash flows, while inflation can reduce the purchasing power of investment income.
These factors may contribute to increased volatility and negatively affect a fund’s overall performance.
Benchmark and Underlying ETF Disclosures
First Trust provides additional disclosures concerning certain funds that use other exchange-traded products as reference assets or underlying investments.
The disclosures explain that certain funds are not sponsored, endorsed, sold, or promoted by State Street SPDR S&P 500 ETF Trust, PDR, or Standard & Poor’s and their respective affiliates.
These organizations have not evaluated the legality or suitability of the funds or the accuracy and completeness of the descriptions and disclosures relating to the funds and their FLEX Options.
They also make no express or implied representations or warranties concerning the advisability of investing in the funds or FLEX Options, or the results that may be obtained by investors.
Similarly, certain funds are not sponsored, endorsed, sold, or promoted by SPDR Gold Trust, WGTS, or their affiliates.
These organizations have not reviewed or approved the funds’ investment strategies or related disclosures and do not provide guarantees concerning the performance of the funds or their options positions.
Additional disclosures apply to funds referencing the iShares Silver Trust. The iShares Silver Trust, iShares Delaware Trust Sponsor LLC, and their affiliates have not endorsed the relevant fund or its FLEX Option strategy.
These organizations also make no representations or warranties regarding the suitability of the investment products or the results that investors may receive.
The disclosures clarify that the referenced organizations are not responsible for the management, administration, marketing, or trading of the First Trust funds.
First Trust Advisors’ Role and Regulatory Registration
First Trust Advisors L.P. serves as the investment adviser to the applicable First Trust funds.
The company is affiliated with First Trust Portfolios L.P., which serves as the distributor of the funds.
First Trust Advisors is also registered as a commodity pool operator and commodity trading advisor and is a member of the National Futures Association.
These registrations and affiliations form part of the company’s regulatory and operational framework for providing investment advisory and related services.
The investment adviser is responsible for managing the funds in accordance with their stated investment objectives and applicable investment policies. However, First Trust acknowledges that investment techniques and risk analysis applied by portfolio managers may not always produce the intended results.
Investment management decisions involve uncertainty, and actual market performance may differ from expectations.
The company’s disclosures therefore emphasize that investment strategies cannot eliminate market risks or guarantee specific financial outcomes.
Important Information for Investors and Financial Professionals
First Trust states that the information provided in its disclosures is not intended to constitute an investment recommendation or financial advice for any specific individual.
The company also clarifies that providing this information does not establish an advisory or fiduciary relationship under the Employee Retirement Income Security Act (ERISA), the Internal Revenue Code, or other applicable regulatory frameworks.
Financial professionals remain responsible for independently evaluating the risks associated with investment products and exercising their own professional judgment when determining whether a particular fund is appropriate for their clients.
Investors should review the applicable prospectus, shareholder reports, and regulatory filings to obtain complete information about a fund’s investment objectives, strategies, fees, expenses, and risk factors.
Investment Risk Awareness Remains Essential
First Trust Advisors’ disclosures highlight the wide range of considerations associated with investing in exchange-traded funds and specialized investment products.
While ETFs can provide access to different asset classes, investment strategies, and market exposures, they remain subject to market volatility, liquidity limitations, operational risks, cybersecurity threats, and potential investment losses.
Target Outcome funds and products using FLEX Options involve additional complexities because their intended results depend on specific investment periods, reference asset performance, and predetermined upside caps and downside protection structures.
Distribution payments also require careful consideration because distributions may be reduced or classified as returns of capital under certain circumstances.
For investors and financial professionals, understanding these characteristics is essential when evaluating investment suitability and portfolio risk.
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