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Weird ice cream flavors have in recent years spread like mad and now include such inviting types as raw horseflesh or sardines and brandy. Is something similar happening in the world of ETFs, or Exchange Traded Funds?
Mario Draghi, chairman of the Financial Stability Board, hinted as much last week. On Monday, the FSB delivered a more detailed report on the matter, noting that these once “plain vanilla” investment products have taken a “disquieting” turn and have tacked on “new elements of complexity and opacity.”
The new flavors of ETFs pose new challenges regarding counterparty and collateral risks and could even cause liquidity problems for large asset managers and banks, the FSB said. That’s rather a mouthful compared to the original idea of ETFs, which, as the FSB notes, was to add some flexibility and cost-efficiency on top of the diversification benefits that standard mutual funds already offered.
To be sure, ETFs have been under a constant barrage of criticism from John Bogle, the legendary founder of Vanguard and the investor of index funds.
The warning comes as TD Ameritrade, a big American broker, rejoiced at how investors are increasingly “moving in and out of” the “spaces” ETFs purport to cover. “Retail investors are embracing the exposure to more specialized markets that ETFs can provide,” said Mike McGrath, TD Ameritrade’s director of ETFs, adding that they are especially popular among “younger and trendier” members of so-called Generation X and Generation Y.
Assets under management by ETFs have been growing around 40% a year over the past 10 years, eight times as fast as mutual funds or direct equity markets, according to the FSB.
Many ETFs have “physical” traits meaning they buy the securities underlying the index. The FSB said this type was prevalent in the U.S. and in offerings by large independent asset managers. But almost half the ETFs in Europe are “synthetic,” meaning they use derivatives and swaps instead of actually buying the constituents of the index for which it is a proxy. According to the FSB, they are generally provided by asset-management arms of banks, and one reason they may be growing is that they create synergies by serving as a counterparty to derivatives trading desks at the parent banks.
Remember securitized subprime mortgages? Those triple-A-rated bonds were available in thousands of types, unlike the mini-menu of similarly-rated U.S. Treasuries, which varied only by maturity duration. As later became evident, the sheer diversity boosted their opacity, as did complicated collateral schemes that ultimately depended on cheap short-term liquidity for support.
Could the proliferation of ETFs — the FSB noted you can now buy “leveraged ETFs, inverse ETFs, and leveraged-inverse ETFs” — be a sign of something similarly untoward?
Investors in ETFs may like the asset their fund proxies, but if what they really own are a set of swaps with a bank and if that bank defaults, their savvy will be for naught.
The FSB even notes that synthetic ETFs may belie incentives that aren’t properly aligned, and that “conflicts of interest can arise from the dual role of some banks as ETF provider and derivative counterparty.” Now that would be shocking…
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Keep taking my advice WSW you just might learn something although I doubt that. That gold you always maligned constantly for years has done well huh. why swami, because the dollar has tanked thanks to the FED paperhanger, your boy so you profited by betting against him and the buck which was your play. Hilariously hypocritical. I remember at 860 you said it was headed for a long journey down. Wrong again hedge troll!
The 10% I have in gold to hedge against currency risk and inflation (minimal) is in the ETF GLD! It is doing well! No complaints.
Do we need more regulations, more descriptions, more separations, audits or more cheerleaders for the wise? Any who are responsible needs to be asked this question: owners, regulators, politicians or Washington? Politicians first, now before the brew .
Another fraud mirage disguised as a moneymaker in the rigged graft game.
Real Time Economics offers exclusive news, analysis and commentary on the economy, Federal Reserve policy and economics. The Wall Street Journal’s Phil Izzo and Sudeep Reddy are the lead writers, with contributions from other Journal reporters and editors. Send news items, comments and questions to realtimeeconomics@wsj.com.
Read more Economics coverage.
Digg
Weird ice cream flavors have in recent years spread like mad and now include such inviting types as raw horseflesh or sardines and brandy. Is something similar happening in the world of ETFs, or Exchange Traded Funds?
Mario Draghi, chairman of the Financial Stability Board, hinted as much last week. On Monday, the FSB delivered a more detailed report on the matter, noting that these once “plain vanilla” investment products have taken a “disquieting” turn and have tacked on “new elements of complexity and opacity.”
The new flavors of ETFs pose new challenges regarding counterparty and collateral risks and could even cause liquidity problems for large asset managers and banks, the FSB said. That’s rather a mouthful compared to the original idea of ETFs, which, as the FSB notes, was to add some flexibility and cost-efficiency on top of the diversification benefits that standard mutual funds already offered.
To be sure, ETFs have been under a constant barrage of criticism from John Bogle, the legendary founder of Vanguard and the investor of index funds.
The warning comes as TD Ameritrade, a big American broker, rejoiced at how investors are increasingly “moving in and out of” the “spaces” ETFs purport to cover. “Retail investors are embracing the exposure to more specialized markets that ETFs can provide,” said Mike McGrath, TD Ameritrade’s director of ETFs, adding that they are especially popular among “younger and trendier” members of so-called Generation X and Generation Y.
Assets under management by ETFs have been growing around 40% a year over the past 10 years, eight times as fast as mutual funds or direct equity markets, according to the FSB.
Many ETFs have “physical” traits meaning they buy the securities underlying the index. The FSB said this type was prevalent in the U.S. and in offerings by large independent asset managers. But almost half the ETFs in Europe are “synthetic,” meaning they use derivatives and swaps instead of actually buying the constituents of the index for which it is a proxy. According to the FSB, they are generally provided by asset-management arms of banks, and one reason they may be growing is that they create synergies by serving as a counterparty to derivatives trading desks at the parent banks.
Remember securitized subprime mortgages? Those triple-A-rated bonds were available in thousands of types, unlike the mini-menu of similarly-rated U.S. Treasuries, which varied only by maturity duration. As later became evident, the sheer diversity boosted their opacity, as did complicated collateral schemes that ultimately depended on cheap short-term liquidity for support.
Could the proliferation of ETFs — the FSB noted you can now buy “leveraged ETFs, inverse ETFs, and leveraged-inverse ETFs” — be a sign of something similarly untoward?
Investors in ETFs may like the asset their fund proxies, but if what they really own are a set of swaps with a bank and if that bank defaults, their savvy will be for naught.
The FSB even notes that synthetic ETFs may belie incentives that aren’t properly aligned, and that “conflicts of interest can arise from the dual role of some banks as ETF provider and derivative counterparty.” Now that would be shocking…
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