Toronto Escorts

Cracks appear in ETFs' halo

oil&gas

Well-known member
Apr 16, 2002
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Ghawar
Globe and Mail

TOM BRADLEY
May 13, 2011

Personal disclosure: I'm a dyed-in-the-wool active manager, but admit
to having used exchange-traded funds in my portfolio. I've tread on the
dark side for tax planning purposes and, occasionally, to hedge certain
long-term positions. I also must confess that I've not taken issue with
our clients using ETFs, despite the fact that our company offers a simple,
low-cost mutual fund alternative.

With that out of the way, I must also say that I get pretty steamed about
the lack of scrutiny ETFs enjoy. They seem to have an impenetrable halo
over their heads, which emanates from their noble roots - cheap, simple
and diversified. I grumble because the ETF landscape has been changing
at breakneck speed and is now far from halo perfect. Fees are edging
up (there are even performance bonuses in a few cases), complexity is
emerging as a real risk, and performance often lags behind the target
indexes.

I recently read a report on ETFs published by the Financial Stability
Board, which is an international body set up to "assess vulnerabilities
affecting the financial system." The report points out that "the speed
and breadth of financial innovation in the ETF market has been remarkable
in some large financial systems over the past five years, and has brought
new elements of complexity and opacity into this standardized market."

The authors focus on the structural issues around ETFs and some of the
new risks. For example, in Europe, 45 per cent of ETFs are "synthetic,"
which means they obtain their desired return by entering into an asset
swap with a counterparty, usually a bank. This derivative strategy is in
contrast to "plain-vanilla ETFs" that own the actual securities of the
index they aim to replicate. The report is balanced in its commentary
and sounds an early warning to regulators and market participants
about potential areas of concern - illiquidity, counterparty risk,
poor disclosure and misaligned incentives.

If the Canadian regulators or industry were to commission such a report,
it might raise some of the same issues. Uncertain liquidity and lack of
transparency are obvious ones. Fortunately, the structural risks are
less of a worry in Canada because, thus far, most of the ETFs are of
the plain-vanilla variety.

But where a Canadian report should focus its attention is on the
behavioural aspects of the ETF market. While providers pay lip service
to the importance of long-term investing, they are enthusiastically
encouraging widespread speculation. The reality is that a small portion of
the $40-billion in ETFs in Canada are used to form a low-cost foundation
for long-term portfolios.

We're now approaching 200 ETFs in Canada after having just a handful 10
years ago. The flood of new offerings (reminiscent of mutual funds in the
80's, 90's and ... er ... well, today) has steadily carved the bond and
stock markets into smaller and smaller pieces. The race is on to achieve
first-mover advantage, whereby firms try to get their ETFs established
as the standard, or benchmark, in as many sectors as possible. As a
result of this proliferation, many of our ETFs are highly illiquid -
they trade like micro-cap stocks - and need to be bought and sold with
great care and patience.

The ETF firms are playing to the active traders and speculators,
whether they be individuals in their basement or professionals in office
towers. Trading volume and assets under management are focused on the
hot and, dare I say, more speculative areas of the market. All of this
is fine for the purposeful trader, but the Financial Stability Board
isn't worried about them, and neither am I. It's the investors who are
unknowingly investing less and speculating more that are the concern.

I came across a quote a few years ago that reinforces this point. John
Bogle, the father of indexing, was credited with saying: "As the splinters
get thinner, they grow sharper, and the odds of folks hurting themselves
with these pointed objects now approach 100 per cent."
 
Ashley Madison
Toronto Escorts