Exchange traded funds (ETFS)have been a huge success but now there are fears that they are too big and could upset markets.
David Jane, a Milton Asset Management fund manager, commented recently that some people suppose that “ETF buyers are not a herd, chasing the same fashions and trends - when clearly they are.”
Other industry commentators agree and are also worried about investment in market indices generally and in particular in the ever-growing number of exchange traded funds (ETFs).
They are increasingly apprehensive about the underlying worth of ETFs distorting markets, the market behaviour of such funds and the way investors show a herd like drive to keep buying this type of investment.
What are these tradeable funds?
An exchange traded fund is a tradeable security, for example it can invest in the constituents of an index (like S&P500).
The exchange traded fund is created to replicate the performance of a particular investment or invest direct in the equities of companies of a sector such as health, technology, commodities or bonds.
Some market observers feel that, particularly in the US, ETFs have come to dominate retail flows, with the increasingly less popular managed funds losing investors to ETFs.
A worrying event on 24 August 2015
A significant incident to do with ETF liquidity took place on 24 August 2015. It was a volatile day during the Chinese market crash, and 1,000 trading US securities were suspended.
This upset the arbitrage mechanism of some ETFs so their price fell below the indices they were programmed to track.
Luis Aguilar, commissioner of the Securities and Exchange Commission expressed regulatory concern: “Should we consider curtailing the growth of ETFs?” The SEC got under way a review of the EFT market in October 2017.
The US Securities and Excahnge Commission. Souce Shutterstock.
There is some fear that the world of the ETF could lose liquidity and let down millions of investors. There are worries about some ETFs asset values are now too big and other ETFs too specialised and non- transparent for comfort.
In a nutshell, what happens when, and if, the ETF ‘bubble’ bursts, instantly the herd gathers to sell and maybe it can’t? ETF providers don’t want to think about what would occur if there was some sort Armageddon caused by ETFs.
After the fall, more appreciation of ETFs
Exchange traded funds first appeared around 2000 but have been a strong investment choice for investors since 2009 when it started to become hard to find decent income.
In 2008 there were $710.7bn assets under ETF management, by April 2017 there were over $4 trillion, reported the Financial Times.
In 2003 there were 276 different ETFs worldwide, in 2016 there were 4,779 according to Statista. European ETFs now exceed 2,000 from nothing in 2001.
After the financial crisis of 2008 a lot of ordinary investors realised that ETFs could provide a cheap, tax efficient, tradeable investment in a range of sectors.
The vast majority of ETFs are equity-orientated, then fixed income, commodities, multi-asset, alternative, then currency funds.
ETFs usually invest in the physical shares in companies, even when they mirror an index, though it is a bit different when it comes to commodities and foreign exchange.