Posted on 04/15/2011 6:47:04 AM PDT by SeekAndFind
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.
(Excerpt) Read more at blogs.wsj.com ...
Some thoughts to consider to ETF owners out there :
* 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.
* 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?
* For ETFs that track the price of precious metals ( e.g., Silver and Gold ), how sure are we that they OWN enough of these metals to justify and back up the price?
They seem grossly illegitimate to me
bttt
I do not recommend GLD or SLV to clients. The word is they have been looted of all physical metals by one of the trustees (JP Morgan) in order to cover their naked shorts.
GDX, GDXJ and SIL are ETF's specializing in precious metal mining stocks. From everything I have heard and can tell, they are legitimate. I would appreciate it if any Freeper who has heard or knows differently would let me know.
This can be a problem for a couple reasons: 1) there are transactions costs with derivative trading desks embedded in these ETFS, meaning they will underperform their underlying asset over time. 2) Unless they get these OTC derivatives cleared through a clearing house (and there are only a few such OTC clearing firms), the ETF holder is exposed to counterparty credit risk.
Generally, ETFs that trade the underlying, or use exchange traded futures to mimic the underlying, are probably fine. Those that use synthetic derivatives include extra risks that the investor should be aware of.
I don't think anyone here favors the nanny statist idea that we should eliminate all risks from every day life. But on the other hand, novice investors who don't know much about advanced OTC derivatives should probably stay away from such ETFs. The best investment advice is to not invest in something you don't understand.
Obviously brokers are going to criticize ETFs.
Still, it's good to know what assets your ETF has. If it's just CR*P in derivatives remember that some ETFs have actually been used as "cash banks" by derivatives traders who jump into the market and pull out following the rules laid out in Parrondo's Paradox. IWM, for example, a Barclay's product, was being swapped around in MULTI BILLION DOLLAR units just before the fall 3 years back.
If you could follow it, you could make a lot of money ~ until the fall and then you couldn't make anything.
How can you know?
What you need to do is go looking for Perando's Paradox and check out the articles about stock trading.
All good stuff.
I did much better in the "early years" and then the big boys figured it out and there was less to get ~ and it hasn't really recovered.
You'd have more luck with high stakes card games.
sfl
ETFs that buy on leverage or buy derivatives are a different matter--the underlying investment is risky to begin with, and then the underwriters are wrapping up that investment into an ETF.
For this reason, it's not an "ETF" that is toxic...it's the underlying securities that are.
Yes, since State Street Bank and it’s stooge Barney Frank are involved, EFTs will be as toxic as they can be. Financial regulation for all but Barney and the Massachusetts banking mob.
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