There has been a storm of debate in the blogosphere over the issue of exchange-traded funds (ETFs) and whether they’re justifiably marketed as retail investment products or should in fact be restricted to professional investors. The key issue is, do they do what the label says? Or, in some cases, are investors being mislead?
The debate is heating up just as asset manager Blackrock takes over the $375bn ETF business of Barclays via its acquisition of BGI for $13.5bn. BGI, of course, was among the biggest pioneers in the ETF space through the launch of the iShares series.
It is thought BlackRock was particularly keen on acquiring the ETF arm as it would be this — more than anything else — that would give it an advantage over its fixed-income rival Pacific Investment Management Co.
So what’s the potential problem?
Well, while many of these products were indeed marketed as easy-to-understand trackers, their tracking success rates have not been so great. Articles like these have consequently hit the blogosphere en force:
ProShares, Direxion Are NOT ETFs – Index Universe.
Know what you own, redux – Abnormal Returns.
What’s wrong with ETFs – Index Universe.
Why ETFs Are a Scam – Seeking Alpha.
Plus, many more. They all make a similar point, however; namely a variety of:
The key for all of the ETFs is that the longer the period of time you look at their performance, the worse they match up against their objectives. If you were to look at any of the above ETFs on any given day, there is a greater propensity for them to track what they’re supposed to track. But as you move out from 1 day to 2 days and so on — the correlation begins to break down very quickly.
Yet, as Jim Wiandt writes in Index Universe, this is not necessarily true of all products. The above situation is mainly applicable to derivative-based, inverse and leveraged ETF types only. There are indeed good reliable ETFs out there too that do just what the label says.
What’s more, because ETFs are among the most transparent vehicles in the world, even the performance of the more complex ones is hardly unexpected. All possible caveats are outlined in their prospectuses– they’re just harder to understand.
Accordingly Wiandt calls not for the SEC but the marketing agents. As he states (our emphasis):
I’ve got a solution even more simple than bringing down the SEC’s hammer on all of those products that are already out the door: stop calling them ETFs. Right now, let’s end the branding blur and reclassify any of the products that are not down the middle (“down the middle” to me means funds that hold actual securities and attempt to replicate a diversified index, and that are ideally regulated investment companies complying with 40 Act diversification requirements). There are few ETPs that will be punished by this reclassification. Even GLD and IAU, for example, which are relatively straightforward products tracking spot gold, have their quirks, including tax treatment as “collectibles” and not funds.
So let’s start there, right here. I would support calling them structured products. Does anyone disagree with me on that? Send in your comments. To me, even ETPs has too close a ring to ETFs. And on the other issue of raising the bar and regulating them to a degree like options, I am open to that discussion. The constant drumbeat of investor discontent with these products (which as we’ve pointed out is more due to investor misunderstanding than bad products) convinces me that we need to do something to save investors from themselves.
So when is an ETF not an ETF? When it’s an ETP or structured product.