ETF leaders warn on new style products

There are particular concerns that the swarm of new investors that have entered the sharemarket since March are particularly vulnerable to products that offer upside from falling share prices.

A coalition of the world’s biggest fund managers is pressing for consumer protection reforms in the booming Exchange Traded Fund market, where a rush of exotic products is putting new investors at risk.

With speculative products bunched together with traditional index funds under the ETF banner there are mounting concerns that investors need much clearer “labelling”, so distinctions can be made between conservative funds that simply aim to mirror an index and funds that may be leveraged (based on borrowed money) or funds that act as derivatives.

“We need to see some warnings out in the market on new style ETFs, where consumers may not realise what they are buying. The sector has evolved a long way from the original idea of a fund that simply reflects an index,” says Robin Bowerman, the head of market strategy and communications at Vanguard Australia.

There are particular concerns that the swarm of new investors that have entered the sharemarket since March are particularly vulnerable to products that offer upside from falling share prices, or the promise of “sharemarket protection”.

Vanguard, along with key global players including BlackRock, Fidelity Investments, Invesco and State Street, have recently urged regulators in the world’s biggest sharemarkets to “support implementing more consistent identifications and categorisations of Exchange Traded Products”.

In the local market the Australian Securities and Investments Commission is understood to be examining the issue in consultation with local ETF managers, while in the US the coalition of major ETF players has put a submission to each of the three leading exchanges that list the products.

“The heart of the issue here is that protection in the markets from upside or downside is never free. Even if the products are clearly understood they can be very expensive — a leveraged ETF can cost five times in fees what a traditional ETF will cost, worse still they are doing damage to the wider brand of ETFs which have had such success with retail investors,” says Chris Brycki, founder and CEO at Stockspot.

Brycki points to the BetaShares BBOZ Australian Strong Bear (Hedge Fund) which was the most traded product in the market at the peak of the crash in March when it achieved a monthly trading volume of nearly $2bn. “If you get it right on the market falling, you will still lose money with these inverse ETF products over any extended period of time. Case in point is the Strong Bear fund, which is down -16.5 per cent over 12 months even though the Australian share market is down -6 per cent.”

Issuers of exotic ETFs, such as BetaShares and ETF Securities (which offers the ETFS Ultra Short NASDAQ 100 Hedge Fund), defend such products, suggesting they are for periodic use by experienced investors.

But in the local market BlackRock Australia has suggested that “most investors continue to adopt ‘ETF’ as a blanket term for any product that offers exchange tradability. Many products that can be grouped under the term ‘ETF’ have very distinct risk profiles and/or features. For example, some use futures to deliver leveraged or inverse performance to an index … As such, we believe that requirements should exist that constrain the application of the term ‘ETF’ to a specific subset.”

As Marc Jocum, an investment associate at Stockspot suggests in a recent report, using inverse ETFs to protect against a falling market is not an effective long-term strategy.