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ETF Mischief


I came across an article highlighting the mischief lurking in the ETF arena.

ETF is an Exchange Traded Fund.  It is an investment funds traded on exchanges like stocks.  It usually holds an underlying asset (e.g. Gold) and therefore provides investors with a convenient avenue for exposure to a particular asset, which is also supposedly very liquid.  Initially these started out in very simple formats and eventually became more and more complex - as with most good ideas in finance.

The main point of concern to me was the example of a fund manager assigning an Emerging Market ETF to an investment bank to manage (where it promises to deliver the underlying returns) in exchange for collateral.  The collateral, unbelievably, consisted of Japanese equities and unrated US and European corporate bonds!

This raises two obvious risks that the ETF is not subject to the risks of Emerging markets but rather, to the solvency of the investment bank and that the resulting collateral provides risk exposure to unrelated assets.

It appears to me that the field of finance attracts the most energetic people – but finance, unfortunately, isn’t most useful to society when it’s most energetic.  On the contrary it requires far more patience than exhibited by the hyper-intensive financial markets of today.  The energetic talent is obviously better suited to more productive endeavours such as engineering etc.  The rewards, sadly, are overwhelmingly in the unproductive areas of finance.  I’m sure I’ll touch on this subject again in the future.

In short, if you plan to invest in an ETF, make sure you read the prospectus very carefully to ensure that you are getting exposure to the actual assets that you want to invest in.
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