In his recent column in The Globe & Mail, Steadyhand mutual funds’ Tom Bradley (See Cracks Appear in the ETF Halo) highlighted a recent report by the Financial Stability Board (FSB), titled Potential financial stability issues arising from recent trends in Exchange-Traded Funds (ETFs). The report points out that the rapid growth in the ETF market has led to “a number of disquieting developments in some market segments”. Among them are ETF products tracking markets with low liquidity, “synthetic” ETFs that employ derivatives and increased reliance on securities lending by ETF providers.
The FSB is especially worried about the growth in synthetic ETFs in Europe where the swap counterparty is typically the bank also acting as the ETF provider. An investor in such a synthetic ETF might be at risk if the bank defaults. The report says that, in Europe, synthetic ETFs now make up 45% of assets under management.
The key takeaway from Tom’s column and the FSB report for investors is to take a close look at ETFs before investing their hard-earned money. The plain-vanilla ETFs that track broad stock and bond markets are very safe products and remain excellent portfolio building blocks. Investors strolling off the beaten track need to exercise a lot more caution.