Are ETFs to blame for market volatility?

-- | 07/03/2018

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Glenn Freeman: In this edition of "Ask the Expert" I'm talking to Morningstar's Alex Prineas about exchange-traded products and whether they have had any role in the recent bout of market volatility and what this means for ETF investors and some of the complexities that people need to be aware of.

Alexander Prineas: Yeah, I mean, I've heard a number of people make those claims. I think to some extent it's true, but ultimately, we have had market crashes, we have had market corrections since long before ETFs were a feature of the market. We managed to have the global financial crisis when ETFs were really just a tiny feature of the investment space. We had the tech wreck. ETFs were barely existent at that time. So, I don't really think it's accurate to say ETFs are the cause of market rises and falls.

Certainly, investors are putting money into the market and ETFs are an efficient way to put money into the market and to take it out. And so, investors are using ETFs more and more. But that's not to say that the ETFs are the cause of the market falls. There's a whole range of ways that investors are getting exposure to the market, whether it'd be holding equities directly, using ETFs, superannuation funds, pension funds, and all of these investment decisions, these investment products and structures make up the market as a whole.

Freeman: And within the global ETF space we've seen at least a couple of products that have actually been wrapped up. What sort of exposure do we have to these types of vehicles in the Australian sector? Should investors be worried?

Prineas: The first thing I'd say on that is that our analyst colleagues in the U.S. – we don't issue research on those products or those types of products. They are not really designed for long-term investors. They are designed for short-term trading and day trading which is not really the focus of our managed fund and ETF research. We prefer products that are designed to be held for the long run. So, we didn't issue research on those.

The second point I'd make is that there's nothing quite that exotic available in the Australian market. The product market here, the ETP market, is broadening out and it is becoming more complex. But certainly, we don't have any inverse VIX ETNs which was the product that went to near zero or zero. I think the dust is still settling on those products.

There are some more complex ETPs available here. Nothing on that scale. But I think one of the things investors can look to here is, there's a few clues and helpful things that investors can do. First of all, most of the market is traditional passive ETFs. They are just long-only. They hold equities or bonds. They are relatively simple investments. They are just a box into which equities or bonds are placed. And so, as the end investor you own shares in those bonds or equities.

There is a clue in the product names. So, if a product is an ETF, it will generally say ETF in the name. And then asset guidelines will require ETP providers to have words in the name that suggest if there's something much more complex going on. So, you will see products termed as exchange-traded managed funds, exchange-traded hedge funds, exchange-traded structured products. And you will also see words like synthetic used in the name if a product is getting its market exposure entirely via derivatives or via, say, a contract with an investment bank which can introduce counterparty risk and also basis risk which is the risk that the derivative product doesn't directly match the asset that you are trying to track.

So, yes, there are clues in the name of the product. And then we'd also encourage investors to go beyond just the name by reading the product disclosure statement and reading published and independent research such as that from Morningstar.

This report appeared on 2021 Morningstar Australasia Pty Limited

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