Exchange traded funds have reshaped the financial world, allowing investors to access various market segments cheaply and efficiently. However, the investment vehicle is not without its risks, and the Securities and Exchange Commission has called for greater education into the relatively nascent market tool.
The Securities and Exchange Commission has solicited the perspectives on the state of exchange traded products, which include both exchange traded notes and ETFs, and received general support for greater education, along with praises from the ETF industry, reports Jeff Benjamin for InvestmentNews.
For instance, State Street Global Advisors, who manage the suite of SPDR ETFs, believes that ETFs are efficient, transparent and provide price discovery.
“In the most volatile markets over the last 15 years, ETFs have continued to trade effectively,” Joshua Weinberg, V.P. and managing counsel at SSgA, said. “We have observed that ETF trading volumes increased sharply in September 2001 and in late 2008 as investors looked to ETFs for their key attributes of transparency and liquidity.”
The Vanguard Group also called ETFs highly regulated, effective and efficient investment products.
However, Heid Stam, managing director and general counsel for Vanguard, argues that full transparency is harmful to funds, pointing to chances of abuse from investors trying to front-run ETFs.
Disclosing a complete list of portfolio holdings “would be particularly concerning for index funds during specific events impacting a target index, such as publicly announced corporate actions and index reconstitutions,” Stam said. “In such instances, market participants may use a fund’s list of portfolio holdings to reverse engineer its proprietary portfolio management and trading techniques, anticipate the amount of a particular security the fund must buy or sell, and profit by transacting in the security prior to the fund’s transactions. This would harm the fund and its shareholders by causing the fund to pay more, or receive less, or securities in which it transacts.”
Unlike other fund providers, Vanguard already reveals its stock ETF holdings at the month end, with a 15-day lag. [Why Vanguard Stock ETFs Are Slightly More Opaque]
While a number of actively managed ETFs also provide daily disclosures, many money managers have been loath to reveal their secret sauce through an active ETF offering. Consequently, more have been looking in to Eaton Vance’s exchange traded managed fund structure. [SEC Again Rejects Precidian Non-Transparent ETFs, Solidifying Eaton Vance Lead]
Meanwhile, the SEC has cautioned against the increased complexity of products and the rising growth of the more sophisticated ETFs, compared to traditional beta index-based ETFs.
“Most mainstream ETFs function exactly as they were designed to, but others, most often in the commodity space, can expose inherent limitations that the average person doesn’t understand,” Paul Schatz, president of Heritage Capital, told InvestmentNews, citing concerns related to contango and backwardation in the futures market. [Commodity ETFs That Know How to Navigate the Futures Market]
Additionally, a number of geared ETPs utilize options and futures to generate a daily leveraged or inverse return to an underlying index. Due to its daily rebalancing and compounding issues over longer periods, these leveraged and inverse ETFs may diverge from their intended strategy in the long-term or in more volatile conditions. [Do You Know How Your Leveraged ETFs Work?]
For more information on ETFs, visit our ETF 101 category.
Max Chen contributed to this article.