There are rows brewing in the world of Exchange Traded Funds. Some providers are creating complex ETFs, new types of fund which offer kinds of active management or offer to gear or short underlying assets. At Evercore Pan-Asset we do not use of any of these. They do not pass our tests of simplicity and low costs.
We are asset allocators. Knowing that getting the choice of asset class right is the main determinant of your returns, we then try to implement our chosen strategy as cheaply and simply as possible, in a way which reduces risks. We are not wedded to ETFs. The simple ones just happen to be the cheapest and best way of investing in asset categories with Stock Exchange liquidity and transparency. If something better comes along we will buy it.
We looked at the ETFs that short markets when they came out. It was easy to reject those. When we think markets are in difficult times we do move into cash for clients. If we are wrong clients still make a return on their money. If we are right we protect them from declines in share, bond and property markets as well. If you increase the size of the bet by shorting a market, you can lose serious money if you are wrong. We do not think that is the right approach for long-term trust funds, or for wealthy individuals who wish to look after their money prudently.
We looked at the geared ETFs, funds which offer you twice or three times the upside on a market when it is rising. The bad news is you also double or treble your losses if the market goes in the other direction. These ETFs cannot guarantee to deliver the double or treble performance owing to the technical way they are structured. It was again an easy decision to say we would not be buying those.
It would be best if these complex ETFs were called something other than ETF. Exchange Traded Notes are also different in their structures, relying much more on derivatives, contracts for difference, options and the like. We never buy them, as they too contain different types of risk than a simple ETF based on a portfolio of shares. We saw what pressures can build up in the world of synthetic products and complex instruments during the crash of 2008. We were happy sitting in cash.
The more complex ETFs there are, the more important it will be to do some homework before buying one. You need to examine the underlying assets, any contracts for differences, and other financial instruments. You need to consider counterparty risk as well as market risk in the complex cases.