Wednesday, June 17, 2009

"When is an ETF actually a structured product?" or Tales of the Wall Street Marketing Machine

Wall Street is set up to separate the unwary (and often the wary) from their money.
From FT Alphaville:
There has been a storm of debate in the blogosphere over the issue of exchange-traded funds (ETFs) and whether they’re justifiably marketed as retail investment products or should in fact be restricted to professional investors. The key issue is, do they do what the label says? Or, in some cases, are investors being mislead?...

So what’s the potential problem?

Well, while many of these products were indeed marketed as easy-to-understand trackers, their tracking success rates have not been so great. Articles like these have consequently hit the blogosphere en force:

ProShares, Direxion Are NOT ETFs - Index Universe.

Know what you own, redux - Abnormal Returns.

What’s wrong with ETFs - Index Universe.

Why ETFs Are a Scam - Seeking Alpha.

Plus, many more. They all make a similar point, however; namely a variety of:

The key for all of the ETFs is that the longer the period of time you look at their performance, the worse they match up against their objectives. If you were to look at any of the above ETFs on any given day, there is a greater propensity for them to track what they’re supposed to track. But as you move out from 1 day to 2 days and so on — the correlation begins to break down very quickly.

Yet, as Jim Wiandt writes in Index Universe, this is not necessarily true of all products. The above situation is mainly applicable to derivative-based, inverse and leveraged ETF types only. There are indeed good reliable ETFs out there too that do just what the label says.

What’s more, because ETFs are among the most transparent vehicles in the world, even the performance of the more complex ones is hardly unexpected. All possible caveats are outlined in their prospectuses– they’re just harder to understand.

Accordingly Wiandt calls not for the SEC but the marketing agents. As he states (our emphasis):

I’ve got a solution even more simple than bringing down the SEC’s hammer on all of those products that are already out the door: stop calling them ETFs. Right now, let’s end the branding blur and reclassify any of the products that are not down the middle (”down the middle” to me means funds that hold actual securities and attempt to replicate a diversified index, and that are ideally regulated investment companies complying with 40 Act diversification requirements)....MORE