ETFs have been the unquestioned success story of the fund industry over the past few years, taking in record inflows and scaling new asset levels every month. A common criticism from detractors, however, is that a mass selloff of ETF shares during a downturn could spark volatility and cause financial markets to spiral out of control
But as one ETF expert has pointed out, volatility is in the hands of the shareholders. “ETFs don’t create that risk. Investors do,” said Ben Johnson, the global ETF research director for Morningstar, in an interview with WealthManagement.com.
He noted that such concerns with ETFs mirror fears people had when mutual funds came out in the 1960s.
“[P]eople fretted that unsophisticated retail investors would buy and sell at the wrong time,” he said. “But in the crash of the early 1960s, it was professionals who caused the volatility, and if anything, the retail [mutual fund] investors served as a stabilizing force. ETFs are just a new format to buy and sell securities, like mutual funds decades ago.”
As for risks associated with leveraged and inverse ETFs
, Johnson said they present risks to people who “don’t understand the underlying mechanics.” While such vehicles have been banished from most advisor platforms and now are used by a niche of well-informed users, he said the risks of people misusing them will always be present.
He also noted that the proliferation of ETF products could present a problem for investors — which some providers are already working to solve.
“[T]here are 2,100 ETFs on the market,” Johnson said. “Providers are building model portfolios and selling them to advisors and directly to individuals. That includes Vanguard, BlackRock, State Street and Schwab.”
As for active ETFs, he said they are helpful in widening access and improving pricing of active strategies for smaller investors. However, US ETF providers have not embraced them because they have to publish their portfolios on a daily basis.
The Canadian situation is different. According to Bloomberg News, Canadian regulations treat active ETFs like mutual funds: managers are only required to disclose their top 25 holdings quarterly, while full portfolio disclosure is required semi-annually. Because of that, active managers have taken an 18% slice of Canada’s ETF pie, compared to just a 1% sliver from the US market.
“Right now, prevailing winds aren’t blowing toward active management,” Johnson said. “But [if regulators approve] non-transparent, active ETFs, that might spark interest.”
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