December 14, 2011 / 6:46 PM / 8 years ago

COLUMN: Are ETFs in trouble? - Lipper

LONDON (Reuters) - Exchange traded funds (ETFs) have found themselves under ever more scrutiny from regulators and market participants this year and expectations are that new rules for the sector are just a matter of time. [ID:nL5E7MT5XQ]

It’s tempting to think of ETFs as unwilling victims of new regulation, but to my mind, ETFs have much to gain.

The point is that it isn’t just regulators who are seeking improved transparency on fund holdings and on the use of derivatives by mutual funds, crucially it is end-investors too. And once the fog has cleared, they might come to see ETFs — with daily published portfolios and clearer statements on the use of derivatives in general — as a role model for all kinds of mutual funds.

The discussion surrounding ETFs could leave you with the feeling that they are unregulated products; that fund promoters can go wild when creating new products and with the use of derivatives in the portfolios. [ID:nN1E79I1DJ]

In reality though, ETFs follow the same local and/or international legislation of any other mutual fund; the EU UCITS regime for example.

So, why all the fuss around ETFs? In my opinion, there is nothing uniquely wrong with these products as they are using the same tools and techniques used by other funds under the UCITS regime. Some authorities, however, have raised questions as ETFs grow in popularity among professional investors. A deeper look into the questions posed shows that the points made by the critics are not only applicable to ETFs, but to any mutual fund.

CONCERNS

I wonder if the popularity of ETFs, which have sold well in tough market conditions, has made them a useful conduit to raise more general concerns about the mutual fund industry as a whole. To see Lipper data on net sales of equity funds in Europe by product type, click here: link.reuters.com/baw55s

Of course, some of the concerns mentioned by market authorities are reasonable points to make, but they apply far more broadly; derivatives in general and swaps in particular are nothing new, and alongside stock lending, are widely used within the asset management industry.

Yes, ETFs have been a sales success, but for all the fanfare, they still account for less than 10 percent of assets under management in the global fund industry. In what is a well diversified range of products, to my mind this does not constitute a structural risk. To see the Lipper data on European equities assets under management by product type, click here: link.reuters.com/pyv55s

So perhaps ETFs have become a victim of their own success, as regulators jump on the most popular fund products in recent times to highlight concerns about the complexity of some fund types and about the use of derivatives and stock lending in the investment industry more widely.

I think there can be no doubt all this attention will lead to new regulations for the all mutual funds. But contrary to the expectations of most market observers, I think this new regulation will change the landscape for “regular” mutual funds much more than the environment for ETFs. After all, relatively speaking, ETFs have a useful head-start on transparency.

The sector won’t escape unscathed. Some asset classes like commodities are only investable via the use of swaps under the UCITS directive and investment here is likely to face a shake-up. The ETF sector is also likely to find itself subject to a redefinition of funds into complex and non-complex products as regulators seek to better safeguard retail investors; the performance dynamics of products like short or leveraged long ETFs, after all, are beyond the understanding of the average private investor.

Editing by Joel Dimmock

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