The world’s largest money manager, BlackRock Inc., which owns 42% of the exchange traded fund market, has issued a report calling for increased transparency and regulation concerning synthetic exchange traded funds. Synthetic exchange traded funds rely on derivatives (options and swaps) to replicate exposure to a reference asset. This practice introduces risks associated with “mis-tracking as well as counterparty risks,” Jennifer Grancio, managing director and head of BlackRock’s iShares U.S. distribution, was quoted as saying.
The exchange traded fund industry includes more than 1,300 ETFs and over $1 Trillion under management. Blackrock says it is moving away from synthetic strategies. “We believe, where possible, holding the physical securities is preferred,” Ms. Grancio was quoted as saying, adding: “And where that is not possible, we are moving to the highest level of collateralization and disclosure.”
BlackRock says that transparency should extend to counterparties, and all revenue associated with an exchange traded fund, including fees and expenses, product structure and objectives, all holdings, standards for diversifying, and uniform trade reporting for all equity trades.
BlackRock’s announcement follows expressions of concern by regulators that investors and sales agents are not well informed about exchange traded funds and do not understand their risks. FINRA announced that it is focusing on abuses involving sales of exchange traded funds.
In recent years, Wall Street has created innumerable extreme and exotic exchange traded funds, including niche, leveraged and inverse leveraged exchange traded funds, which have hidden risks that often harm investors. The risks associated with these extreme and exotic exchange traded funds include lack of diversification, high fees, illiquidity, costs and losses associated with frequent closures of such funds, and volatility stemming from the fact that exchange traded funds trade at a premium or a discount relative to the net asset value of the underlying holdings.
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