Are ETF investments set to take a big fall? For the first time ever, individual investors’ purchases of exchange traded funds has surpassed that of investment advisers during the last six months, according to The Charles Schwab Corp. and Jessica Toonkel’s InvestmentNews article, “Retail investors now piling into ETFs, says Schwab.” Advisers began using ETFs early on, and retail investors, as they became more comfortable with ETFs, followed suit.
Overall, investment advisers and individual investors each hold about 50% of the ETFs. But at Schwab, “Ninety percent of adviser clients use ETFs, compared to 17% of Schwab’s individual investor clients.” Approximately 40% of Schwab’s proprietary ETFs are owned by registered investment advisers, a figure that has markedly increased over the past few months. One quarter of the advisers queried by Schwab in July said they intend to use ETFs even more over the following six months, according to the article.
Schwab is considering expanding its ETF offerings by launching a mid-cap and a real estate investment trust ETF as well as a broad-market bond ETF.
“That’s where we hear demand from advisers,” a Schwab representative reportedly said. Schwab launched three fixed-income ETFs in August, and those portfolios now have $120 million in assets.
Exchange traded funds have become a huge part of the market. ETFs comprise about forty-five percent of the overall exchange volume. Investors have poured $1 trillion into “bewildering array” exchange-traded funds. Estimates put the number of exchange traded funds at over 1,000, and more than half of them were launched in the last two or three years, according to the article.
Exchange-traded funds that mirror a broadly diversified index such as the Standard & Poor’s 500 offer benefits of liquidity, transparency, low expenses, diversification and tax efficiency.
But there are other exchange-traded funds that lack some or all of these benefits and come with significant risks: lack of diversification and high volatility among them.
Some ETFs are inherently dangerous and unsuitable for most investors. Twenty-five percent of exchange traded funds fell sixty percent of more in the May 6th flash crash, in which the Dow fell nearly 1,000 points in 15 minutes before snapping back. Seventy percent of the trades that were canceled involved exchange traded funds.
Leveraged and inverse exchange traded funds are especially dangerous, as are many of the more exotic or narrowly focused ETFs.
Hedge fund replicator exchange traded funds, which pack high-octane derivatives under the hood, are being marketed to investors who cannot afford to lose their investment. Regulators are concerned. Hedge funds are generally high-risk, high-reward investment vehicles that are largely unregulated and are unsuitable for most investors.
Other extreme exchange traded funds trade volatile commodities futures. Even more extreme exchange traded funds are leveraged and inverse, whose net asset values move in multiples of a given basket of securities, or in the opposite direction. ? They are designed for day-traders and are unsuitable for buy-and-hold investors. While these funds are sometimes marketed as hedges or “insurance” against adverse market moves, the danger lies in the way they are really sold and used to speculate in the hope of above-market returns.
John Bogle, the founder of Vanguard and the creator of the first index mutual fund in 1975, is one of those who believe that extreme exchange traded funds may blow up in investors’ faces. “It’s insanity,” Bogle was quoted as saying. “This is a classic case of Wall Street trying to capitalize on the worst instincts of investors.”
Brokers and firms that sell exchange traded funds have a duty to understand and explain the risks of the investment they are selling, and, at a minimum, must not recommend an investment without a reasonable basis to believe that it is suitable for the investor.
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