ETFs Coming Of Age

October 19, 2011

I agree with you, Devin, that the ETF hearings in Washington arrived right on time.

As you observed, and as all the panelists agreed in the hearing today, a lot has changed since the first U.S. ETF, the SPDR S&P 500 ETF (NYSEArca: SPY), came to market in January 1993.

It’s important to note that while plain-vanilla funds like SPY giving investors convenient access to broad swaths of the market still make up most ETF assets, much more complicated ETFs are becoming a bigger piece of this rapidly growing market.

Indeed, newer products investing in futures, or that have double-, triple- and inverse-exposure schemes, are expanding more quickly than investor understanding. An education gap in a rapidly changing industry is a problem. So it’s good Congress is showing interest.

And it is about time. In the 18 years since their birth, ETFs have shot up to more than $1 trillion in investor assets and they comprise as much as 40 percent of the value traded on U.S. exchanges.

Good solid information about all ETFs and especially these newer products is especially important today because ETFs are being blamed for causing recent market volatility. Some critics are even saying that they may be threatening the stability of the global financial system. Those very questions gave rise to the hearing.

Noel Archard, a managing director at iShares, struck the right note at the hearing when he said that it’s time for regulators and investors to put aside anecdotal critiques of ETFs and start digging into serious data.

But be forewarned: Some of the questions turn on very granular and mechanical aspects of the ETFs. Still, it’s crucial to take it all in.

So, read the two Kauffman Foundation reports published in the past year that argued that ETFs are killing the U.S. initial public offering market, and that enough ETF trades aren’t settling smoothly, such that they are creating risks to the global financial system. Harold Bradley was in D.C. for the hearing, and reiterated the concerns Kauffman developed in the two white papers he co-authored.

Better yet, read the “Briefing Book” that IndexUniverse’s Dave Nadig and Matt Hougan worked up ahead of the hearing in Washington. For my money, that’s a gold standard for the industry, exploring as it does everything from how ETFs work to noting finer points some of the ETF critiques overlook.

Regarding the trade-settlement issue Kauffman raised in its second paper, Dave and Matt point out that registered market makers aren’t beholden to the same settlement requirements as other investors. Securities generally must settle within three working days after the trade—so-called “T+3,” but market makers have up to “T+6.” That means ETFs can land on the troubled-trade list when they really shouldn’t.

 

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