Thoughts:
ETF markets - Post crisis investors are looking to increase their risk appetite. It would seem that brokers/financial institutions are repeating the same mistakes pre-crisis; and the same practices seen throughout retail banking, of pushing products not fully understood, onto unknowing consumers.
ETF's are quite complex structured products akin to derivatives imho. My partner, Pat, can tell you much better than I, as he has way more experience in trading commodity related ETF's. Often correlations will remain high with the underlying instrument it is built off, but has many more dynamics of its own.
ETF's built off other indices or built off futures or bonds are at risk to those respective market risks, and the risk of the product itself. Indexation and limits to indices are complex issues in itself, enough to make my head spin.
In addition to those risks are the risks of the ETF market itself pertaining the economic aspects. Supply/Demand balances are often limited to how the product maybe structured. Due to limits of the product excess demand can out-weight supply causing price correlations to break down in the short term (or flip flopping between backwardization and contango if based of futures). The short term being a few days to a few weeks of price divergence as we saw in the natural gas ETF market back in summer of 09.
If traditionally passive investors are informed by their brokers that ETF's make an alternative low risk way to diversify their portfolio, this is a grave mistake. This in effect will make the ETF market more naive in the long run if more passive type markets start to invest into the market, thus increasing the risk of adding more volatility to their portfolio. Often short run fluctuations can cause investor/trader behavior to panic and cause herd mentality sell offs (or bullish runs in light of positive sentiment).
I am not trying to say if x happens then y and z shall follow but, there are real risks that makes the ETF market much more complicated on a deeper level than simple indexed products that mirror larger products at a lower cost (the cost issues are a whole different topic on its own that I shall not get into).
Hopefully going forward investors will keep up with due diligence and not blindly invest in products unknowingly as back in 2008.
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Alexander Lê
Managing Partner
Analyze Capital LLC
email: analyzecapital@gmail.com
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