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UBS rogue trader highlights ETF concerns Add to ...

The rogue trader at UBS who has apparently racked up losses of some $2-billion (U.S.) and subsequently was charged with fraud in London has sparked some debate over the value of exchange traded funds.

Based on reports, Kweku Adoboli made trades using ETFs, which are generally baskets of stocks that trade on exchanges. They have become enormously popular among investors for their low cost and the fact that they can be traded throughout the day – but the explosion in the number of offerings, and the complexity of some of them, has also raised concerns about whether investors really understand the products.

Now, the scandal that has hit UBS is likely to bring more attention to this area of the market. Terry Smith, writing on the Straight Talking blog (via FT Alphaville), stirred up a few issues on Friday, noting that “ETFs are regarded by many investors as the same as index funds. They clearly are not.”

He then notes some of the key differences:

1. Not all ETFs hold physical assets, but rather use derivatives to track assets.

2. ETFs, especially those that use leverage, do not always match the performance of their underlying asset.

3. They are often used by fast-moving banks and hedge funds, which can short-sell them.

“As a result of all this I have long thought and written that there is a certainty that ETFs are being mis-sold to the retail market and that the risks that are being incurred in running, constructing, trading and holding them are not sufficiently understood,” Mr. Smith said. “After the UBS incident I think this should be regarded as indisputable.”

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