ETFs: A Double-Edged Sword for Passive Investors


For nearly the past five years, exchange-traded funds have fueled the institutional and retail investors’ drive toward passively managed strategies.

“We have had 52 straight months of inflows into ETFs globally,” said Richard Tseng, director, global portfolio solutions at Bank of America Merrill Lynch, during a panel discussion at The Summit of Asset Managers in Brooklyn.

However, the investment into the $5 trillion global ETF market are not either/or propositions between active and passive strategies, according to fellow panelist Sylvia Jablonski, managing director, capital markets-institutional strategist at Direxion Investments.

“What we see out there is a lot of advisors, whether they claim to be passive or active, are a combination of both,” she said. “Even if you consider yourself a passive advisor, you are marking decisions to choose the passive flow to get exposure to S&P, small cap, emerging markets. You are deciding whether to overweight one sector or one region over another.”

Jablonski also noted that it was a great time to marry cheap, cost-efficient, and transparent vehicles lie S&P 500 ETFs to more sophisticated active strategies.

“The transparency and technology that has been brought to market allow investors to be more aware of about what they are buying, what their costs are, and what they are getting for that price,” added Karl Desmond, assistant vice president, beta solutions, product development at OFI Global Asset Management.

The relatively low price of cap-weighted portfolios comes at a price, according to fellow panelist Patrick Gelshenen, executive director at TOBAM.

“You can replicate a portfolio like the S&P 500 quite easily, but no free lunch comes along with it,” he explained. “As of March 2018, 40% of the S&P 500 is in two sectors- IT and financials. It’s important to keep this in mind because a lot of people use the S&P 500 in cap-weighted portfolios to get diversified equity exposure when, in fact, it is not diversified.”

In the world of fixed income, ETFs are not the silver bullet that some believe they are, according to final panelist Dmitry Green, chief risk officer at Mariner Investments.

They provide the liquidity that has vanished from the underlying market, he said. “If you wanted $500-million or $1-billion exposure to credit right now, it would take you two months the achieve with single bonds.”

Unlike the bond underwriters, when the credit market eventually melts down, ETF administrators do not have an obligation whatsoever to support those bonds, he added. “When the banks were there, they would stand behind the bond if they underwrote the bonds.”

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