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competitors. Our ETF structure combines full investment in listed equities with the use of swap transactions to ensure precise tracking. Swaps can be transacted with multiple counterparties (6 major investment banks), thus diversifying the risk. Moreover, the swaps are reset frequently as the funds expand or contract, so that the absolute amount of risk is small – typically less than 0.10% of the fund's assets. This approach has resonated well with the European ETF investor community.
Our investors have not been shy about poking under the hood. So ETFs are still an attractive wrapper? Yes, but a separate and important question is the distinction between ETFs and other exchange traded products. These products are not subject to the same robust regulatory framework as funds and therefore warrant a higher degree of scrutiny. This is not to say the products are bad – indeed, in many respects Source's exchange traded commodity products are even more robust than many ETFs – but in the absence of strict governmental oversight investors need to do more homework. We also agree that the industry could do a better job of educating investors that not all exchange traded products are funds. In sum, we welcome the scrutiny: we think ETFs are generally well constructed and well managed and will stand up to rigorous evaluation. Indeed, we have some of the most sophisticated financial institutions in the world as our investors, and they have not been shy about poking under the hood. In the latest reply of EFAMA towards the concerns raised by the 12 ETF Radar Magazine | Issue July 2011
FSB, one of the key problems is that a significant number of exchange-traded investment products are not ETF's. How can the industry improve the understanding among investors? I do think the industry could be more pro-active in educating investors that not all exchange traded products are regulated funds. At an institutional level this is well understood, but as we see more retail participation it will become increasingly important to make the distinction clear. How is your approach at Source in educating investors? At Source, we approach this from two angles: first, we are extremely clear in our marketing materials about product structure (going so far as to employ different colour schemes for non-fund products!). Second, although our commodity products are certificates rather than funds, we provide a focus on liquidity, transparenc y and minimising counterparty risk that is no different to our other products. Our ETCs are fully b a c ke d b y t h e u n d e r l y i n g commodity or – where this is not feasible – with US Treasury bills, which are by far the world's most liquid security. In our opinion, it would make sense for the European regulators to step in here and allow commodity products to be delivered in a regulated format (as is the case in the US). In the absence of such a framework, we have constructed our products in a manner that is otherwise as consistent as possible with the UCITS rules. Have some ETF's and ETP's meanwhile become too complex for an ordinary investor? I don't think that ETP structures have become too complex for investors to make sensible decisions and most product sponsors provide high levels of
transparency and disclosure to facilitate this process. However, complexity can also come from the underlying investment objective of the product – in this respect, ETPs are no different from conventional mutual funds. Although most ETPs aim to track well-known benchmark indices, there are also more complex products on offer: e.g., products linked to emerging markets, volatility and hedge fund replication strategies. These are likely to appeal only to more sophisticated investors. It's down to investors to decide what kind of underlying assets they wish to take exposure to and to ensure that they understand the risks. What are your thoughts about an European ETF Association – and perhaps a Global ETF Association? There is currently an ETF working group within the European Fund and Asset Management Association that includes most of the major ETF sponsors. As ETFs are regulated investment funds, this is an obvious and effective way for us to address industry concerns. There may be some merit to a separate European organization to look at non-fund related issues (e.g. trade reporting). A global organization, however, would seem to have limited value given the differences in regulatory regimes and investor preferences.
A global organization would seem to have limited value. Some investors have raised the question of whether ETF short selling can have a negative impact on the performance of a fund – particularly for investors who have nothing to do with the shorting?