According to EDHEC-Risk Institute, any discussion of the risks associated with ETFs should go beyond simple assumptions about their potential risks and also take into account the reality of both the risks that the benefits of investment in these instruments.
A new study by EDHEC-Risk Institute analyzes the real risks of Exchange-Traded Funds (ETFs) in Europe. This research is in response to questions raised by regulators and industry professionals. According to EDHEC-Risk Institute, any discussion of the risks associated with ETFs should go beyond simple assumptions about their potential risks and also take into account the reality of both the risks that the benefits of investment in these instruments.
Among the findings of the study of EDHEC-Risk Institute, we find:
- The vast majority of European ETFs are managed in a UCITS and in this sense provide a level of security and are potentially exposed to the same risks as any UCITS. Place special emphasis on the supposed risks of ETFs does not make sense in general, much less for the protection of investors because ETFs are a fraction of the products marketed to the general public in Europe and the bulk of the products marketed to individuals do not have the same level of protection as that provided by the UCITS framework.
- With regard to counterparty risk, it makes no sense to oppose the one hand the products of physical replication and synthetic replication, and secondly, to tell the difference between swaps funded and unfunded . These two distinctions are irrelevant in practice and gives a false sense of security “comparative.” In fact, whatever the replication techniques used, the ETFs are exposed to counterparty risk. And lending-borrowing of securities, common for physical replication ETFs, expose a Fund to counterparty risk as surely as the use of OTC swaps needed to replicate synthetically.
- Investors should pay more attention to topics of the first order that determine the actual reduction of counterparty risk: the level of the guarantee, the quality of the pledged assets and the fund’s ability to enforce its rights over these assets failure of the counterparty.
- The massive marketing campaigns and media relations set up by some providers of ETFs in order to promote distinctions between types of replication based on the counterparty risk are misleading and do not contribute to a proper consideration of risk by investors.
- The issue of counterparty risk must be managed by clear guidelines on the reduction of counterparty risk to the quality, ease of trading and diversification of the assets offered as collateral. These criteria should apply regardless of how counterparty risks are generated and managed and to all UCITS and competing products.
- Transparency should not be limited to the issue of counterparty risk and its reduction but should include information on the profitability of ancillary activities such as money lending and borrowing of securities.
- Finally, it is curious to note that while most of the ETFs are passively managed media-backed indices, no standardization or obligation to inform about the risk of tracking error is present in the regulation European. Similarly, the regulator should provide a legal definition of what constitutes a sign and take a position on the need for transparency and auditability of indices, which are the main determinants of financial risk borne by the ETFs.
Download the whole document: What are the Risks of European ETFs? (Title)
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