Can An ETF Collapse? The Study that was proven false.

Have you ever read something that just didn’t seem correct? Recently, an article published in the Financial Times by Andrew Bogan, Ph.D, Brendan Connor and Elizabeth Bogan, Ph.D stated that Exchange Traded Funds could potentially collapse. Their thesis purports that if a situation developed where more investors are shorting an ETF than actually own the shares, there wouldn’t be enough shares left for the long investors if investors redeemed all the shares at once. They claim this would then shut down the ETF entirely and leave someone holding the bag. The article also blamed ETFs for the recent “flash crash,” which saw the Dow drop over 1000 points in a matter of a few minutes. They also argued that ETFs are misunderstood by investors. You can read the article here .

While the article has some interesting points, the ETF industry has quickly proven the thesis absolutely false. How?

Kyle Waller, research analyst at Wiser Wealth Management, Inc, states that “only properly settled shares, in good delivery, can be delivered to the Issuer for redemption.” This basically means that if you purchase an ETF and the trade has settled, then you own the underlying shares. A person simply shorting an ETF does not own settled shares. Therefore, they are taking on the additional risk.

Matt Hougan of IndexUniverse.com stated in his blog, “the [researchers] concern is addressed in the prospectus and Statement of Additional Information (SAI) of every ETF I’ve ever looked at. Here’s what it says in XRT’s [Retail ETF questioned in the article] SAI:”

“An Authorized Participant submitting a redemption request is deemed to represent to the Trust that it (or its client) (i) owns outright or has full legal authority and legal beneficial right to tender for redemption the requisite number of Shares to be redeemed and can receive the entire proceeds of the redemption, and (ii) the Shares to be redeemed have not been loaned or pledged to another party nor are they the subject of a repurchase agreement, securities lending agreement or such other arrangement which would preclude the delivery of such Shares to the Trust. The Trust reserves the right to verify these representations at its discretion, but will typically require verification with respect to a redemption request from a Fund in connection with higher levels of redemption activity and/or short interest in the Fund. If the Authorized Participant, upon receipt of a verification request, does not provide sufficient verification of its representations as determined by the Trust, the redemption request will not be considered to have been received in proper form and may be rejected by the Trust.”

Hougan goes on to say, “This means, when redeeming shares of XRT, you have to say that the shares aren’t lent out. If there’s high short interest in the fund, you’ll have to prove it, or the redemption doesn’t go through.”

Looking at the ETFs that we use here at Wiser, I agree with the assessments of Matt and Kyle. I do not see the Bogan & Connor report as having much merit for concern, especially with the ETFs that we use in our models.

What does concern me is how quickly this report showed up on CNBC without the completion of any fact checks. The report itself lacked the data to prove its points and also contained a few assumptions that are not correct. The report incorrectly assumes that investors poorly understand ETFs because they represent 70% of the canceled trades on May 6th, now known as the “flash crash.”  A recent article in Barrons points the finger at Waddell and Reed, a mutual fund company, for starting the flash crash. This triggered other program trading, which resulted in a very volatile day in the market.

Not only did CNBC not do some fact checking prior to talking about the Bogan & Connor report, they also did not really portray ETFs correctly. Kyle Waller picked up on this and commented that, “CNBC called ETFs derivative products, which implies a lot of risk to the average investor.  However, the plain vanilla stock ETF truly represents an un-leveraged position in a basket of stocks, deriving its value from the underlying creation unit.  These kind of ETFs are derivatives the same way common stocks are derivatives of the company’s value.”

It seems to me that more people need to attend the next ETF conference. So many advisors, individuals, institutions, media outlets and, evidently, Ph.Ds do not understand this innovative product.

You can read the Bogan & Connor Report, CNBC’s coverage, Matt Hougan’s blog, and the iShares Response here:

Bogan & Conner Report

CNBC Report

Index Universe Response to Bogan & Conner Report

iShares Response to the Bogan & Conner Report

iShares Response to Bogan & Conner Followup 

iShares Blog on ETFs, Kauffman Report and the Flash Crash 

 

 

 

learn-more-2024

Recent posts

  • what is financial planning
  • 5 Psychological Biases in Financial Decision-Making

Share This Story, Choose Your Platform!

Wiser Wealth Management, Inc (“Wiser Wealth”) is a registered investment adviser with the U.S. Securities and Exchange Commission (SEC). As a registered investment adviser, Wiser Wealth and its employees are subject to various rules, filings, and requirements. You can visit the SEC’s website here to obtain further information on our firm or investment adviser’s registration.

Wiser Wealth’s website provides general information regarding our business along with access to additional investment related information, various financial calculators, and external / third party links. Material presented on this website is believed to be from reliable sources and is meant for informational purposes only. Wiser Wealth does not endorse or accept responsibility for the content of any third-party website and is not affiliated with any third-party website or social media page. Wiser Wealth does not expressly or implicitly adopt or endorse any of the expressions, opinions or content posted by third party websites or on social media pages. While Wiser Wealth uses reasonable efforts to obtain information from sources it believes to be reliable, we make no representation that the information or opinions contained in our publications are accurate, reliable, or complete.

To the extent that you utilize any financial calculators or links in our website, you acknowledge and understand that the information provided to you should not be construed as personal investment advice from Wiser Wealth or any of its investment professionals. Advice provided by Wiser Wealth is given only within the context of our contractual agreement with the client. Wiser Wealth does not offer legal, accounting or tax advice. Consult your own attorney, accountant, and other professionals for these services.

Sign up for our newsletter!

Our latest blogs, podcasts, and educational videos delivered to your inbox weekly.