By Julian Rea

The recent headline “Credit Suisse defends $2.2bn ETN that lost 96% of its value overnight” in the FT, left me expecting an inflection point for ETFs. Assets will of course continue to grow, but in the near term investor perception will take a knock and regulatory scrutiny will escalate massively.

Focus is likely to increase on leveraged and inverse ETPs first, with the recent Vix-linked product collapses putting a broad clutch of ‘derivative-based’ products in the cross-hairs too, reviving the largely unproductive physical vs synthetic debate.
The likelihood of further market corrections and/or a longer downturn on the horizon will also see many index-linked products perform poorly. No big surprise, though, now saying “but we warned you about this in the prospectus” will be given shorter shrift. I am a massive believer in ETFs, but there is a significant and problematic lack of detailed understanding about these products in many areas of the investment community, particularly in and around the retail space.

This is in part because an incredibly favourable narrative around the evolution and growth of ETFs has seen it attract limited scrutiny and criticism to date. But this is going to change. ETP and index providers have an opportunity to be proactive, to get on the front foot and take responsibility for moving the discussion around ETPs forwards, but they need to act sooner rather than later. A collective effort to speak frankly and openly about a range of topics, including the more complex mechanics of an ETF, or where the operational risks to investors actually lie (and where they don’t), or scrutinising index replication quality, will serve the industry well in the longer term.

This won’t necessarily be easy; some in the industry have tried to broach these topics in the past, only to find that often investors, advisors and indeed the press, are not ready to have this conversation. But perseverance will pay off. No question, there is still a very bright future ahead for ETFs, and those providers issuing well-conceived and well-built products can thrive. But the industry must heed the alarm bells and act now, or it may be left counting the cost of complacency in future.

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