The question of whether an ETF can collapse is the focus of a fascinating new report by Bogan Associates, an under-the-radar investment firm in Boston.
The concern of the Bogan report, as well as other market participants I’ve been talking to, is that the complexity of exchange-traded funds and their increased use as trading vehicles by hedge funds can be quietly but quickly creating serious market risk.
At the heart of the matter is what stock ETFs really are: Derivatives with unlimited share creation prospects. Unlike regular mutual funds, which buy and sell stocks with the cash from investors, ETFs buy so-called “creation units” from participating institutions. Each creation unit represents 50,000 shares owned by an “authorized participant.”
I can’t stress the complexity of the structure. If the very nature of these “creation units” is beyond the comprehension of most investors the actual mechanics of ETFs involve an even far more complex matrix of transactions.