More Incomplete ETF Reporting

Here are three articles I found last night about the UBS scandal calling into question the extent to which ETFs are the next blight on mankind.

UBS' $2b Man Kweku Adoboli And The Perils of ETFs

ETFs Under The Spotlight As Shadow Falls Across UBS' Delta One Operation

Tom Stevenson:ETFs Have Potential to Become The Next Toxic Scandal

These articles pretty much all say the same thing, noting the proliferation (especially in Europe) of ETFs that use derivatives to track whatever it is they are meant to track.

Um, yeah, if you don't want a derivatives based ETF you own to blow up catastrophically due to some unforeseeable failure somewhere in the world then don't use derivatives based ETFs. The articles read like these funds are at great risk of blowing up any minute. Maybe they are but that is a different kettle of fish to the equity backed funds (the ones that just own stocks).

One crucial point not addressed in any of the articles was that UBS and Kweku were not done in by a failed product, they were done in by how he traded. He could have blown up just as spectacularly with any tradable instrument (Nick Leeson). Ditto Jerome Kerviel.

This is similar in a way to options. Selling a call against some stock you own every now and then is not the same thing as maxing out on short puts right before the market cuts in half.

This is also similar to loading up on some lottery ticket biotech stock right before an FDA announcement surprisingly goes against the company.

The point is that people can blow themselves up with anything and they can have success with anything. It should be about how the product is analyzed and then used (or avoided). Did it take Kweku to make the world realize that derivative based funds carry an additional risk that the plain vanillas do not (and again this is not what caused the loss, it was what he did with the product).

We do know that plain vanillas can have problem. Many ETFs freaked out in the flash crash and traded briefly at a penny before getting right side up. If you realized that a basket of stocks that was worth $50 at 2:15 was not then worth a penny 20 minutes later then this event did not blow you up. Plain vanilla bond funds also have trouble now and then as the funds are more liquid then the underlying bonds which causes the market price to trade more dynamically than the IIV.

These types of temporary deviations will probably happen again in some future time of market duress. Equity ETFs we had got caught up in the flash crash and a bond ETF we use had a quick spread between its market price and IIV in the Lehman aftermath and I have to say not only is it not a big deal now as I look back, it wasn't a big deal as it was happening.

None of this might matter to you however. If you disagree with the conclusions I am drawing then obviously you should not use ETFs of any kind but the way the issue is being covered seems to be more about attracting eyeballs, not addressing the actual particulars involving flawed human behavior.