Volatility is back. While the recent market sell-off was characterised as long overdue by commentators, there were a number of products that suffered more than most.
Two major banks – Credit Suisse and Nomura – ended up liquidating their exchange-traded note (ETN) products that had allowed investors to profit when volatility was low, after all, gains were wiped out in a single trading session.
Clearly, these are investments you would not want to find yourself invested in. But what other financial products are set to break investors’ hearts in 2018?
The candidate wealth managers were most likely to point to is bitcoin.
‘Bitcoin or blockchain stocks. Both these fit the bill of “don’t buy what you don’t understand”.’ said Hawksmoor Investment Management head of research, Jim Wood-Smith. ‘Anyone pretending that they do is bluffing or delusional.’
Wood-Smith is not the only one baffled by cryptocurrencies. Fiona Gillespie, senior investment manager at Anderson Strathern Asset Management, said: ‘Although very interesting, the cryptocurrency stable confounds us.
‘For many investors, such embryonic concepts are exactly what one should look to, but we are frankly not that brave to be such an early adopter.’
Gillespie also highlighted volatility-related strategies, which she pointed out would not be suitable for her clients.
‘We saw the impact of wild movements just the other day, with a 96% or so fall in some VIX related exchange-traded funds (ETF), again, something which we feel not suitable for our client base. A useful hedging strategy for sophisticated investors, but far from a core investment.’
Issues over visibility in synthetic ETFs are another concern raised by wealth managers.
Roddy Buchanan, head of wealth management at WH Ireland, pointed out that where there is not complete visibility of underlying holdings, there can be a degree of mistrust.
He said: ‘Physically backed [ETFs] are one thing but those that are actually synthetic have more of a question mark around them. This is not to say that you would avoid them like the plague, far from it.
But it’s just being cognisant of the risks involved. As with all the things it is very much being well aware of the risks, and having one’s eyes wide open.’
Walker Crips’ Newbury office head Crispin Cripwell agreed with Buchanan, but added that he would ‘never touch’ synthetic ETFs.
Cripwell noted that investors tend to drift into riskier assets in times when mainstream valuations are called into question.
‘A lot of people were concerned about valuations going into the financial crisis and they were invested in alternative assets, so for example forestry funds or wind energy.
‘The idea is that they would be economically isolated from what was going on elsewhere and should not be impacted by the ups and downs. In fact, it did not really work out that well: a lot of them got absolutely crushed in the 2008 to 2009 downturn.’
Issues with leveraged ETFs
For John Spiers, chief executive of EQ Investors, there could be a number of issues with leveraged ETFs in the coming year.
He said: ‘We feel the key point is that volatility was unnaturally low during 2017. We should expect it to be higher in future, possibly much higher. That means that gearing will become even more dangerous, so leveraged ETFs on equity markets could prove to be quite a bad investment in 2018.’
Spiers pointed to Proshares UltraPro S&P 500 ETF, which is three times leveraged, and the Direxion Daily S&P Oil & Gas E&P, which is also three times leveraged, as notable examples.
He added: ‘With the recent increase in production in the US, oil prices have potentially further to come down, so that’s clearly a sector I would avoid personally.’
Also in the world of exchange traded products, Matt Hoggarth, a senior investment analyst at Thesis Asset Management, flagged emerging market fixed income ETFs as a possible, particularly risky investment in 2018.
‘We’ve heard of one or two emerging market ETFs where their holdings were trading on pretty crazy valuations relative to sovereign bonds – simply because the inflows meant the funds just kept buying the same bonds because they had high ratings in the index.
‘That definitely can be a downside of passive, particularly on the fixed interest side, if you are chasing particular assets that are illiquid respective of valuations.’