Smart beta roundtable: where next for exchange traded funds?

Parker: There has been reaction against swap-based ETFs in the market in recent months, due to a couple of controversies that have sprung up. Is this reaction over the top?

Draper: It’s all about transparency. We’ve gone through a lot of investigation now over the past year or two.

But, I think, just the mentality, you’re the risk manager, if something does go pear-shaped, if you have a physical product, even if it had securities lending most of the physical providers, can turn off securities lending within a reasonable amount of time.

But if you’re a swap provider you need to think: worse case, can I access another swap provider if there was collateral?

Parker: The big money in swap ETFs is when you are the manager and counterparty. That’s where the real benefit is and, of course, that’s where the biggest risk lies.

Draper: We’re only talking about extreme cases here. I mean, that’s the point that you really understand from [the] risk manager perspective what happens. That question wasn’t asked until 2008. Then regulators all investigated that pretty thoroughly in the last year.

I think that’s where if I was sitting in with my manager I would ask what happens in each market case? Tell me what happens with the swap provider, what happens with my collateral, for example. It’s just those types of questions you ask to tick the box in due diligence and then hopefully you can move on.

Murphy: It’s not even so much that you can’t make them comfortable with it. It’s this perception. It’s the same sort of perception that exists with structured products and things like that and how you explain those to your private clients and how they actually benefit from using them.

I think that there is a responsibility to make sure that you can clearly articulate what’s going on in the portfolios, particularly for advisers to speak to their clients. But for investment managers constructing each proposition, they’ve got to be able to clearly explain that and show their due diligence.

Parker: Moving on to another topic: are we getting close to a time where commodity exchange traded products (ETPs) can be truly efficient?