How ETFs could kill the stock market and crush global capitalism – Harvey Jones

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The investment world has fallen in love with exchange traded funds (ETFs), including a growing number of IFAs.

In April, the total invested in ETFs topped $4 trillion and a further $40 billion pours into the sector every single month.

Nothing grows forever but right now ETFs are giving it all they have got. Some claim the market could hit $10 trillion by 2020, as new fiduciary rules force US advisers to favour low charging investment funds.

The ETF love affair is making some people very worried indeed.

 

ETF world
There is plenty to like about ETFs, which can be traded quickly like stocks and shares with no upfront fees and annual charges from as low as 0.07%.

A DIY investor could create a low-cost portfolio by parking their money in a massive global tracker such as Vanguard FTSE All-World ETF, which invests in around 3,000 companies worldwide for 0.25% a year, and pretty much forget about it. Well, it’s an option.

 

Fallen star
The success of ETFs appears to have settled the debate over active and passive management, if only by sheer weight of numbers.

Neil Woodford picked a bad time to suffer his annus horribilis, as active management advocates could have done with his star quality today. Still, at least they have Terry Smith for now.

More IFAs are now accepting the inevitable by charging a fee for their advice, then allocating client money into a balanced portfolio of ETFs.

There are plenty of positives about ETFs but some negatives too.

 

Storm warnings
Analysts are warning that ETFs could be in the eye of the next global stock market storm.

They fear the rush into passive strategies is fuelling a massive overvaluation as share prices detach from fundamentals, inflating bubbles such as the one we may be seeing in the technology sector today.

ETFs then risk turning a downturn into a cascade of selling as the herd heads for the exits, with too few active investors able to stabilise the market by hunting down buying opportunities.

Another concern that if passive funds are all buying the same big companies regardless of performance, they will stifle competition, destroy economic growth and kill capitalism for good.

 

Active love
Let’s not be apocalyptic about this.¬†You only have to see the share price swings on company results day to realise plenty of traders are still buying individual stocks.

Active fund management isn’t dead. There may be 2,500 ETFs in the US but there are six times as many mutual funds.

The current ETF frenzy will not last forever and the pendulum will swing back to active management, especially when market volatility returns.

Low-cost ETFs should be applauded for shifting wealth from the fund management industry to individual investors but that revolution is almost complete and some day soon, investors may be ready to fall in love with active management ag

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