ETFs The BlondeMoney Micro Shot

  • Due to worldwide QE, money has flowed from active into passive money strategies skewing the market
  • As a result, the ETF market has grown to be one-quarter of market capitalisation of the S&P500
  • There are endemic frailties within the ETF market, with the liquidity transformation having 3 distinct risks:
    • Timing
    • Liquidity
    • Hedging
  • There have been warning signs – August 2015 & February 2018

Risks for Your Portfolio:

  • Are you getting the value you think you should be from your ETF?
  • Can you redeem when you need to/ want to?
  • Diversify out of ETFs

Download the PDF report


Brett Moorcroft

Nice summary. Liquidity transformation products caused the last melt-down. SIV’s would buy long-dated illiquid ‘AAA’ securities financed by short-dated CP which got rated highly also due to a backing bank. Then some investors question the AAA’ness of the underlying and suddenly no more CP buyers and SIV is forced to liquidate underlying long-dated illiquid “AAA’s”. Price begets price and spirals occured quickly. Banks were then stuck with the SIV assets and then people questioned the bank value etc etc….

In this case I guess when someone questions the value of a component or two of an ETF and sells the ETF, then the market maker has to dump either the underlying or the ETF. Like you point out, the problem is really when the underlying is not liquid. But then, unlike the SIVs, there is no “backing bank” who has to take on the asset if not saleable. Although most exchanges do require, for an ETF to list, a designated market-maker to make orderly markets in the ETF. So I guess they could be on the hook for the ETF and therefore the underlying.??? A rambling response, but worth investigating more as to how strong the obligation is on a market-maker?


Rules for market makers here:

The fact is that they are only bound by making prices a certain percentage away, if a stock were limit down. Even if they pull out, the sanctions from the exchange have not thus far been very punitive – simple fines for example, and being allowed back onto the exchange.

The exchange would likely suspend prices if it became disorderly and they wouldn’t be on the hook. The only person on the hook is the issuer; but they would demand cash from their APs. Who are, often, banks… so it’s back to the banks again. Would they pass the hot potato back to the asset manager? Or just step away and preserve their own capital?

Feedback welcome from y’all…


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