Investing to Wealth » ETFs http://blog.macroaxis.com Macroaxis Blog Thu, 09 Feb 2012 07:51:05 +0000 en hourly 1 http://wordpress.org/?v=3.3.1 From Rogues to Riches: How ETFs are Lining Wall Street’s Pockets – While Picking Yours http://blog.macroaxis.com/2011/09/23/from-rogues-to-riches-how-etfs-are-lining-wall-streets-pockets-%e2%80%93-while-picking-yours/ http://blog.macroaxis.com/2011/09/23/from-rogues-to-riches-how-etfs-are-lining-wall-streets-pockets-%e2%80%93-while-picking-yours/#comments Fri, 23 Sep 2011 10:00:27 +0000 Shah Gilani http://moneymorning.com/?p=56439 the rogue trader at UBS AG (NYSE: UBS) who lost $2.3 billion last week was trading exchange-traded funds (ETFs). Or that Jerome Kerviel, another rogue trader at Societe Generale SA (PINK ADR: SCGLY) who lost $7.2 billion in 2008, was trading ETFs.

Maybe you didn't know that ETF trading accounts for 35% to 40% of all exchange volume, according to Morningstar Inc. (Nasdaq: MORN).

Maybe you didn't know that the U.S. Securities and Exchange Commission (SEC), the U.S. Commodity Futures Trading Commission (CFTC), the Financial Stability Board (FSB) and the Bank of England (BOE) are each concerned that ETFs pose potential systemic risks.

Maybe what you don't know can actually hurt you.

ETFs: Growing Popularity, Growing Danger?

Just when you thought that exchange-traded funds were a simple, smart and safe way to diversify out of underperforming stock-and-bond mutual funds, along comes reality.

What these regulators and financial- stability oversight agencies are increasingly worried about is whether Wall Street's presumed good intention in creating these hugely popular investment vehicles is being undermined by unintended consequences.

But, let's not forget, we're talking about Wall Street, where unintended consequences are a rarity. The reality is that ETFs were originally conceived - and are increasingly being engineered - to ratchet up trading for the Street's own benefit.

And while you may not think that affects your investing or trading of ETFs, or your portfolio-diversification plans, you'll be surprised - and maybe even alarmed - to learn that you're wrong.

Let me explain ...

Instruments of Diversification ... Or Disaster?

ETFs started out as tradable alternatives to mutual funds. Initially, product portfolios consisted of stocks, or baskets of stocks, that replicated such key indexes as the Dow Jones Industrial Average, the Standard & Poor's 500, or the Nasdaq Composite Index.

The idea was to offer products that mirrored benchmarks - and that traded all day, like stocks. The tradability of these instruments offers effective liquidity that conventional mutual funds lack , with the added benefit that ETFs would also be easy to short.

Product offerings multiplied quickly. In addition to exchange-traded funds based on stocks, product sponsors created ETFs that replicated oil-and-gas, gold-and-silver and diversified-commodities portfolios - all of which were based on futures contracts.

A lot of ETFs started out as a cheaper alternative to futures trading. Futures traders must cover high initial-margin deposits. And positions are marked-to-market daily, which requires immediate additional margin coverage when losses arise. The upshot: f utures trading is too expensive and too volatile for investors who are used to traditional stock market investing.

Today, investors can find exchange-traded funds that offer exposure to all kinds of risk instruments - from currencies and bonds, to thin slices of the yield curve and volatility. And there are even "leveraged" and "inverse" ETFs that multiply risk exposure and allow traders to make all kinds of directional bets.

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