ASIC has published new information on its consumer finance website, MoneySmart, to help consumers understand the different types of Exchange Traded Funds (ETFs) and their risks.
ETFs can provide a convenient and low-cost way for investors to diversify and receive returns close to the performance of market indexes or other assets, usually with lower fees than traditional managed funds. But while standard, ‘physical’ ETFs generally invest in the underlying investments they are designed to track, ‘synthetic’ ETFs also use derivatives, such as swap agreements, to achieve similar outcomes. Benefits to investors of synthetic ETFs may include access to new and varied asset classes and low performance ‘tracking error’. Downsides include increased complexity and counterparty risk.
Standard ETFs are widely available in Australia. A few synthetic ETFs are currently available in Australia and they are increasingly available overseas.
ASIC Chairman Greg Medcraft said: ‘ETFs are growing in popularity and people should understand the different features and risks of ETFs before investing. We want investors to be informed and confident if investing in ETFs so therefore ASIC has published clear and straight forward information at www.moneysmart.gov.au to help investors understand these products. While conventional ETFs are often relatively straight forward, there are complexities and risks to be aware of. Furthermore, the use of derivatives by synthetic ETFs creates separate additional issues for investors to consider. Either way, people should not invest in products they don’t understand.
‘ASIC is monitoring this area closely and will review thoroughly the introduction of any new types of ETFs in Australia, as some of these can be complex investments that may not be suitable for many retail investors,’ he said.
ASIC’s consumer information update follows its work in November 2010, where new measures were introduced to help address the risks of the two synthetic ETFs currently available, including:
- the products must use the word synthetic in their title, so investors can identify them
- the swap counterparty must be an entity of substance such as an ADI or its foreign equivalent, or an entity with an irrevocable guarantee from an ADI or ADI equivalent
- the ETF provider must hold substantial security (collateral) for its swap agreements; this collateral must be liquid and be consistent with the investment objective for the ETF
- counterparty exposure should not normally exceed 10% of the ETF value, and if temporarily exceeded, the counterparty should immediately pay up to reduce this exposure
- investments in these types of products should be non-recourse.
In recognition of the growing popularity of ETFs in Australia and the need to help investors understand the risks and other considerations associated with them, ASIC has started a review to identify and assess the risks associated with both standard and synthetic ETFs. The review will seek to clarify the impact of these risks to Australian investors. It is envisaged that the review will involve discussions with participants of the ETF industry in Australia.