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The return of TLAs

Three letter acronyms, or what the military has a habit of calling TLAs, had such a bad crisis that investors could be forgiven for avoiding them like the plague. But while some TLAs such as CDO, ABS, RBS and FSA are still struggling to rebuild their reputations, one notable exception is roaring ahead. ETF.

Exchange-traded funds have come a long way since they were invented in 1993. As we report this week, they have shrugged off the financial crisis and grew by 28% last year to $1.48 trillion of assets under management, according to research by the doyenne of the sector, Deborah Fuhr at BlackRock.

She estimates they will continue growing at around 30% a year for the foreseeable future. At this rate, they will be bigger than the US equity market by 2022.

This should be ringing alarm bells with investors and regulators. ETFs perform a valuable function in providing investors with a quick and efficient means of exposure to sectors, countries, regions or themes at the push of a button. But as they gather momentum, concern is growing that they will risk overrunning the markets in which they invest and exposing investors to unforeseen risks.

In some markets, particularly commodities, concern is growing that there is not enough physical underlying to match the surge in interest, and that ETFs could exacerbate any future market shocks. As long as an ETF is completely matched stock-for-stock or by cash collateral, this should be manageable.

But as the market runs out of stocks, ETFs will increasingly be created out of complex derivatives structures. Derivatives products that make our lives easier with no apparent risk? Ring any bells?

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