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There’s always another disaster waiting to happen – so keep your eye on ETFs

4 June 2011

12:00 AM

4 June 2011

12:00 AM

There’s always another disaster waiting to happen – so keep your eye on ETFs

If we learned anything from the recent financial crisis, it is that when a thing looks too good to be true, it is. If a sector is attracting frenzied investor attention and pundits say spectacular
growth must continue, it is surely heading for trouble — not next week, perhaps, but soon enough to allow a minority of sceptics to say ‘I told you so’. In markets, good ideas
pursued to extremes mutate into disasters and, at any given moment, someone somewhere is concocting the next one.

And so I draw your attention to Exchange Traded Funds, or ETFs. These instruments — the prototype of which, the Standard & Poor’s Depositary Receipt or ‘Spider’, was
launched in 1993 — are akin to index or tracker funds, except that as the name suggests they are traded on exchanges where their prices move from minute to minute. They offer simple ways of
investing in domestic or emerging stock markets, or classes of commodities. You can tuck them away in your portfolio, or buy and sell them all day long at modest transaction costs. In his guide to
commodity investment (The Spectator, 21 May), Alex Brummer referred to ETFs as ‘an easy dealing alternative’ to shares in mining companies for those seeking exposure to gold or
platinum. In the FT, John Authers called ETFs ‘a great idea… every retail investor with an internet connection can make their own attempt at being a global macro hedge fund
manager.’

So far so good. But as Authers also acknowledged, ‘concerns have begun to multiply’ as the sector has taken off like a rocket — growing by around 40 per cent per annum in the past
decade and accounting for $1.4 trillion of assets by March this year. Although most ETFs are constructed on sound ‘tracker’ principles, meaning that they actually own the basket of
assets whose value they aim to reflect, many others are ‘synthetic’, meaning they own derivatives which may behave erratically or involve unreliable counterparties; and some are
‘leveraged’, meaning they deploy borrowed money in the hope of amplifying returns.


All this may sound a bit technical, but bear in mind that if you hold collective investment products, or entrust your nest-egg to a wealth manager, you probably already own thin slices of a
selection of ETFs. And wise folk are beginning to feel uneasy about them. The Bank of England is said to be worried. The Financial Stability Board in Basel, set up by G7 ministers to watch for
smoke on the financial horizon, has just issued a warning. Gillian Tett, the FT columnist who predicted the credit-derivatives crash two years before it happened, says, ‘It’s hard not
to feel a sense of déjà vu.’ And the loquacious City player Terry Smith agrees: ‘The pace of development in the ETF area has been described as breakneck,’ he blogged
recently. ‘I just wonder whose neck will get broken.’ You have been warned.

Conspiracy of the bosses

Am I bothered that Michael Spencer, chief executive of the inter-dealer broker ICAP, took home £23.7 million last year? Funnily enough, I’m not. Spencer may not be the most lovable
bloke in London but he is a talented entrepreneur who has spent 25 years building up a business that is now the biggest of its kind in the world. He staked his own capital to do so, and he deserves
the rewards his fellow shareholders choose to offer him. But that sets him apart from many other FTSE chiefs, whose median pay rose 32 per cent last year to £3.5 million — with an 86
per cent rise in the top 25 companies.

And that really does bother me, because most of these recipients are mere employees, recently hired in, who had no hand in creating the companies they run. Leaving aside the leftist argument that
workers are suffering real income falls while the bosses’ bonanza rolls on, the key point is that a chief executive’s principal task is to deliver for shareholders — who have
suffered rotten returns for more than a decade while top pay has almost quadrupled. Yes, many FTSE chiefs are non-Brits running global businesses, and boards have to pay up to attract the best
global talent. But no one can seriously claim this is a healthy trend: it looks more like a global conspiracy. As one retired FTSE chairman remarked to me recently, ‘You can’t help
feeling something’s gone wrong with capitalism.’

A present for the Duke

The Duke of Edinburgh’s recent lament for the decommissioning of the Royal Yacht Britannia found an echo in obituaries of Bill Clarke, the former City editor of the Times who was the father
of British Invisibles. Under various names over four decades, this was the body which energetically promoted British financial services around the world until it too was decommissioned last year
— or at least merged into a more defensive lobby group called TheCityUK. In its heyday, British Invisibles ran convivial selling missions to foreign cities, often timed to follow royal visits
and make use of Britannia’s staterooms as a reception venue before she sailed for home; the first was at Naples in 1980, and there were many more. Guests were suitably impressed and the
organisers believed billions of pounds of business came to London as a result.

The Duke will be 90 next Friday. He is now (almost) universally recognised as a national treasure and he deserves a decent birthday present. Britannia, permanently moored at Leith, has become a
rather naff tourist attraction, with its Royal Deck Tea Room and its peep into the Queen’s cabin. But if the Duke is right that she (the ship, that is) was still ‘as sound as a bell and
could have gone on for another 50 years’ when John Major’s government insisted in 1994 that she had to go, then it cannot be beyond the wit of naval engineering to bring her back into
service, both royal and financial, in time for next year’s Diamond Jubilee.

The refit and future running costs could be met by annual whip-rounds in the City, as a gesture of atonement for distress caused and gratitude for past business generated. How the nation would
cheer.


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