ETFs and the importance of transparency
Following recent scrutiny, exchange traded funds (ETFs) have emerged as some of the more transparent mutual funds available to investors.
This can be seen at a number of levels. Take fees, for example. The websites of ETF providers outline in simple terms the underlying fees for each fund, with many ETFs listing a single ‘all-in’ fee that represents all costs charged by the provider.
Meanwhile, as they trade intra-day on exchange, investors can easily track the current market price of ETFs, with some providers streaming market prices in real time to their websites. The composition of their underlying indices and the levels at which they are trading are also publicly disseminated and updated regularly on providers’ websites.
The manner in which ETF portfolios are managed have also become increasingly transparent. Traditionally, investors in mutual funds were only able to assess the ways in which their funds might use derivatives or lend out securities once or twice a year – through reading annual or semi-annual reports. Today, some leading ETF providers supply information relating to these activities online in close to real time.
But why has this ramp-up in transparency occurred and why is it important?
Underlying ETF functionality has become so transparent partly because of the competitive dynamics of the ETF market.
The vast majority of ETFs are designed to provide what is described as “plain vanilla” exposures. As open-ended funds that aim to track market indices, they strive to replicate the risks and returns of the market – known as beta. They are not designed to deliver outperformance, or alpha, which actively managed funds attempt to deliver. Neither are they designed to provide investors with a conditional “pay-off” that might outperform the market, in the manner of a structured product.
As they are unable to differentiate themselves on these terms, ETF providers have instead looked to do it in other ways. Some of these are obvious, such as competing on the basis of offering lower all-in fees. Others are not so obvious, such as competing in terms of the structure or operational integrity of their products – for example, by seeking to minimise the risks posed by counterparties on their deals or contracts.
That dynamic has also led ETF providers to make their already publicly listed products very publicly transparent in terms of their underpinnings. This serves investors well, not just because transparency is good in and of itself, but also because with full transparency comes a very clear incentive for the ETF provider to ensure that the product is sound from a fiduciary standpoint – in other words, operates in the interests of the investor.