Baillie Gifford's managing partner Charles Plowden has likened exchange traded funds to the sort of complicated financial instruments that led to the global financial crisis of 2007.
Speaking at a conference in Edinburgh, Mr Plowden, who is also manager of the £1.5bn Monks investment trust, said ETFs are being sold by banks without care to people who don't know what they are buying.
“ETFs account for about 30 per cent of the money in the US market, and they are created, it seems to me, by investment bankers so they can have a product to sell", he said.
"Just like before the financial crisis when mortgage products and CDOs [collateralised debt obligations] were created by investment banks, and sold to people, those buyers didn’t know what they were investing in, didn’t care what they were investing in.
"It is the same with a lot of the ETF money now, it is dumb money.”
The fund manager acknowledged that he has a vested interest in talking down ETFs as he is an active fund manager and would not have a job if the whole world bought the passive instruments.
But he said ETFs could cause a crisis in equity markets because “it is like every investor is wearing a blindfold".
"They don’t know what they have invested in. It is fine when everyone wearing the blindfold is moving forward, but as soon as one trips up, everyone falls down.
"It was the same with the last financial crisis, we were big investors in Northern Rock. And it turns out the Northern Rock mortgage book was good quality. [Since the crisis] the government has made money from the mortgages it had from Northern Rock, and Virgin Money made a profit from the Northern Rock Mortgages it had.
"The company folded because of all the bad mortgages in the world, causing it to trip up. It could be we see the same with ETFs. There are now more indices tracking the US market than there are stocks on that market, and some of them will be bad products.”
Mr Plowden said a profound problem with index trackers is they are backward looking, that is, they own more of the stocks that have done well in the past, but may not perform well in future.
He said an ETF tracking the US market will have a substantial exposure to US banks, which are being disrupted by fintech, and will be exposed to big oil companies losing out to renewable energy, and retailers losing out to Amazon and similar.
Mr Plowden said an investor can buy ETFs that exclude one or other of those sectors but not all.
The fund manager believes an ETF investor is more likely to be short-term in their thinking and sell out in periods of short term volatility because ETFs are marketed as being cheap to buy and sell.
Tony Yousefian, investment adviser at Fund Calibre, said the performance of the Monks investment trust has been excellent since Mr Plowden took charge.
David.Thorpe@ft.com
