Is the profitable ETF bubble just an illusion?

More than a quarter of all daily trading volume in the US are made up by ETFs, according to Cantor Fitzgerald, one of the industry's largest market makers.

Gary Clement for The National
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Lo and Behold, Reveries of a Connected World

. Watch this before December is up. It's a film by Werner Herzog - the man who does not carry a mobile phone and covers the birth of the internet, artificial intelligence and predictions of doom.

I think it's befitting for a couple of reasons: it's a chance to think bigger picture and examine how we live. It's also a precursor to a black swan.

Stick with me - there's a reason I bring this up.

Today we're delving into Exchange Traded Funds or ETFs. Why? Because it has been decreed - we live in the age of the ETF. Vast amounts of ponderings and write ups have focused on this type of investment. A few years ago some called it the most important development for investors in decades.

New reader start here: Invented in the late 80s, the ETF started out as a product to stop a repeat of 1987's Black Monday and is now a US$3 trillion global industry.

But, not everyone's a fan. The godfather of passive investment - Vanguard's founder, Jack Bogle - isn't keen. He recently wrote of ETFs vs TIFs - his acronym, which stands for Traditional Index Funds.

He created his first TIF in 1976 and more than a decade later was approached by the inventor of the ETF, Nathan Most, who was hoping the two could join forces. Mr Bogle turned Mr Most down, because he could not agree with the trading method being put forward - namely to trade the Index fund "all day long, in real time". This went against the whole point of Vanguard's first forays: to be passive and compound returns over the lifetime of the fund.

Millions of people bought into ETFs though. Think of them as reducing the market they track to a single product, these units can be bought and sold throughout the day, the same as you could stocks in individual companies. Unlike individual shares though, an ETF unit is made up of every company on the index it copies. So when it's bought or sold, it reflects the movement of that market, not individual holdings.

In other words, ETFs mimic the performance of a specific market or index - but can be traded like individual stocks. It's one way investors can buy into markets that are not open to foreigners.

And it's this constant trading that costs investors.

Which is why Bogle sticks with his TIFs.

My point is that, yes, low maintenance, index-based products are a better bet for people like you and me. But even with these products, you've got to look at the small print, and the seemingly insignificant spending - compared with other tools that have us paying for advisers, active trades and so on.

Look out for these small spends. TIFs have outperformed ETFs for months by about 1.5 per cent. Doesn't seem much, but it has an effect on your takeaway packet when you get out of it.

The bigger picture for me though is this: ETFs were created to get out of a stock market black hole. It was the day the Dow Jones plummeted 22 per cent that set of the chain of events that gives us ETFs.

ETFs have ballooned as investors got out of actively managed funds and into these passively managed ones instead. Now, more than a quarter of all daily trading volume in the US are made up by ETFs, according to Cantor Fitzgerald, one of the industry's largest market makers.

Professional stock pickers complain - saying that ETFs can create bubbles, funnelling vast amounts of money into the same trades. Passive investment is doing them out of a job. Let's hope it isn't doing more, creating a swan event that's getting bigger and blacker in the process - that'll make ETFs the problem, not the solution.

Can ETFs create and profit from market distortions just as the human equivalent wants to? But in doing so, have our automated money mechanations come tumbling - perhaps with many more consequences playing out in the process?

There isn't a lot of depth, but Lo and Behold does a great job of skimming the surface and connecting so many dots - something that needs doing. It also delves into what happens when it goes wrong - and how it can go terribly, horribly wrong.

What a fitting way to end the year. It has a great cast including Elon Musk - perhaps that'll whet your appetite.

Nima Abu Wardeh describes herself using three words: Person. Parent. Pupil. Each day she works out which one gets priority, sharing her journey on

.

pf@thenational.ae

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