Stock market is a "fully-fledged epic bubble" and will burst

[xeny]

leef44 said:

This is sounding more and more like Lloyds Insurance companies where they re-insure their insurance position with another Lloyds member. Each time, someone makes a commission. All insurance brokers are very happy for many years until the house of cards collapses.

Tell me I'm wrong.

I don't understand the multiple ownership issue you're worrying about, but certainly when you see a fund advertising it is a "fund of funds" you want to look closely at the fee structure.

[leef44]

xeny said:

I don't understand the multiple ownership issue you're worrying about, but certainly when you see a fund advertising it is a "fund of funds" you want to look closely at the fee structure.

I guess I'm concerned that there is more money invested in ETFs than the valuation of the companies which their performance is based on. If the total value of all companies is $100, is it possible that total ETF funds are (say) $160 so that we are riding on a wave of growth in ETF indices based on more and more investments going into them.

Is this a bit like Bitcoin where the value keeps on going up because more and more investment is going into it?

[NowWatchThisDrive]

leef44 said:

I guess I'm concerned that there is more money invested in ETFs than the valuation of the companies which their performance is based on. If the total value of all companies is $100, is it possible that total ETF funds are (say) $160 so that we are riding on a wave of growth in ETF indices based on more and more investments going into them.

Is this a bit like Bitcoin where the value keeps on going up because more and more investment is going into it?

When you own "shares" in an ETF, the ETF provider (e.g. Blackrock, Vanguard, Fidelity) owns a corresponding amount of the underlying assets, so if the ETF underlying is something in fixed supply (e.g. an index of stocks, each of which has a fixed number of shares outstanding) there is a theoretical limit to how big the ETF could be. There's various practical reasons why this could and would never happen, but look purely at the numbers and it's not even close; the S&P, for example, has a market cap of just under $37 trillion, while the combined AUM of the 5 biggest ETFs tracking it is about $914 billion. Precisely estimating the amount of passive investment that exists in a given index is a whole ballgame in itself, and something that is the preserve of professional traders at banks and hedge funds who specialise in trading around index rebalances, but for most investors it's not really something to worry about.

At the individual company level, there are some companies which are sufficiently well-owned by passive investors through a small number of ETFs, that some have publicised concerns about the possible anti-competitiveness arising from ownership concentration; Matt Levine at Bloomberg has a recurring "Are index funds communist" theme on this in his daily newsletter (which, btw, I'd thoroughly recommend to anyone with a passing interest in markets and an appreciation for good writing!).

[leef44]

Thank you NowWatchThisDrive

I will digest some of that reading material.

[Mr Whippy]

ATM said:

No

You're all missing the point.

What he means is ETF A has a holding of ETF B and ETF C. So it doesn't hold the underlying shares in actual companies like Tesco. It holds the ETF just like you or me holding the ETF.

Now this can be further compounded in that ETF B can hold ETF D and E. Again it doesn't hold the underlying but just ETFs.

Do you see where this is going?

You have a stack of ETFs all holding more and more ETFs.

You need to show the accounting.

The ETF will hold the actual shares eventually.

I can see how the risk of that could be seen to be happening, but each ETF is buying exposure to a certain number of shares. The more of that ETF you own, however you own it, buys more exposure to shares.

If you own ETF A and ETF B (which also holds ETF A), then you'll just own *more* exposure to more of ETF A, not the *same* exposure in ETF A.
When ETF A sells more exposure, it has to buy more stock.

[leef44]

Mr Whippy said:

ATM said:

No

You're all missing the point.

What he means is ETF A has a holding of ETF B and ETF C. So it doesn't hold the underlying shares in actual companies like Tesco. It holds the ETF just like you or me holding the ETF.

Now this can be further compounded in that ETF B can hold ETF D and E. Again it doesn't hold the underlying but just ETFs.

Do you see where this is going?

You have a stack of ETFs all holding more and more ETFs.

OK, so ETF A would actually buy more shares and not have some sort of derrivative contractual obligation. In other words, there isn't some sort of arrangement with ETF B which says, if this share/index goes up then contractually we owe you more money so we have a bigger liability to you. What they would do is actually buy more shares so that they are not exposed.



You need to show the accounting.

The ETF will hold the actual shares eventually.

I can see how the risk of that could be seen to be happening, but each ETF is buying exposure to a certain number of shares. The more of that ETF you own, however you own it, buys more exposure to shares.

If you own ETF A and ETF B (which also holds ETF A), then you'll just own *more* exposure to more of ETF A, not the *same* exposure in ETF A.
When ETF A sells more exposure, it has to buy more stock.

[DonkeyApple]

leef44 said:

Mr Whippy said:

ATM said:

No

You're all missing the point.

What he means is ETF A has a holding of ETF B and ETF C. So it doesn't hold the underlying shares in actual companies like Tesco. It holds the ETF just like you or me holding the ETF.

Now this can be further compounded in that ETF B can hold ETF D and E. Again it doesn't hold the underlying but just ETFs.

Do you see where this is going?

You have a stack of ETFs all holding more and more ETFs.

OK, so ETF A would actually buy more shares and not have some sort of derrivative contractual obligation. In other words, there isn't some sort of arrangement with ETF B which says, if this share/index goes up then contractually we owe you more money so we have a bigger liability to you. What they would do is actually buy more shares so that they are not exposed.



You need to show the accounting.

The ETF will hold the actual shares eventually.

I can see how the risk of that could be seen to be happening, but each ETF is buying exposure to a certain number of shares. The more of that ETF you own, however you own it, buys more exposure to shares.

If you own ETF A and ETF B (which also holds ETF A), then you'll just own *more* exposure to more of ETF A, not the *same* exposure in ETF A.
When ETF A sells more exposure, it has to buy more stock.

That's correct. In essence, whatever happens the end result is physical stock being purchased.

So if ETF A holds just BP and ETF B holds just ETA A and ETF C holds 50% of ETA and 50% of ETF B then if you buy a holding in ETF C then ETF C buys into ETF A and B in the contractual amounts. ETF B would then have to buy ETF A in its contractual amount and finally ETF A would be buying all the BP stock to fill your order in ETF C. In short, you'd just be buying a physical holding of BP via a whole load or wrappers and fees.

There will be funds that take exposure via OTC contracts in underlying funds or equities but even those funds won't see an upside to running your position on their book, ie they lose when you as the investor eventually win, so even when OTCs are used they will be hedged in the underlying. The benefit of the OTC not being that of hoping to win when the investor loses but to take advantage of leverage, execution speed, tax jurisdictions etc.

[Mr Whippy]

There are ETF and there are ETF trackers and then all sorts of other exotic products that are 'exchange traded'

If an ETF say's they own shares in XYZ, then for every unit they sell to some entity, they'll have to buy exposure to more of the shares they say they are exposed to.


If they own trackers or anything else, then you're buying promises of value based on a number. I've no idea how that all works out. Such is the 'system'
And if the system fails, then the tangible business stocks/shares are probably going to become worthless too any way.


All I'll say as I always do, is diversify.

Cash, shares, ETFs, PMs, property, crypto, blah blah blah.

Only a mentalist would go all in on ETF tracker type stuff if they have a propensity to worry about black swans on the long tail of the curve. Which arguably we should all worry about... which is why we should diversify

[stongle]

Fully replicating / physically backed ETFs are as you described. There are however probably more leveraged or synthetically backed ETFs than physical.

There is nothing wrong with leveraged or synthetic ETFs; but they are (and should be) the preserve of experienced or (most) non-retail investors.

Leveraged ETFs do have lower costs, as they require significantly lower financial resources in their creation (think Balance Sheets of those producing them). Using derivatives to generate the same performance as a physical holding is much cheaper as it swerves lots of operational and capital costs. The downside to that, is valuation and ensuring they are fully delta hedged (so there is an element of trust / credit risk inherent). Its that tracking of risks / delta hedging that means lots of financial institutions won’t touch them as collateral; and as such (because they can’t build the valuation look through) is why they are not suitable for retail.

I see that DA has given a precis on the differences; but the cost saving using derivatives rather than physical stock holdings can be as high as 0.5% (which is significant) and that’s after allowing for +/-‘ve MtM and margin costs.

[leef44]

Thank you DA and Stongle, very informative explanations.

Are leverage ETFs on the increase due to cheap finance? Is there a risk that the exposure could lead to a crash if a sudden rush of positions are unwound e.g. cheap finance coming to an end, sensitivity to interest rates?

[ATM]

leef44 said:

Thank you DA and Stongle, very informative explanations.

Are leverage ETFs on the increase due to cheap finance? Is there a risk that the exposure could lead to a crash if a sudden rush of positions are unwound e.g. cheap finance coming to an end, sensitivity to interest rates?

I dont even get a by-line in the gratitude list. Even though I dug is out of a hole and got us back on track. I am always under estimated and under appreciated in these forums. I'm going to tell my Mum about this.

[DonkeyApple]

leef44 said:

Thank you DA and Stongle, very informative explanations.

Are leverage ETFs on the increase due to cheap finance? Is there a risk that the exposure could lead to a crash if a sudden rush of positions are unwound e.g. cheap finance coming to an end, sensitivity to interest rates?

It's a combination of things. Cheap finance is at the core but on the client side it's the demand driven by greater risk appetites, shorter term thinking and greater interventions etc.

Personally, I think there are better ways for a UK investor to leverage an ETF for investment purposes but leveraged ETFs are aimed at a global retail market not just our little island.

[LeoSayer]

For funds that have equity exposure via derivatives, do they still benefit from the value of dividends?

If so, how does this work?

[DonkeyApple]

LeoSayer said:

For funds that have equity exposure via derivatives, do they still benefit from the value of dividends?

If so, how does this work?

The dividend always has to be replicated.

A 100p share pays a 10p divi. The value of the company is now 90p. That's the crude basics from the perspective of a vacuum.

If an instrument doesn't reflect that change then you'd simply arbitrage it out of existence and bag free money.

[stongle]

DonkeyApple said:

LeoSayer said:

For funds that have equity exposure via derivatives, do they still benefit from the value of dividends?

If so, how does this work?

The dividend always has to be replicated.

A 100p share pays a 10p divi. The value of the company is now 90p. That's the crude basics from the perspective of a vacuum.

If an instrument doesn't reflect that change then you'd simply arbitrage it out of existence and bag free money.

Massive market for dividend futures etc, for ETFs I seem to remember there is an efficiency to the ETFs (but its been a while since I looked and it was mainly US sectors). The problem with the Dividend market, is in a crisis you can get spanked. As Soc Gen, BNP, Natixis found out last year. And a few years before there was the whole BP not paying a dividend that hit the DeltaOne desks hard.

This shouldn't filter down to retail investors; but there is a very close link between the ETF Creation Redemption teams; and the Delta One / Securities Financing desks (for Equities at least). A lot of the stocks that are backing ETFs are lent back into the market to generate additional fees / upside (possibly yield enhancement or as borrow supply - cover shorts).

I'm still a little less certain that ALL retail should be buying synthetic ETFs, not unless you know what you are doing.

[leef44]

ATM said:

leef44 said:

Thank you DA and Stongle, very informative explanations.

Are leverage ETFs on the increase due to cheap finance? Is there a risk that the exposure could lead to a crash if a sudden rush of positions are unwound e.g. cheap finance coming to an end, sensitivity to interest rates?

I dont even get a by-line in the gratitude list. Even though I dug is out of a hole and got us back on track. I am always under estimated and under appreciated in these forums. I'm going to tell my Mum about this.

Indeed

Thank you for bringing this back on track and elaborating on what I was trying to ask

[leef44]

DonkeyApple said:

leef44 said:

Thank you DA and Stongle, very informative explanations.

Are leverage ETFs on the increase due to cheap finance? Is there a risk that the exposure could lead to a crash if a sudden rush of positions are unwound e.g. cheap finance coming to an end, sensitivity to interest rates?

It's a combination of things. Cheap finance is at the core but on the client side it's the demand driven by greater risk appetites, shorter term thinking and greater interventions etc.

Personally, I think there are better ways for a UK investor to leverage an ETF for investment purposes but leveraged ETFs are aimed at a global retail market not just our little island.

My concern isn't so much what happens on our little island but more globally. Also what isn't offered in the retail market doesn't mean it doesn't impact the little person on the street.

Sub-prime and CDOs is an example. There is this complacency and arrogance (aka greed) in the financial markets where they get creative in finding more efficient ways to make money. It escalates and then before too long they find they are dug in so deep they don't know how to get out of the hole so dig in deeper. Eventually the whole thing implodes.

I was wondering whether leverage ETFs could get out of hand in the same way.

[DonkeyApple]

leef44 said:

My concern isn't so much what happens on our little island but more globally. Also what isn't offered in the retail market doesn't mean it doesn't impact the little person on the street.

Sub-prime and CDOs is an example. There is this complacency and arrogance (aka greed) in the financial markets where they get creative in finding more efficient ways to make money. It escalates and then before too long they find they are dug in so deep they don't know how to get out of the hole so dig in deeper. Eventually the whole thing implodes.

I was wondering whether leverage ETFs could get out of hand in the same way.

Anything can get out of hand but the financial crisis was the wake up call for individuals to not over borrow, over spend and go through life without building foundations from which to easily survive market conditions for the most part. Post the financial crisis every retail investor and consumer is far wiser so will not be over borrowing or over spending as they now know the total importance of not carrying on as they were before. Pre 2007 when a bank said you could borrow 5 times your income people didn't realise the risk of doing that but now they do so they will all be saying 'no thank you' to the kind and generous offers and instead borrowing based on what they can easily repay while also saving for their future.

[vulture1]

leef44 said:

DonkeyApple said:

leef44 said:

Thank you DA and Stongle, very informative explanations.

Are leverage ETFs on the increase due to cheap finance? Is there a risk that the exposure could lead to a crash if a sudden rush of positions are unwound e.g. cheap finance coming to an end, sensitivity to interest rates?

It's a combination of things. Cheap finance is at the core but on the client side it's the demand driven by greater risk appetites, shorter term thinking and greater interventions etc.

Personally, I think there are better ways for a UK investor to leverage an ETF for investment purposes but leveraged ETFs are aimed at a global retail market not just our little island.

My concern isn't so much what happens on our little island but more globally. Also what isn't offered in the retail market doesn't mean it doesn't impact the little person on the street.

Sub-prime and CDOs is an example. There is this complacency and arrogance (aka greed) in the financial markets where they get creative in finding more efficient ways to make money. It escalates and then before too long they find they are dug in so deep they don't know how to get out of the hole so dig in deeper. Eventually the whole thing implodes.

I was wondering whether leverage ETFs could get out of hand in the same way.

An ETF is seen as a safe way to invest. Leveraging something does not seem safe it looks more like gambling.

Also ETF is getting a little stretched in its meaning with some things. An ETF full of mega risky stocks ie Cathy Woods stuff) seems contradictory in its meaning

[BobToc]

I don’t have a particular problem running some leverage (maybe 20% LTV) in a balanced portfolio. I do find the 3x levered S+P ETFs a bit racey, but returns in a bull market have been spectacular. I’ve not spent any time on it but I am a little tempted to put some into my ISA.