The losses of $2bn incurred by an allegedly rogue trader on the Delta One desk at UBS have again raised the subject of the (lack of) risk controls by banks dealing in opaque instruments, the need to separate investment and retail banking and the risks inherent in ETFs, says Terry Smith, chief executive of Fundsmith.
I have written over the past year about the unappreciated risks in ETFs and it is probably time to bring these thoughts up to date. ETFs are regarded by many investors as the same as index funds. They clearly are not: 1. Some ETFs do not hold physical assets of the sort they seek to track. They are "synthetic" and hold derivatives. This gives rise to a counterparty risk, and as we saw with the UBS incident, some interesting risks within the counterparties supplying the basket of derivatives. What if (when?) such ETF trades cause such a mammoth loss in a counterparty which does n...
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