ETFs and the UBS Trader Scandal

Exchange-traded funds (ETFs) are again back in the news. This time it’s their connection to the $2 billion in losses that incurred by an allegedly rogue UBS trader. The trader, Kweku Adoboli, worked on UBS’ Delta One desk.

According to reports, Adoboli made trades using ETFs, which are generally baskets of stocks that trade on exchanges. ETFs have grown exponentially in popularity in recent years, along with their complexity – and that has raised concerns among regulators about whether investors really understand the products.

Adoboli was arrested on Sept. 15 in London on suspicion of fraud and false accounting.

Terry Smith, chief executive of FundSmith, is a vocal critic of exchange-traded funds, stating there are so many issues with ETFs they should “perhaps be banned entirely.”

“Some of them are like index funds, but many aren’t. In particular, the performance of short ETFs and leveraged ETFs may diverge markedly from what an investor who believes they are simply index funds would expect,” Smith said in a Sept. 16 article by the Independent.

In particular, Smith cites the complexities of some ETFs, especially ones that do not actually contain the underlying securities or assets they track and instead rely on asset swap agreements. Such agreements are likely to lead to issues commonly seen during the credit crisis, according to Smith.

And it’s retail investors who may pay the price. “If UBS didn’t understand how they [ETFs] worked, how is the man in the street going to?,” Smith says in the Independent article.