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Investment Uncovered: Why Woodford’s ETF warning light is wrong

Argument that ‘gigantic flows’ into triple-leveraged ETFs last year signal an equity bubble is flawed

Argument that ‘gigantic flows’ into triple-leveraged ETFs last year signal an equity bubble is flawed

Star manager Neil Woodford recently warned of a red light for the equity market being the “gigantic inflows” into triple-leveraged ETFs, which he says is indicative of an asset market bubble.

While there appear to be a number of red lights going off on the flight deck at Woodford Investment Management at the moment (China has been quoted as a concern, for instance), I am not sure the huge inflows into triple-leveraged ETFs is one of them.

Even so, I am not a big fan of leveraged ETFs, or short ETFs, myself. They can behave in a non-intuitive way, they are expensive and the ETF issuers recommend that you should not hold them for more than a day. I am told that some sophisticated investors use them to hedge but I am not convinced this is the case.

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I suspect that investors use them to speculate on the short-term direction of the market, which I think is akin to gambling. If you want to gamble, in I think you would have more fun having a punt on bitcoin. At least that way you can have the pleasure of Whatsapp bragging rights with all the millennials in your office, now that the water cooler has disappeared.

Bubble in the finance worldTo address Woodford’s immediate point, the “gigantic” flows into triple-leveraged ETFs, then: figures from my friends at WisdomTree suggest that flows in 2017 totalled just over $400m globally. A big number for your weekly shop at Morrison’s, yes, but not significant in the context of inflows into ETFs during 2017 alone, which were nearly $900bn.

If I broaden out the statistics a little bit and look at the inflows into all long-leveraged ETFs, the total global flows in 2017 come out at about $2.6bn, which again is something that is hard to get excited about.

Woodford has kindly put a few indicators of his perceived “market madness” on his website – more flashing red lights. The Faang stocks and the sale of De Vinci’s Salvator Mundi for $450m are listed. Woodford also lists the statistics that “7,855 ETFs account for 70 per cent of global equity daily trading volume”. I wonder where these figures came from.

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The ETF planet is a very dynamic place and new ETFs are being created all the time, but I think it will be several years yet before we get up to 7,855 ETFs worldwide.

Figures from consultant ETFGI suggest that there are about 5,400 ETFs worldwide, up about 10 per cent from last year. Similarly, the US is the largest market by far for ETFs. About two thirds of global ETF assets are in the US. Figures from the New York Stock Exchange suggest that ETFs accounted for 30 per cent of traded volume on exchange and 10 per cent of trading on the NASDAQ exchange in 2017.

While Woodford is to be lauded for getting out in front of the press and being so frank – and let’s not forget, he has been right about a lot of things in his time – I do think some precision is required given his wide following.

I do not know whether or not we are in an equity market bubble. Experience suggests that we will only know after a crash. I am sure there are some flashing red lights going off, but we might need the intervention of someone to take some of the emotion out and put a bit more precision into the data.

Peter Sleep is senior investment manager at 7IM

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