Night And Day...

Contrast the murky, opacity of the collateralized debt obligation (CDOs) and credit default swap (CDS) markets with ETFs.

The credit default wwap market is roughly six times the size of the mutual fund industry with a fraction of the transparency. The CDS market, a $60 trillion market of which AIG was "only" a half-a-trillion-dollar player, is the single biggest reason for the vagueness surrounding the toxic debt problem.

Let's reflect on why the magnitude of bad debt remains so hard to understand. A recent quote from a mutual fund portfolio manager might be very instructive along these lines.

In talking about how to assign a valuation to an individual issue like Lehman or AIG, exposed to "toxic" securities, he said: "Things are so big, so leveraged, it can be tough for an outsider to tell." 

Not good for price discovery or market clearing. No wonder credit markets have frozen.

Conversely, with ETFs, positions are known. Exposures can be assessed. Markets can clear because there is price discovery driven by transparency. Without transparency, as we have seen, price discovery is impossible and markets freeze up.

I don't think it is a coincidence that ETF trading volumes have increased dramatically in the last six weeks. Yes, they can be trading vehicles, but they are also transparent investment vehicles whose share of overall equity trading volume was increasing even before the developments of the last several weeks. 

ETFs Gain Stature

There will certainly be other winners in coming quarters from this shakeup in credit markets. The independent investment advisor—those advisors unencumbered by an association with a large brokerage investment banking arm—figures to become more valuable in coming weeks as well.

However, that is a subject for another article. (This rolling transparency revolution will also accelerate what is going on in the world of fees. But that too is a topic for another day.)  

In light of what has transpired the last couple of weeks, ETF—now more than ever—are investment vehicles whose time has come. They are simply a better structure for most investors.

The bottom line is that transparency will now be held in higher regard by the capital markets. I suspect Justice Brandeis would be proud. And an ETF fan.

William E. Koehler is chief investment officer at ETF Portfolio Solutions. He's a regular contributor to IndexUniverse.com and can be reached at:  This e-mail address is being protected from spambots. You need JavaScript enabled to view it

1 | 2 |