Is your ETF a safe bet?

Although exchange-traded funds (ETFs) have increased in popularity recently, investors should beware of the potential conflict of interests between themselves and the fund manager, says Paul Amery.

Europe's exchange-traded fund (ETF) market has grown quickly for one main reason: value. Many investors have switched to ETFs from poor-value actively managed funds, or from bank-issued structured products that may contain several layers of costs and risks.

But ETFs also have potential conflicts of interest between issuer and investor. In a surprisingly frank research report (given that the authors' employer is one of the main European issuers), Deutsche Bank strategists Christos Costandinides and Daniel Arnold have estimated that the managers of ETFs can earn double their funds' fees through so-called "ancillary" activities. Broadly speaking, issuers of "synthetic" ETFs make money on the side from trading, while issuers of "physical" ETFs do so from lending out their funds' underlying shares and bonds.

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Paul Amery

Paul is a multi-award-winning journalist, currently an editor at New Money Review. He has contributed an array of money titles such as MoneyWeek, Financial Times, Financial News, The Times, Investment and Thomson Reuters. Paul is certified in investment management by CFA UK and he can speak more than five languages including English, French, Russian and Ukrainian. On MoneyWeek, Paul writes about funds such as ETFs and the stock market.