These funds were backed by AIG, the struggling insurer. In a defensive move, the issuer, ETF Securities, suspended trading in all products associated with AIG as it awaited the insurer’s fate.
We have recently tipped an exchange traded fund, but do not fret.
There was no suspension on our investments. Nor do I expect there to be one in the future.
The main reason we chose Barclays iShares as our issuer was the low costs. But there is another advantage of iShares — one that unlucky investors caught up with some of the ETF Securities are craving.
No counterparty risk.
Counterparty risk is the risk that the person on the other side of a contract will default. For example, when Lehman went bankrupt, it was unable to fulfil its outstanding contractual obligations.
I spoke to Caroline Hancock of Barclays Global Investors, who confirmed that its iShares listed on the LSE face zero counterparty risk. That is because its ETFs are cash-based.
To quote the iShares slogan, not all ETFs are created equal.
Features common to all types of exchange traded investments are:
- They can be bought like a share from your broker
- They give you easy access to a wide variety of investment Vehicle
- They are cheap
We have invested in a cash-based ETF — a good move in light of recent events.
Not all ETFs are created equal
The great thing about our position is that the fund holds underlying "securities" in a ring-fenced separate account.
This means the investor is exposed to no counter party risk of the issuer.
In the case of failure of the fund issuer, the investor has recourse directly to the pool of underlying shares, or in our case, bonds.
Our investment is as transparent as these investments can be.
Unfortunately, the same is not true of some of the offerings from ETF Securities.
The investor owns a note, fully exposing the investor to counterparty risk of the note issuer.
Exchange Traded Notes, such as some of those provided by ETF Securities, are debt instruments.
They are not funds but do share several characteristics of the funds, as both structures are linked to the performance of an index and trade on an exchange.
This risk can be reduced through guarantees, unfortunately it is the guarantor, AIG, at the source of the problems.
If the credit worthiness of the issuer falls into doubt, as happened with AIG, a suspension is on the cards.
Worst case scenario?
If there is a full counterparty collapse, the investor may not see their investment again.
Tell a friend
We private investors have got to watch each others backs. We’re a small, exclusive community.
So tell a friend. Whether they invest privately or as part of a social or work investment club, they should know. They might be particularly interested in the discussion if they hold ETFs.
Remember, The Fleet Street Letter is here to keep you abreast of how to stay out of harm's way in the bear market.
As the credit crunch rolls on, everything around us is collapsing. So much that we took for granted is being called into question. And this leads to fears, sell offs and runs on banks.
We’re in a crazy time and right now and as a wise man once said, only the paranoid survive.
Pass on the word and if you have had any problems with your ETFs get in touch — fsl@f-s-p.co.uk.
I’ll relay what I have learnt from Caroline and the iShares team.
Best wishes,
Theo Casey
Investment Director
The Fleet Street Letter
P.S. If you enjoyed this article then we encourage you to sign up for The Fleet Street Letter. Get contrarian, cutting-edge analysis for sensible, long-term investments that secure you high growth and healthy dividends.
