As index investing has grown, ETF and index fund providers have been able to make use of this explosion in indices to provide more niche strategies to investors.
Bailey added: "It is important to remember that an ETF is just a wrapper – albeit a very innovative one. So, it was inevitable that they would be used for something more than just tracking a stock index.
"In the 2000s we saw the first [exchange-traded commodities] launch, a similar but somewhat different structure to the conventional ETF, making it easier for investors to get exposure to a commodity such as gold or oil.
"While in the UK retail investors can’t really buy an ETC with direct crypto exposure, this is starting to happen in other countries, whether a futures-based ETF like in the US or direct exposure like some in Europe."
Too much of a good thing?
Given these developments, can anything be boxed up into an exchange-traded product and run as a passive fund, despite liquidity constraints or regulatory concern?
Cryptocurrency is a case in point – the Securities and Exchange Commission has, after many months of deliberation, allowed the launch of the ProShares Bitcoin Strategy ETF in October this year (2021).
However, just a few days later, the SEC kiboshed another provider's plans for crypto-based ETFs, intimating that it cannot see fit to authorise leveraged ETFs of this type, suggesting there may be limits to innovation.
After all, advisers recommending authorised products such as an ETF may find there to be an uneasy marriage between the investment product and esoteric and exotic or as-yet-unregulated investments.
Can cost-efficiency and transparency outweigh the potential lack of liquidity and regulation of the underlying basket of assets the ETF is tracking?
How much innovation is a good thing? Should retail investors be wary?
Lamont says: "Investors should always be vigilant, particularly when accessing emerging asset classes like crypto. ETFs can provide amazing market access to niche corners of the markets, but [investors] should take advantage of the transparency offered by ETFs and look under the bonnet before investing."
For example, if an adviser is discussing a way for clients to access crypto using a tried-and-tested product such as an ETF, what should they consider? Advisers should perhaps bear in mind the following:
- How the fund is providing exposure to the asset class.
- Ask whether the fund is buying listed equities that have exposure to bitcoin or blockchain technologies, or does the fund offer direct exposure to the underlying crypto currency.
- Analyse the risks, (market, regulatory, etc), which should be well understood before investing.
The range and diversity of passive funds now available could be something to be celebrated, but investors and their advisers should also take advantage of the transparency offered by passive investments and learn to look closely at the rules a fund follows.
