Organic Financial Group founder Gary Norden is looking to raise capital for a hedge fund that will exploit "significant weaknesses" within specific ETFs.
Mr Norden is working with Canadian quantitative analyst Nam Nguyen and US trader Larry Gazette to identify ETFs that are likely to underperform in the event of a downturn.
"These products have never been tested in a difficult environment," Mr Norden told InvestorDaily.
"If there is a major event it's going to be hard for everybody to exit at the same time in a number of markets."
Part of the problem is the huge amounts of money being channelled into passive ETF products, Mr Norden said.
"You can only have so many sheep without shepherds. And with everybody being passive: they're following [the index], but how are they all going to get out?" he asked.
While illiquidity in the face of a financial crisis is a broader issue, Mr Norden's hedge fund will be focused on specific vulnerabilities with ETFs.
Many ETFs mirror the return of a particular index without accurately matching the market, he said. For example, an S&P500 ETF may not hold all 500 of the largest companies in the US.
"We've seen some ETFs that are constructed with an almost opposite view to another one. Those kind of things we find interesting because they open up vulnerabilities," Mr Norden said.
Smart beta ETFs are also in the hedge fund's sights, he said – adding he wants to raise money in order to hire more quants to identify additional opportunities to short specific ETFs.
"We want to get more people involved because we think that the 'cockroach' theory is if you find three or four there are probably a few hundred lurking somewhere else," Mr Norden said.
"We want to raise more funds so we can do it properly. Because if this unravels, it will unravel in a big way."
UniSuper recruits Merill Lynch analysts
ACSA hires former director as CEO
AMP Capital appoints director in Dubai
Why MiFID II matters for Australia
Five unconstrained fixed income ideas
Getting on board the ‘grey nomad’ caravan