Industry leaders in exchange-traded funds (ETF) have urged the Australian market to be wary of letting in manufacturers of narrow and leveraged products after they have sparked backlash and concerns from US investors and regulators.
"One thing that's happening in the US is you can take a good thing too far," Vanguard Investments global chief investment officer Gus Sauter said in Sydney earlier in the month.
Sauter said there were some providers that had made ETFs so narrow and sector-specific they had failed to generate enough interest and were eventually shut down.
"We had a wound care ETF, so it's [exposed to companies that make] band-aids and stitches. So I'm thinking, 'What's that, Johnson & Johnson?'" he said.
"And so, mercifully, the ETF went under. It was so narrowly sliced and diced that it appealed to no-one, so we have seen a lot of consolidation in the ETFs in the US. And I believe there will be a lot more consolidation in ETFs in the US."
The US ETF industry had 871 funds with assets of $756 billion at the end of August, but 541 of those had under $52 million in them, according to BlackRock. Twenty-five ETFs have been delisted in the US so far this year.
Sauter said other mistakes in the US included leveraged ETFs, which had not worked how investors expected them to.
"There is an ETF that was levered short real estate, so in 2008 the US real estate market index was down I think 47 per cent," he said.
"You would think if you were levered and short in that you couldn't make a better investment in your lifetime.
"And in fact the levered short ETF was down 50 per cent. I mean, it should have been up ... but what happens is that these levered short products have a flaw in them that isn't really well understood by investors and so that's hopefully a mistake you all can avoid."
Russell Investments ETF product development director Amanda Skelly said the key to success of any ETF was ensuring there was enough market demand to grow assets under management and generate volume so that spreads were within reasonable ranges.
"We are firmly of the view that ETFs must have a role in an investor portfolio from a strategic or tactical perspective. For many investors, broad-based ETFs meet their needs," Skelly said.
"With some of these very narrow ETFs, the role they play can be extremely limited and there just isn't enough demand to maintain a sustainable offering."
She said the Australian regulators needed to take note of experiences in other markets, particularly the US where the risks of leveraged products had not been understood.
BlackRock global head of ETF research and implementation strategy Deborah Fuhr said leveraged ETFs listed in the US had been misunderstood by investors, which was why the Securities and Exchange Commission and Financial Industry Regulatory Authority had stated they were inappropriate for many investors.
The comments come as several US ETF providers, including those that have experienced product closures and have offer leveraged ETFs, aim to list their ETFs in Australia as the local industry's funds under management booms.
Providers interested in a local listing include WisdomTree, ProShares, PowerShares, PIMCO, Claymore and Rydex, according to market speculation.
