Community post: Why ETFs should be questioned

Our friend Keith Mclachlan raised some concerns around ETFs this week.

Our local ETFs keep getting lower TERs, but worse and worse market-makers (wider spreads, worse liquidity, &/or longer periods of zero market-making). Bidding spreads, liquidity & market-makers are hidden costs that aren’t disclosed in the TER. Beware of these.

— Keith McLachlan (@keithmclachlan) March 20, 2018

We decided to offer him a chance to elaborate for the sake of presenting a balanced view. His response is below.

I’m always tentative to criticize the passive space because:

I run an active fund, so I’m biased. I can admit that while still using ETFs in my personal capacity (where and when they make sense). Everything has a place, but the screams of the religious converts are too loud in the ETF space to overcome.
ETFs have been brilliant in setting themselves up as a the “consumer champion” and, thus, I get plenty of hate for so much as even questioning said view. Life is too short to try and educate people and then get hate in return.
Many less scrupulous ETF salespeople sell ETFs as “safe”. They are not “safe”. They are beta, and beta is just as risky as the market/index/sector it tracks. In South Africa, Naspers makes much of our large-cap beta actually quite risky, in my opinion. Just because something has done well over the last ten years, doesn’t mean it will do well going forward.
Unfortunately, because point #1 and #2, the noise is too loud to successfully educate the public on my above the point #3.

Also, please note, my view about Just One Lap is that what you do is brilliant! Education is key! But, education in the financial space tends to sell conclusions too, which makes it potentially biased. You have concluded (with good reason), that EFTs are the way to go. Hence, you educate a subjective opinion as if it were objective fact.

It is nothing personal, but I disagree with some of your ETF conclusions.

Here is when I use ETFs and here is when I don’t:

When I use ETFs:

o When the underlying market is liquid and efficient. In this case, active is unlikely to add value, hence minimise cost, maximise spread and use an ETF. E.g. Top 40.

o When I do not know nor have time to understand a market. Hence I use ETF for reach, spread and diversification. E.g. World equity or foreign markets in niches.

When I don’t use ETFs:

o When the underlying market is illiquid and inefficient. In this case, active can add material value. e.g. Small caps.

o When I understand the market well enough to make good decisions in it. e.g. Equity (particularly small caps) in South Africa.

There is a time and place for ETFs and there is a time and place to active. These just differ person by person.