A trading crunch stemming from the mushrooming of index-tracking exchange traded funds is a "crisis waiting to happen" in world markets, according to wealth manager Indosuez.
However, Frederic Lamotte, who oversees 110 billion euros ($118 billion) as chief investment officer at Indosuez, told the Reuters Global Investment Outlook Summit he was sanguine about the impact of the U.S. election and higher inflation.
Speaking at the Reuters office in London, he said gold, equities and retail property in parts of Europe were his favorite plays for 2017, along with emerging markets—especially in Asia.
Lamotte was worried, though, about the boom in ETFs—vehicles listed on stock exchanges that invest by closely tracking an index of shares or bonds or commodities.
Charging low fees, ETFs have become increasingly popular, a shift that was underscored by record trading volumes in several ETFs immediately following the U.S. election.
Lamotte has banned bond ETFs from his portfolio and allows equity ETFs only for short-term tactical trades, highlighting the danger of a liquidity crunch should a market shock trigger retail investors to flee.
While ETFs themselves are highly liquid, he noted tougher regulations after the 2008 crisis had compressed trading volumes on underlying assets, especially bonds because it is much costlier for banks to hold them on their own balance sheets and act as market makers.
"A lot of the selling points of ETFs such as simplicity, transparency, cost, efficiency liquidity—a lot of it is a lie," Lamotte said. "Today, you have a lot of ETFs in high yield (bonds). The size of the high-yield market is huge. High-yield is attractive to investors. The problem [with ETFs] is that the underlying is not liquid."
Lamotte said at the time of the 2008 crisis, the value of bond ETF holdings were roughly equal to what global market-making banks were holding on their books.
"So if the ETFs were selling everything they had, it was the size of what the banks could buy as market makers,” he noted. “Today, world fixed-income ETFs hold 38 times the size of what globally investment banks are allowed to hold. So that's a crisis waiting to happen."