Europe should adopt US-style warning system for ETFs

A warning system for retail investors using ETFs, similar to that used in the US, could help raise awareness of the nuances of the funds, says a Morningstar research head.

In the US, broker-dealers which offer ETFs on their platforms have warning systems in place to notify investors when they are about to invest in leveraged or inverse ETFs, which use derivatives and do not always behave as an investor might expect.

A similar system could be beneficial to the European market, where there have been concerns raised - most recently by BlackRock - about whether investors understand the characteristics of some ETF structures.

"We had this moment in the US two or three years ago and that is what we have done at the gate-keeper level," says Scott Burns, director of ETF research at Morningstar.

"They haven't had that moment yet in Europe so perhaps this is a good time to consider some of that more formally." Morningstar already has classifications on its website to flag up the different ETP structures.

BlackRock has called for a change in classification for ETFs but Burns argues that this is not needed, he suggests renaming individual funds instead: "In the US we have a fund call US Oil, people would assume it owns oil but it doesn't, it's a one-month spot futures rolling strategy. Wouldn't it be great if it was called US oil futures ETF?"

Individual investors in the US are also required to go through qualifications in order to trade derivatives.

Burns suggests that this could be applied to ETFs which use derivatives, both in Europe and the US: "You could have something as simple as acknowledging that you are aware this is based on oil futures and you are aware how oil futures work."

In Europe, the ETF market is dominated by institutional investors, which make up about 80% of the market, however, with initiatives such as RDR in the UK, it is assumed that there will be growth in retail investors using ETFs.