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The ETF Ponzi Scheme

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Question asked 05/07/2025

The ETF Ponzi Scheme

Hi Guys, I am sure I am not the only one concerned about the continuing seemingly unstoppable rise in Industry Index ETF valuations, with only minor drawdowns. Perhaps you can answer the mystery. For my part I think it has the hallmarks of a Giant Ponzi Scheme. Index Funds must follow the related index with Buy and Sell orders to closely follow the index. However, they also must create and redeem the number of units on issue in the ETF, according to the volume of Buy/Sell Orders received. Here in Australia we have an almost unique situation where the Superannuation Sector is subject to a rising minimum Contribution to Super now 11.5 % pa of workers Gross Wage. Much of this capital in continuing to roll into ETF's with both Insto's and SMSF's fuelling the growth in funds in ETFs, to record levels. Insto's must also maintain their weighting by market sector, causing them to increase their allocation of funds., many choosing ETF's to achieve this. This has distorted the Value and Yields of many market sectors and stocks. Witness the CBA with a Yield of 2.5% and our Banking Sector now the most expensive in the world.. But the ETF and Share price continue to rise?? Has the world gone mad?? What am I missing here? When and How do you see this Ponzi Scheme blowing up? Thanks James for your expert commentary

Answer

Hi Richard,

A great question/observation and a subject that’s getting so much airtime of late that we’re almost trying not too write about it!

Firstly, we are firm believers in the stock market for wealth creation with the All Ordinaries Index, which goes back to the 1970s, delivering a long-term average annual returns of ~11%.
Importantly over long periods, dividends account for ~40–50% of total ASX returns, with franking credits adding further benefit to many Australian investors.

During these gains there have been many “unusual periods” and at the moment ETFs are undoubtedly contributing with the “Certainty Trade” taking CBA up to around 12% of the ASX200. But history tells us these anomalies are usually cyclical, a bit like the resources! Historically we see a 20% pullback by the ASX every 7-10 years with inflation (rate rises) and recessions often the cause.

We don’t believe the current boom in ETFs is significantly different to the previous fads in options, warrants and lepos, when the next thing comes along characteristics will change. If anything ETFs can be regarded as lazy investing BUT while they continue to receive inflows by definition they will perform strongly. We’re not sure what will be the catalyst to see investors seek value outside of the likes of CBA and Wesfarmers but when they do the readjustment could be short & sharp – concentration of capital creates risks.

We are expecting stock rotation to figure strongly across the market over the coming 6-months, and this, we think, will create a better environment for investors who focus outside of holding just an index via an ETF.

This very same stock rotation could be the undoing of CBA as we saw on Thursday when CBA retreated over 1.5%, while BHP rallied over 4%. The nature of ETFs means the more BHP rallies and CBA slips the more money will flow into the miner from the banks as the rebalancing unfolds. Changes in trends could therefore last longer and go further than fundamentals would ordinarily dictate.

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ASX200 Total Return Index (Accumulation Index)

LAST UPDATED 02/07/2025 15:53

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