Investors are turning to the products as a more liquid alternative to index trackers, but Hudson believes they are deceptively complicated and the lack of transparency poses a systemic threat to the financial system. "They seem to be a low-cost and liquid way of accessing the markets and being able to get in and out quickly has been one of the concerns of investors since the financial crisis," she said.
"You don’t want to be locked into things and ETFs seem to be well-positioned in that way. However, they display all of the features we blamed for the financial crisis – excessive complexity, securitisation and leverage."
Hudson thinks the sheer amount of money flowing into developing markets and commodities through these funds is a serious problem, as they are increasing volatility and distorting rationality.
She commented: "There have been outflows from emerging markets since their peak this year of $8bn, $5.9bn of which came from ETFs."
"As the markets are not so large and well developed, having this amount of money washing in and out isn’t very helpful."
"If liquidity is low and you have got a market which is more and more driven by ETFs and less and less by fundamental investors then the rationality has gone."
Hudson says that this herding effect contributes to a growing risk.
"If you follow the way markets are trending, what is called the risk-on/risk-off trade, I would say the effect is already being felt," she continued.
The strategist points to the way correlations are forced between different commodities that naturally shouldn’t be related.
"Perhaps it matters less on individual market indices like the S&P, but if you look at the ones on commodity indices, they are buying different things that should be uncorrelated and moving in different directions," she said.
"If you think about fundamental drivers of commodity markets, industrial metals should be aligned with cyclicals, soft commodities with factors like the weather, and the other types have their own fundamental drivers."
"But the correlation between these commodities is rising and this is potentially dangerous."
Hudson also points to the risks with corporate bond products as particularly significant, with one major issue being the way the index is formed: just as the largest components of an equity index will be the largest companies by market cap, the largest components of a bond index will be those institutions that have taken on the most debt.
"If you take a high yield corporate bond index, you might find the more speculative borrowers are the biggest part of the index, which might not be what you thought you signed up for," she said.
The iShares Markit iBoxx GBP Corporate Bond product is the second most-viewed ETF on FE Trustnet this year, underlining investor interest in this area.
Mona Shah, deputy manager of the Rathbone Multi Asset Enhanced Growth Portfolio, says corporate bond ETFs are often not as passive as they look.
"Managers often know in advance when a company will drop out of the index, so they can make adjustments to their positions before this. These are the sort of judgment calls which mean a fund should be considered actively managed," she explained.
Shah says she has used the iShares FTSE 100 ETF, but remains concerned about more specialist areas - namely emerging market ETFs, which continue to grow in popularity.
"Sometimes these countries’ indices are dominated by a few companies, large commodities firms for example, and they may not be in the area you want to gain access to," she explained.
"For us, for example, we prefer the consumer stocks in the emerging markets, and that is not reflected in the indices, so we don’t use ETFs for emerging markets."
From a retail investor’s point of view, the irrationality of the markets on the macro level may not seem to matter so much, but it contributes to the dislocation of the products from the underlying index they are supposed to track.
Furthermore, the volatility of the products and the risk to investors is increased by the competitive nature of the market.
Hudson added: "Competition is fierce and the providers are competing for the same business and with low margins, so there are potential risks to the investor if their provider collapses."
Tony Yousefian, CIO at OPM Fund Management, uses ETFs but says the risks involved mean further regulation is necessary.
"We need to be careful to ensure there is sufficient regulation and oversight in place so this ETF problem doesn’t blow up and the best thing we can do is to regulate ETF providers, otherwise we will end up with another AIG situation."
Hudson doubts regulation is possible, however, saying the genie may be out of the bottle.
"I don’t think the regulators would be able to tackle the problem," she continued. "I don’t think ETFs are evil, but the problem is what happens when something becomes market dominant."
"If you were to regulate, who would you stop investing in them? Or what size would you restrict them to? It’s not clear how you could do it."
As regards retail investors, however, Hudson questions the philosophy behind picking an ETF.
"People are less well-informed about what they are investing in with ETFs. It’s about as far as you can get from Warren Buffet’s value investing," she finished.