Virus-stricken markets have created prime conditions for much-loved products to prove their worth
While ETFs have enjoyed a seemingly unstoppable rise in success and popularity over the past 10 years, critics have kept their arms crossed. Even as the industry surged past US$6 trillion in global assets under management, they argued that it’s only as good as its performance during financial-market stress.
That’s exactly what the past month has brought. Around the world, supply chains and industries have been disrupted by the unfolding coronavirus outbreak, creating what’s arguably been a genuine proving ground for ETFs.
“Coronavirus-induced market turmoil has put the mechanics of ETFs to the test,” a recent commentary in the Financial Times observed.
Some previous studies have pointed to systemic risks posed by ETFs, particularly given immense concentrations of securities within certain funds. If some negative event were to trigger a widespread panic-selling frenzy, markets could seize up, popular funds would collapse, and investors would end up trapped amid the ETF bust — or so that thought experiment goes.
But as noted in the Times, trading activity in the largest equity and fixed-income ETFs in the U.S. has reached some of its highest levels on record in recent days, but none of them have imploded. Case in point: State Street’s S&P 500-tracking SPY, the world’s largest ETF, represented over 80% of outflows during the first four days of trading last week, but it has stayed well away from any danger of dissolution.
In contrast, Vanguard’s VTI, another broad-exposure stock fund, was the runaway leader in inflows last week. The difference in flows between SPY and VTI, according to MarketWatch, comes down to the fact that SPY is favoured by liquidity-seeking institutional investors, while VTI caters more to individual investors who appear to be more comfortable sticking to their buy-and-hold guns.
Worries concerning bond ETFs were also dispelled. Critics have expressed fears that if too many bond ETF investors pull out at once, managers would have difficulty selling the less liquid funds. Prices would decrease further and more outflows would ensue, creating a vicious cycle.
But as Financial Times columnist Richard Henderson noted in a separate piece: “[B]ond funds tracking riskier assets also held up while the underlying markets sold off last week.”
More than half of the outflows from bond ETFs last week were from BlackRock’s HYG, the world’s largest fixed-income ETF. But while the fund’s price briefly dropped below the value of its underlying bonds, the overall orderly nature of the selloff represented a “real-world example of bond ETFs adding liquidity to the fixed-income market,” as CFRA’s head of mutual fund and ETF Research Todd Rosenbluth put it to Henderson.