Mackenzie Investments' head of ETFs outlines benefits that shone through in COVID-19 crisis
Immediately after the exchange-traded fund structure celebrated its 30-year anniversary, Michael Cooke declared that ETFs are taking their rightful place alongside mutual funds as investment vehicles that deliver a raft of benefits to investors. After three months that include stomach-churning routs and rallies in key equity markets, he hasn’t changed tack.
“Just as we saw a sort of cascade of liquidity disruptions across many historically deep and liquid markets like US Treasuries and investment-grade corporate bonds, ETFs held their own,” said the SVP and head of ETFs at Mackenzie Investments. “There were pockets of disruption in the ETF market during the recent coronavirus crisis, but by and large they weathered the storm very admirably and again proved their relevance and utility for investors.”
Cooke said that with its three-decade track record that has seen good markets, bad markets, liquidity crunches, and financial crises, the ETF space has matured into a sophisticated and efficient infrastructure. Time and again, he said, ETFs have proven to be very reliable tools for transferring risk and expressing investment views.
Taking a hard look at liquidity
“ETFs are always, to some extent, going to be subject to the efficiency and smooth functioning of the underlying financial markets they invest into,” he said. “But now we’ve seen that in some cases when those underlying markets stop trading and face liquidity challenges, ETFs can actually act as more efficient, more effective tools to provide price discovery and liquidity for investors seeking exposure to those spaces.”
Liquidity certainly could become a more critical consideration for investors of all stripes. Following a rapid and unanticipated COVID-19 crisis-induced decline, markets underwent a recovery that was just as quick and unexpected. Some investors, seeking to participate in that upward movement, might have sought to do so through the broad-based, diversified, and liquid exposure provided by ETFs.
“It can also work the other way,” Cooke said. “While we can reap the best rewards from less-liquid investments, they could prove inconvenient for investors who need cash for risk management, personal expenses, or other purposes. In those cases, building a portfolio liquidity sleeve using ETFs can be a wise choice.”
An important caveat, however, is the fact that liquidity for ETFs can be defined in different ways. While the liquidity of a stock or bond is restricted to its average daily trading volume, an ETF’s liquidity is defined not just by its trading volume, but also that of the underlying assets.
“Unlike equities or fixed-income securities, ETFs can create or redeem more units almost without any restriction, as long as there’s a liquid underlying portfolio,” Cooke said. “Beyond ETF-level liquidity, investors might also want to consider if the underlying stocks or bonds are fairly easy to trade.”
COVID-19 hasn’t killed cost focus
In the wake of the recent turbulence, there’s an increased expectation that investors will be more mindful of downside risk management. Does that spell an end to the long-term trend of cost-consciousness that has defined the rise of index-based strategies in recent years?
“I don’t think so,” Cooke said. “We do live in a world of competitive pressures, a changing regulatory environment, and different expectations for financial-market returns going forward, all of which can incline investors to become more focused on cost; the crisis has arguably accelerated that focus.”
He was similarly hesitant to call an end to the race to lower management fees among asset managers. While he does acknowledge that some active managers – including a number of Mackenzie managers – have been able to weather the recent volatility nicely and validate their reasonable price points, other asset classes and categories haven’t done so well and may still therefore be subject to pre-pandemic levels of fee pressure.
“I think we need to see a more stable period perhaps over the next several months, where asset managers can reflect on how the most recent period has affected their portfolios, how it's affected them corporately and then make appropriate decisions,” Cooke said.
Ultimately, the choice of ETFs and the factors behind their selection is in the hands of investors. But whatever they do, Cooke said, they should resist the urge to overhaul their allocations right now.
“The worst of the storm is not the time to be thinking about making changes to your portfolio or even evaluating the different strategies that you hold,” he said. “It's best to do that when things are a little calmer and you can be more reflective and more deliberate in evaluating the appropriate investments for you.”