Exchange-traded funds (ETF) trading volumes were up almost 40 per cent in the US as virus-induced volatility spooked markets over late February through March, new data from the BlackRock-owned iShares shows.
In a release last week, iShares said ETF trades constituted 37 per cent of all US exchange trading from February 24 to March 23 or “nearly $40 for every $100 traded in the U.S. stock market was done through an ETF”.
Last year ETFs represented an average 27 per cent of US on-market trades.
“For years investors have tended to trade ETFs more in times of uncertainty and the market activity of recent weeks underscores the utility of ETFs in times of market duress,” the release says.
The iShares report says investors used ETFs to “rebalance portfolios and hedge positions” during the carnage that saw US$340 billion – or almost four-times the daily average in 2019 – of the products traded on March 12 when US markets dropped 10 per cent.
“In the U.S., ETF trading volumes surged to a record $1.4 trillion the week of March 9,” the release says. “Similar records were set around the world.”
Hugh Stevens, head of the NZX-owned Smartshares, said the local exchange also experienced a large surge in ETF-trading over the last month – although not quite at the US scale.
ETFs represent about 3 per cent of NZX capitalisation. As of mid last week Smartshares reported about $3.4 billion under management.
Stevens said much of the recent ETF trade has focused on fixed income products, which came under scrutiny in March as global fund prices dislocated from underlying net asset values (NAV).
According to Financial Times (FT) report last week, discounts on bond ETFs compared to NAV blew out so wide that “some predicted investors would lose faith in the fund structure altogether”.
But the FT article says a Federal Reserve corporate debt-shopping spree also rescued the fixed income ETF market.
“On Monday, the central bank announced it would begin to buy corporate debt to quell the crisis — including bond ETFs,” the FT says. “And it picked BlackRock, one of the biggest providers in the $1.1tn market, to manage the purchases. ETF prices surged.”
However, the iShares note says that the “recent discounts in bond ETFs don’t reflect a problem with the ETF structure itself”.
“Rather, investors should think about an ETF as a leading indicator of market prices since it transmits real-time information about the quality and accessibility of the underlying markets,” the iShares release says.
For example, iShares says its iBoxx $ Investment Grade Corporate Bond ETF (with the ticker code LQD) – the largest and “most liquid” of its ilk – traded 90,000 times on March 12 while its top five underlying bond investments changed hands an average 37 times each.
ETF market-makers (also known as ‘market participants) were, therefore, ahead of traditional bond managers in valuing the underlying assets, iShares argues.
“Indeed, LQD’s price signaled the most relevant and timely information about where market participants valued corporate bonds in the heat of volatile trading,” the note says.
The iShares report says large and highly-liquid ETFs also managed to maintain relatively tight spreads during the recent market volatility.
“In many cases it has been more efficient to trade the ETF than underlying securities, even in generally liquid markets,” the note says.
Even in the most liquid market of all – US government bonds – ETFs have kept tighter spreads than the comparable ‘off the run’ long-dated Treasuries: iShares says its US government bond ETF spread varied between one and eight basis points (bps) over the last month while underlying bond spreads “widened sharply, to as many as 91 basis points”.
“This gap of more than 80 basis points was the largest ever recorded in the asset class, underscoring how much more efficient it can be to trade iShares ETFs versus a basket of constituent bonds in times of market duress,” the iShares note says.
Stevens said NZ-listed fixed income ETFs were likewise providing a “secondary level of liquidity” allowing investors to access the market at a price reflecting a fair value of the underlying securities.
Traditional bond managers remain sceptical, however.
Grant Hassell, AMP Capital head of global fixed income, said bond ETFs could experience some liquidity issues as month-end rebalancing kicks in.
Hassell said fixed income ETFs, and bond indexing in general, exposed investors to low-quality credit – with the current crisis likely to see a spike in defaults – and the largest sovereign borrowers.
He said fixed income ETF investors should look beyond the sticker price to evaluate the true cost of the approach.
“Fees are a small part of the total outcome [for fixed income funds],” Hassell said. “Investors need to consider the extra value active management can add as well as tax efficiencies.”
The FT report says the Fed decision “to include ETFs in its purchases has been taken as a nod to the products’ widespread use among fund managers”.
“It has also been seen as a potential backdoor for the Fed to influence longer dated corporate debt held by the ETFs — extending its sway over borrowing costs,” the FT says.
