February 2018 was a rocky month for the equity market. By design, a number of short volatility products collapsed during that period. Nonetheless, exchange-traded funds (ETFs) across many asset classes managed to sustain themselves without a significant negative impact, according to a report by Pensions & Investments. In fact, the largest and most liquid of these products seemed to emerge essentially unscathed from the period of uncertainty.
'These Funds Delivered'
According to Elisabeth Kashner, the director of ETF research at FactSet Research Systems, “these ETFs kept on keeping on during the recent sell-off. The primary job of an index-tracking fund is to do just that…and these funds delivered.”
The data supports this assessment: FactSet conducted evaluations of time-weighted average spreads to monitor difference, volume, and change in shares outstanding for the top 35 U.S.-listed ETFs in the first 12 days of February. Over a similar period, the CBOE Volatility index moved from 12 (in late January) to 50 (on February 6), and back down to 19 (on February 16).
The FactSet report indicates that trading spreads and index tracking error ranges for most of the 35 products didn’t budge during this period of intense volatility. Some of the largest movements in the categories of spreads and changes in daily shares outstanding took place in interest-rate-sensitive equity ETFs, like those linked to real estate or dividend stocks. This makes sense, as the market and investors broadly looked to the pace and intensity of interest rate shifts led by the Federal Open Market Committee early in the month.
Shelly Antoniewicz, the senior director of industry and financial analysis at the Investment Company Institute, was quick to suggest that index-tracking funds were not to blame for the volatility.
“Market turmoil can be dramatic and unsettling, and it’s natural for commentators and the press to look for causes and consequences,” Antoniewicz explained, adding that “it’s wrong to assign responsibility for the market’s movements to specific investing vehicles, such as index funds.”
Renewed Interest In ETFs
In the past decade or so since the 2008 financial crisis, critics of index funds have suggested that indexation may negatively impact asset markets, perhaps even increasing stock correlations and distorting valuations. This has primed fund providers and supporters more broadly to come to the defense of ETFs. After all, detractors are not without some strong examples to cite: the “flash crash” of 2010 revealed how ETF quoting could lead to instability.
An event in 2013 showed that ETFs are a tool for price discovery for debt markets lacking liquidity. Then, in late summer of 2015, ETFs ran into trouble because of trading halts caused by volatility in overseas markets. In response, the ETF industry has been searching for a strong example of ETF stability in the face of broader turmoil. February’s events may have been that instance.
Indeed, there may already be evidence that investors are looking to ETFs with renewed interest following their February 2018 performance. Ravi Goutam, head of pensions, endowments, and foundations for iShares at BlackRock, indicated that at least one large institutional client expressed a desire to explore ETFs more thoroughly going forward. Another client was impressed by being able to trade a position of $400 million in an ETF for just 2.5 basis points.
Elsewhere, too, fears about ETF liquidity are being reassured and calmed. Luke Oliver, the head of U.S. ETF capital markets at Deutsche Asset Management, said the “notion that ETF liquidity will dry up during market stress” could be put to rest, adding that it is just those times “when market makers and liquidity providers see opportunity.”
BlackRock indicated that “secondary market trading was even more efficient than usual” for the first portion of February, as ETF trading reached an aggregate of $1 trillion between the 5th and the 9th of the month. ETFs do indeed trade more when the market is highly stressed.
However, as Bloomberg Intelligence ETF analyst Eric Balchunas acknowledges, “the reason ETFs trade more in volatile times isn’t because retail investors are all panicking, as some seem to think. It’s mostly because many institutional investors use them for liquidity purposes, in a similar way they would use derivatives.”