The vehicles have done well, but could be troublesome instruments in choppy markets
Buoyed by unprecedented interest from both investors and fund providers, the global ETF industry is benefitting from steady inflows and rising asset levels. Some say that the rush can lead to bloated valuations and distortions. But aside from what the vehicles can do to markets, investors might have to think about what markets can do to ETFs.
One thing to remember about the rise of ETFs is that it’s happening in a bull market, and valuations are at historic highs. Price-to-earnings ratios for the UK’s FTSE All-Share, Europe’s Eurofirst 300 and the US’s S&P 500 indices are all sitting above 20, reported the Financial Times.
At those levels, the article said, investors should remember past experience and be more conscious of the downside. A correction could be due, in which case actively invested funds would be more able to respond to a sell-off than passively managed instruments.
ETFs have also been found to behave more erratically than expected in times of stress. In its review of the flash crash in August 2015, the US Securities and Exchange Commission found that exchange-traded products, which include ETFs, “experienced more substantial increases in volume and more severe volatility” than standard stocks, and extreme price swings “seemed to occur idiosyncratically among otherwise seemingly similar ETPs.”
The Times report further noted that ETFs operate through market-makers, who would want to buy ETF units at a discount to the underlying assets and sell at a premium. In choppy markets, however, those intermediaries are less likely to make a margin, and will therefore be less willing to provide liquidity.
In an extreme case wherein the manager of the ETF struggles to sell its underlying securities, an investor seeking to redeem their units might not get cash; instead, they might end up holding the underlying investments in their portfolio. Many will likely find that problematic, especially for challenging asset classes such as high-yield bonds.
For more of Wealth Professional's latest industry news, click here.
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Demand for low-cost funds lifts Vanguard to $4.7 trillion
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One thing to remember about the rise of ETFs is that it’s happening in a bull market, and valuations are at historic highs. Price-to-earnings ratios for the UK’s FTSE All-Share, Europe’s Eurofirst 300 and the US’s S&P 500 indices are all sitting above 20, reported the Financial Times.
At those levels, the article said, investors should remember past experience and be more conscious of the downside. A correction could be due, in which case actively invested funds would be more able to respond to a sell-off than passively managed instruments.
ETFs have also been found to behave more erratically than expected in times of stress. In its review of the flash crash in August 2015, the US Securities and Exchange Commission found that exchange-traded products, which include ETFs, “experienced more substantial increases in volume and more severe volatility” than standard stocks, and extreme price swings “seemed to occur idiosyncratically among otherwise seemingly similar ETPs.”
The Times report further noted that ETFs operate through market-makers, who would want to buy ETF units at a discount to the underlying assets and sell at a premium. In choppy markets, however, those intermediaries are less likely to make a margin, and will therefore be less willing to provide liquidity.
In an extreme case wherein the manager of the ETF struggles to sell its underlying securities, an investor seeking to redeem their units might not get cash; instead, they might end up holding the underlying investments in their portfolio. Many will likely find that problematic, especially for challenging asset classes such as high-yield bonds.
For more of Wealth Professional's latest industry news, click here.
Related stories:
Demand for low-cost funds lifts Vanguard to $4.7 trillion
Could investor appetite for passives be plateauing?
