Industry analysis looks into investment vehicles' role in price discovery and performance amid recent market volatility
Even amid the COVID-19-induced price volatility over the last six months in the equity markets, equity ETFs have shown robust liquidity, according to the Investment Industry Association of Canada (IIAC).
In a new analysis, IIAC noted how in spite of their record of performing well in low-interest rate environments, REITs have fared poorly in the pandemic. Preferred-share ETFs, it said, have also lagged the broader markets.
March and April saw instances where industry and sector ETFs traded at larger-than-normal bid-offer spreads in the secondary market. By the beginning of April, the note said, bid-offer spreads for broad-based ETFs had largely returned to normal.
“In strained and volatile markets, ETFs, and in particular equity ETFs facilitated continuous market liquidity and material trading volumes, and also provided transparent price discovery for many underlying equity products,” IIAC said.
While regulators and other investment-industry stakeholders have voiced concerns about ETF authorised participant (AP) arrangements breaking down in periods of market stress, IIAC said there was little evidence of that happening in either the fixed-income or equity ETF space. The broad and diverse AP system, it noted, appears to have maintained its capacity to function effectively throughout the crisis, particularly the middle of March 2020.
And an examination of trade volumes, as well as the closing of divergences between ETF prices to the NAV and price discovery that ETFs allowed in choppy markets, makes it clearly apparent that ETFs did quite well and worked as designed, according to IIAC.
“[T]here has also been some discussion and empirical evidence that ETFs have actually made re-balancing of investors’ portfolios easier through less transactions,” the note added.
And while the brief but acute period of stress throughout the entire financial market created instances of widened ETF spreads, IIAC said many of the bid-offer spreads observed in May across industry sectors were close to those seen in January before the pandemic, thus showing a rapid recovery in spreads across many industry sectors.
IIAC also offered some reminders on how industry participants can get a better chance of receiving the best pricing on equity ETFs, including:
- Avoiding action during the first 10 to 15 minutes of a trading day;
- Trading only when the underlying equity market is open;
- Always using limit orders for trades; and
- Being mindful of overall market instability and volatility.
“Overall ETF markets and ETF technology will likely continue to experience strong growth into the foreseeable future,” IIAC said. “However, with this anticipated growth in the total size of the market, the inclusion of some riskier strategies, and a greater number of ETF providers and Aps, investors and regulators need to keep informed and responsive to changes in the marketplace.”
