Industry reactions to March volatility

Dan Barnes Welcome to ETF TV, I’m Dan Barnes. With me today is Deborah Fuhr, CEO of ETFGI, and we’re going to be talking about the market disruption that we saw in March and some of the conclusions that analysts and industry associations have come to about the functioning of the ETF market during that period. Deborah, welcome to ETF TV.

Deborah Fuhr Thank you. Great to be here.

Dan Barnes So we’ve seen papers from the Investment Association, the International Capital Markets Association and the Bank of England, all looking at the functioning of the exchange traded fund market during a period of volatility in March, particularly focused on fixed income. Were there any particular conclusions, which are common to all three?

Deborah Fuhr I think in general, the answer is yes. I think that they found that during this volatile time, ETFs performed well. There was a lot of trading, there was inflows, there were outflows. We did see discounts and premiums around the pricing of ETFs relative to the NAV. But the conclusion has been that because ETFs are traded intraday, the firms that trade, you have to go out and price the bonds to make sure the prices are accurate. And so we did see that they were actually a better indicator of pricing than traditional mutual funds or index funds. So in general, that would be the conclusion that we see across the three papers.

Dan Barnes I just saw in the ICMA paper that some traders have suggested that ETFs might have accelerated moves in the bond market. What do you say to that point?

Deborah Fuhr Well, I think the reason they say that is because they’re going down and trading underlying baskets when we have the primary trade. So remember, we have two types of trades with ETFs. Secondary trading is when ETFs traded, just like any other security; someone who already owns existing shares and selling them and someone else is buying those existing shares of an ETF. Otherwise, a primary trade when the trade is typically more than 20% of the average daily volume, authorized participants are allowed to buy the underlying basket, typically in increments of 50.000. So the thought being that as they go and buy maybe it’s causing the prices of the bonds to change.

Deborah Fuhr I actually don’t buy that view because we know that in general, nine out of 10 trades are secondary trades which don’t impact the underlying. And we also know that the act of actually going out and creating these bonds has created better transparency. So I think the findings would be people have raised that as an issue. But I think in general, the consensus is more along the lines of ETFs have actually provided a very unique and good role in terms of actually providing much better transparency on the price of government bonds.

Dan Barnes Would it not be true that In secondary trading, perhaps if more funds were coming in to buy funds, then there might be greater issuance or greater volume of ETFs supported, which might increase the amount of underlying assets that had to be acquired?

Deborah Fuhr We have seen net creation. So if you look at the past few months, we’ve seen that there have globally been net creations and fixed income ETFs, especially last month. So I think we’ve seen different buying patterns based on equity markets going up and down. Some investors are seeing there’s buying opportunities, or thinking now’s a good time to invest in either a market or some people have been buying airline stocks, because we think that’s going to rebound or whatever. So I think there’s different reasons people use ETFs, which cause them either to create secondary or primary. So we’ve seen different reactions in terms of where people have been investing. And I can say that in general, the creations haven’t been that large, that we would be concerned that it’s impacting the underlying. But I also think if you have fixed income bonds, whether it’s index or mutual funds, have issued and feel they can’t go and trade, they gate them or close them right? So at least with ETF, you are able to get real time pricing and you are able to get in and out. Whereas we have seen when some of the traditional, mutual funds or index fixed income funds have ended up trading, they’ve seen a real adjustment to their NAV, so I think there is an issue and part of that is driven by index providers, right?

Dan Barnes That’s very true. Have you seen any concerns about the way that market structure functions, fx, do APs walk away  at any point or any issues like that raised?

Deborah Fuhr That’s always been a question from regulators. Should they control APs more? I think often they get confused about the role of market makers and APs, right? So market makers are required to be making markets, except if something unusual happens. Authorized participants (APs) are the firms that are able to go out and create and redeem any ETFs. And what we’ve seen based on feedback from some of the issuers here in Europe is, they actually saw that more APs were stepping up to trade. So we saw a significant increase in the amount of trading volume in ETFs. And when we did see creations or redemptions happening, it wasn’t across just the top ones that tend to trade, it was across a much wider spectrum. Typically, ETFs will have a significant number of authorized participants. And so they didn’t just see one or two trading and they didn’t in general see people stepping away.

Dan Barnes Finally, would you say that these reports have been overall net positive, net neutral, or net negative about the ETF market?

Deborah Fuhr I would take away, that they have been an endorsement, that ETFs actually work as they should. And net positive? So, I think they’re going to continue to watch, because clearly ETFs have broken through the six trillion dollar mark and people want to make sure that they’re going to work appropriately. But I think it’s been a testament to the ETFs that they have worked well during a very volatile time,  with a lot of trading, inflows and outflows.

Dan Barnes That’s great. Deborah, thanks very much.

Deborah Fuhr Thank you.

Dan Barnes I’d like to thank Deborah Fuhr for her expertize, and of course, you for watching. To catch up on our other shows, go to ETFTV.NET or TRADERTV.NET.

Published on June 10, 2020