ETFs proved resilient in market meltdown, says fund trade body

A new report from the Investment Association argues that ETFs proved more resilient than expected in the March sell-off. 

ETFs held up better during the Covid-19 market volatility than expected, according to a paper published by the Investment Association (IA).

The paper looked at the ‘resilience’ of ETFs during the market panic in late February and March, with the key three areas being:

• Premiums/discounts to net asset value
• Trading volumes and liquidity
• Primary market efficiency

Of particular interest, the paper focused on the widening of premiums and discounts during the market sell-off. It is rare for an ETF to trade on a discount or premium to its net asset value (NAV). ETFs aim to replicate an underlying asset or market and, therefore, their prices will typically be closely aligned to their net asset value. 

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However, as the report notes: “During the week of 15 March 2020, investment-grade corporate bond ETFs listed in the US were trading at an average discount of 3.36% to NAV. In a few cases, discounts of over 7% were seen.”

Many were concerned that these discounts represented so-called authorised participants (APs) stepping away from their role. Authorised participants play a key role in making ETFs work. They are professional investors who are granted the right to create and redeem shares of ETFs, which result in ETFs typically trading at their NAV.

The IA report notes: “Concerns have previously been raised by regulators that ETF AP arrangements would break down in times of market stress, with APs stepping away from their role as they looked to reduce risk.”

However, the paper argues that the reason for widening discounts are found elsewhere, and they note that there “was, in fact, no evidence of APs, or indeed other vital market participants, ‘stepping away’ from ETFs”.

The paper noted that ETF providers have systems in place to try to prevent fear of APs stepping away.

The IA also argued that even if APs did decide to step away, other market participants could still provide liquidity. As it says in the paper: “Nonetheless, it is important to recognise that, even if an AP were to step away, investors have other options.

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“While APs are the only firms that can directly conduct creation and redemption business with ETF providers, they are not the only organisations that can provide liquidity. Market makers and broker dealers also play important roles within the ETF ecosystem.”

The paper built on an earlier report, published by the IA in June, that also sought to establish that ETFs proved more stable in the March volatility than many expected.

Commenting on the new paper, Henry Cobbe, head of research at Elston Consulting, said: “It is great to see the IA report look at the detail of ETF resilience during times of severe market stress and give it the thumbs up.

“Hopefully this will help investors get more comfortable with the ETF format for accessing fixed-income exposure in a transparent, liquid and cost-efficient way.”

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