Did ETFs Pass the 2020 Market Collapse Stress Test
There's a paper issued by the Federal Reserve Bank of Boston titled The shift from Active to passive investing potential risks to financial stability. They right to the extent that passive investing is pushing up the prices of index constituents. Two types of potential repercussions for financial stability might arise. I in theory, rising prices can lead to more index investing and the resulting index bubble eventually could burst. But they point out that this might not be the entire market but could be just elements in the market some stocks getting pushed up. While others might have their prices fall because they're not necessarily included in the index. Investors were selling active mutual funds and going in to index funds to the overall market valuation wasn't necessarily going higher. The point out that some stocks will because they are part of that basket that an ETF holds might be more liquid whereas other names are going to be less liquid. So you have different things going on that makes it challenging to figure out whether there is or was an indexing bubble Needed is a stress test. We needed people rushing to get out of ATS and other assets and to see how they hold up. One of the concerns regarding ETF, there would be a flash crash which has occurred in the past where the price of an ETF has fallen dramatically more so than the price of its underlying holdings. And this can occur when there are trading halts in either the ETF or the underlying holdings. These trading halt or circuit breakers that are implemented if the price of security ETF falls below some threshold. And they're there to suppress volatility. Do allow traders time to catch their breaths or trading systems time to recalibrate to timeout. The stress has is very, very important because ETF's are so much bigger than they were. Six trillion dollars in assets in the ETF sector that's up seven fold from two, thousand seven. So. What happened during late February and March as market sold off dramatically. Well I there was no flash crash trading volume, definitely spite. I shares shared some data for the week of February twenty. Fourth Two thousand twenty volatility spikes so the vix, the C. B. O. E. volatility index, it reached forty nine. The highest since February twenty eighteen. and. The S&P five hundred had its largest weekly decline since the two thousand eight global financial crisis. Exchange traded products that week comprise thirty, eight percent of market trading. Whereas back in twenty nineteen, they accounted on average for twenty seven percent. So there was much more trading in ats. Exchange. For the products which include ATS. Traded a record one point, four, trillion dollars volume from February twenty, four, th through February twenty, eighth, two, hundred and seventy percent greater than its average daily trading volume from the prior month. And then that trading was fairly efficient. So the bid ask spreads what investors were buying ETF for or selling e Utah. That price difference was generally line with historical averages in addition, most of the trading volume was trading in the secondary market. Investors trading the ATS with each other, rather than trading facilitated by authorized participants who interact directly with ETF sponsored in creating and redeeming shares. The volume of secondary market trading in exchange traded products was fourteen to one relative to primary activity of this trading with authorized participants. What that means is that ETF in some ways acted as shock absorber when investors were trying to get out even if the underlying securities might have been less liquid by selling ETF's taking much of that trading volume that put less pressure on perhaps some of those less liquid securities. It seemed to function. If we look at what happened during the this market twenty, twenty turmoil compared to the flash crash of two thousand, ten volatility was actually much higher during the march twenty, twenty turmoil. The minimum and maximum levels during a given day for the various indices was higher during March twenty twenty then back in the flash crash twenty ten. And yet the markets seem to function generally speaking at least for equity ETF's. Even. Michael. Berry in March twenty twenty seemed to admit this. He told Bloomberg I have a significant bearish market bat that is working out for now. A global pandemic is absolutely potential trigger for the unwinding of the passive investing bubble. But despite volatility Berry said, he hadn't noticed any signs of dysfunction in the markets that was making it harder for him, the trade or exploit investment opportunities. Equity ETF seems to have passed that stress test it worked even though the volume of trading was so much higher. The number of ATS was so much higher. There were some challenges on the bond side. The vanguard total bond market ETF. B, n De on March Twelfth, it's closing price was six point two percent less than its net asset value per share. The price was less than the supposed value of the underlying holdings on a per share basis. During the prior thirteen years that have had a point one, seven percent premium of the closing price to envy now at six point, two percent discount. Rich powers WHO'S HEAD OF ETF product management at Vanguard said this wasn't unusual. Market prices for Egypt's can move more rapidly than the net asset value that is part of the price discovery process. He's saying that's normal.