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What Happens to ETFs During Times of Volatility
Traders Magazine Online News, February 27, 2018
At the close Monday (February 5th), volumes on all exchanges in the US had surged to $630bn versus an average of $280bn. This number was familiar; it’s almost identical to the $631bn that traded on August 24th 2015. Volatility too had a similar ring to it, closing at 37.32 in Tuesday trading versus 40.74 on Aug 24th 2015 (Source: Bloomberg and Factset as of 2/6/18).
You may remember the date in 2015 because Asia’s and Europe’s markets had sold-off sharply and resulted in S&P 500 Index futures being limit down on the US open. This caused a delay in the open of various US stocks which in turn disrupted the opening and pricing of some ETFs. There are numerous papers written on this subject so I won’t rehash them here. I will, however, contrast with Monday (February 5th) trading.
Similarities… and Differences
In short, there were 300 ETFs (and ETNs) that experienced 800 trading halts that August day. Today there were only 5 halts in 4 ETPs (Exchange-Traded Products) and these were all strategies that track volatility. Given their underlying markets moved over 100% today, this is fully to be expected.
Generally, ETFs did exactly what they were supposed to do. There was an orderly sell-off in the ETFs in line with their underlying markets. We did observe some widening of spreads around the steepest part of the sell-off notably around 3:15pm, but again these did not materially dislocate from underlying markets. The good news is that markets settled somewhat overnight and we did not have to test the system with an August 24th style limit down open in the US market (Source: Bloomberg, as of 2/6/18).
What About High Yield?
Given recent discussion around liquidity in fixed income ETFs, specifically High Yield, it is worth reviewing how they performed. As an asset class, high yield did not see the same degree of sell off as equities, so as an illustration this is not a thorough test.
However, it was interesting to note how the ETF moved with their underlying bonds and provided price discovery. The largest high yield ETF traded 170% of its average daily volume and traded, as did the other major high yield funds, toward and then through the bid price of the underlying bonds (Source: Bloomberg, as of 2/6/18). When this happens, it is easy for commentators to suggest the ETF is trading at discount. However, we understand this to be price discovery as the ETF represents traded prices in the basket of bonds. This is proven this morning where the bond bids have moved down in line with where ETFs were trading yesterday. A smaller test for high yield ETFs, but another proof point for the ETF wrapper overall.
Volatility ETF Difficulties?
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