As the shock of a potential pandemic ripples through the global financial system, investors are flocking to exchange-traded funds to move unprecedented sums of money.
Last week alone, when U.S. stock indexes had their worst week since the global financial crisis, ETFs on American exchanges traded a record US$1.4-trillion, more than quadrupling the weekly average.
Since the continuing sell-off began last week, the daily share volume of the largest Canadian ETF – the iShares S&P/TSX 60 Index ETF (XIU) – has reached an average of 23 million, compared with an average daily trading volume of nine million over the past year.
“When you get massive market swings like this, it’s so much easier to put a lot of money to work in a broad vehicle like an ETF than it is to put $20-billion in 10 or 20 stocks,” said Robert Duncan, a portfolio manager at Forstrong Global Asset Management.
By giving investors a venue to trade without needing to buy and sell underlying stocks and bonds, the ETF space can function as a “shock absorber” during times of market stress, Mr. Duncan said.
On Tuesday, a surprise interest rate cut by the U.S. Federal Reserve failed to soothe markets, as the health and economic implications of the coronavirus outbreak continued to sap investor confidence.
The resulting correction has been startlingly quick – the S&P 500 index is down by 11.3 per cent in less than two weeks, while the S&P/TSX Composite Index has dropped by 8.5 per cent.
Over that time, several ETF trading records have been broken. U.S. ETFs typically trade roughly US$90-billion a day, accounting for one-quarter of total market trading volume. Last Friday, ETF trading hit US$414-billion for a 43-per-cent share of equity trading.
One ETF in particular served as a relief valve for pandemic anxiety – the SPDR S&P 500 ETF Trust (SPY), the mother of all ETFs.
Commonly known by its ticker, SPY is by far the world’s largest ETF with US$360-billion in assets, and it has become a crucial access point to American stocks.
“SPY is an alternative to futures and derivatives for large institutional traders to get extremely rapid exposure to the market,” said Daniel Straus, head of ETF research at National Bank Financial.
On Friday, SPY became the first security in history to trade more than US$100-billion in one day, according to Eric Balchunas, an ETF analyst with Bloomberg.
SPY’s US$113-billion single-day total easily trounced the US$28-billion traded in shares of Apple – the single largest U.S. stock by market capitalization.
ETF critics have long pointed to elevated trading volumes of the popular security as a potential systemic market risk, suggesting that ETFs could exacerbate volatility during a severe sell-off. They question what would happen if the masses who have piled into index ETFs rush for the exits.
But the vast majority of ETF trading occurs on the secondary market – investors buying and selling the ETF shares. The underlying stocks and bonds are only bought or sold when investor demand requires additional ETF shares to be created or redeemed.
Last week, the creation and redemption of ETF shares accounted for only around 7 per cent of trading of all U.S. ETFs, according to BlackRock.
“ETFs add a layer of liquidity,” Mr. Duncan said. “It’s a shock absorber, because that liquidity never existed before.”
The past week has helped to dispel other fears commonly raised about the ETF boom. One of them is that heavily traded bond ETFs could disconnect from the prices of underlying bonds, which are typically much less liquid.
“ETF critics think that because there's a mismatch in the liquidity profile of bonds and ETFs, that there is a day of reckoning coming,” Mr. Straus said.
Last Friday, the bellwhether iShares iBoxx $ High Yield Corporate Bond ETF (HYG) also set a record, with US$8.5-billion traded. It did so in an orderly fashion and with relatively tight bid-ask spreads, Mr. Straus said.
“It bolsters the argument that ETFs improve the liquidity profile of the entire system and act as buffers."