When ETF discounts blew out to record-wide levels after liquidity vanished in the bond market, many commentators were licking their lips at the prospect of highlighting the structural flaws within the ETF wrapper.
One such commentator was Variant Perception's founder and renowned economist Jonathan Tepper who stated on 20 March the “fundamental problem” with ETFs is they provide investors with an “illusion of liquidity” by offering access to illiquid parts of the market.
Amid the coronavirus turmoil, some 80% of investment-grade bond ETFs started trading at all-time high discounts to their net asset values (NAVs), according to Citi research.
The discounts, however, only served to highlight the price discovery role ETFs play. As ETFs trade intra-day, these discounts reflected the true price of the underlying market while the stale NAVs were playing catch-up with the more efficient product.
Authorised participants (APs) were once again at the centre of discussion amid concerns they would withdraw from the market as liquidity dried up.
However, the increased volatility had the opposite effect. According to research conducted by Invesco, the same 16 APs were active across both February and March during entirely different market environments.
Furthermore, the firm’s top three APs lost market share during the more volatile March highlighting how uncertain markets is viewed as an opportunity to increase trades by these liquidity providers.
One area where ETF issuers take stock is in the oil market. Last month, oil prices did the unthinkable and traded below $0 a barrel for the first time in history as storage concerns sent West Texas Intermediate (WTI) to as low as $-40.
The majority of exchange-traded products were designed to offer investors exposure to the front-month contract, however, as prices threatened to hit $0, which would effectively wipe out returns, the issuers chose to roll their exposure to the less volatile later-dated months.
The recent turmoil in the oil markets does shine a spotlight on a design flaw in the way many commodity indices are constructed.
However, gaining exposure to the oil futures markets and the bond market through a UCITS ETF are two very different things so it is important to make the distinction.
The ETF wrapper passed the coronavirus test with flying colours during the March volatility and even managed to highlight the "archaic" nature of the bond market along the way.
The question remains though, how many more tests must the ETF wrapper pass before it becomes accepted by all parts of the investment community?
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