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Hard knocks do not dent ETFs’ enduring reliability

Hard knocks do not dent ETFs’ enduring reliability

Exchange-traded funds (ETFs) have no shortage of fans but, when detractors gather, the charge sheet is extensive.

Some say they are worse than socialism, others claim they divert capital to the biggest rather than the best securities. Soon enough people will blame them for climate change.

Then there is the belief soaring ETF inflows will ramp up markets to unsustainable new highs and lead to a crash. Industry experts argued against this theory, saying ETFs are liquid and transparent and, if the market tanks, all boats go down together.

Hortense Bioy, director of passive research, Europe, at Morningstar, holds to this belief. ‘ETFs are not an asset class,’ he said. ‘They are backed by physical assets and are like mutual funds, except they trade on an exchange.’

Steady sailing

Recent headlines question the robustness of ETFs in periods of volatility. But these passive funds in general have experienced few calamities since launching almost 20 years ago in Europe and since 1993 in the US.

Peter Sleep, senior portfolio manager at Seven Investment Management, said any future market weakness was more likely to be caused by human behaviour than by ETF structure.

‘We have always had volatility and investment bubbles,’ he said. ‘Criticisms of ETFs are, at heart, criticisms of investors as being human.’

Greek tragedy

ETFs survived the tech bubble in the early 2000s, and the financial crash of 2008. Many investors remember, however, when a Europe-listed ETF tracking Greek equities shut down in 2015 for five weeks as the Athens stock exchange suspended trading during domestic volatility. This was a rare example. And indeed, even then, when the Lyxor UCITS ETF FTSE Athex 20 shut its doors, its US-listed counterpart continued trading.

This was a rare example. During that same period in 2015, more than 14,000 Chinese companies suspended trading to stem panic selling, but China ETFs continued to trade. And after the Brexit referendum in June 2016, several actively managed property funds trapped investors’ cash for weeks. But ETFs, which tend to replicate equity-based real estate investment trusts, kept trading.

No pushover

The US Securities and Exchange Commission said ETFs played a significant part in the flash crash of 2010, with 68% of more than 21,000 cancelled trades coming from ETF investors.

But Sleep disputed concerns ETF investors were more likely to run away at the first sign of volatility. ‘I’m not sure ETF investors are more prone to irrationality than other investors,’ he said.

A decade after the last financial crisis, boom and bust economic theory predicts another collapse is inevitable. But that could benefit ETFs, according to Dave Nadig, chief executive of ETF.com.

‘When the markets bottom, money will continue to flow out of underperforming low-conviction active funds into low cost ETFs,’ he said. ‘We’ve seen it after every market pullback.’

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