Morningstar - Q2 2020 - 48

	

Strategies

Avoid Trading ETFs in Turbulent Times
Extreme market volatility has led
to extraordinary dislocations in prices.
Research
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57

RESEARCH

Bond Funds Bent, but Most Did Not Break
How Does Investing in ESG Affect Returns?

Ben Johnson

Quant U

As markets have been roiled by the spread
of the coronavirus, exchange-traded funds' trading
volumes have spiked. Shares of SPDR S&P 500
ETF SPY, the oldest and largest U.S. ETF,
changed hands in record volumes. On Feb. 28,
SPY's trading volume hit $114 billion-an
all-time high, equivalent to 5.6 times its average
daily volume during 2019 and representing
43% of its assets under management. According
to Bloomberg data compiled by BlackRock BLK,
ETF trading accounted for 38% of all equity
volume on U.S. exchanges from Feb. 24 through
March 13. This compares with an average
of 27% in 2019.

	

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A Better Retirement Spending Rule
for Everyone

	

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Manager: Now Open to New Investors
Passive: A Good Way to Own Value Giants
Equity: An Enviable Portfolio

Best Ideas

What explains this uptick? ETFs are a
dynamic investment wrapper. They can be used
by long-term investors as low-cost, taxefficient portfolio building blocks. They have
penetrated actively managed funds as a
way to maintain market exposure and manage
liquidity needs. They can be sold short
by those with a bearish view. And they've become
an additional layer of liquidity in fixedincome markets, stepping in where traditional
bond market participants have stepped out
in the post-financial-crisis period. Given these
funds' diverse uses and user base, it is
no surprise that investors of all stripes have
flocked to them in a market that-to
put it lightly-has been liquidity-challenged.
Unprecedented Dislocations
ETFs trade like stocks-investors pay or receive
the going market price for their shares.
These prices tend to hew closely to the value of

48

Morningstar Q2 2020

their underlying assets. ETF market makers
make sure of this. They are the linchpin of the ETF
ecosystem. They quote bid and ask prices
for ETF shares and compete with one another
to profit from any discrepancy between the
funds' share prices and their own estimates of
the value of the funds' assets.
In normal market conditions, market makers face
little risk and ample opportunities to collect
profits from keeping prices in check and pocketing
bid-ask spreads in exchange for connecting
ETF buyers and sellers. But these aren't normal
conditions. Today, the risk that market makers face
has flared, and the demand for their ability
to price them has peaked. As a result, they are
having greater difficulty and facing bigger
risks pricing ETF portfolios and are quoting wider
bid-ask spreads.
In the early days of the current market
meltdown, ETFs were weathering the storm well.
While bid-ask spreads and premiums and
discounts widened, they remained within normal
ranges. During the week of March 9, as the going
got tougher, many ETF prices came unmoored
from their net asset values. This owed to a
variety of factors, but tumult in the U.S. Treasury
market played a big role.
The impact was immediate and significant.
The March 12 closing prices for Vanguard
Total Bond Market ETF BND, iShares Core U.S.
Aggregate Bond ETF AGG, and Schwab
U.S. Aggregate Bond ETF SCHZ represented
respective discounts to the funds' NAVs
of 6.2%, 4.4%, and 6.3%. In all cases, these were
well, well outside of normal ranges-
none of these funds had ever seen discounts
of this magnitude.
Morningstar - Q2 2020

Table of Contents for the Digital Edition of Morningstar - Q2 2020
