How ETFs provide transparency in turbulent markets

BlackRock |Apr 8, 2020

Global financial markets have been whipsawed in recent weeks by coronavirus worries.

Last week U.S. stock benchmarks fell into “bear market” territory, meaning price declines of more than 20% from recent highs. Many types of bonds faced unusually severe price swings, and gold, a commodity generally thought of as a haven, fell sharply.

Amid the turmoil, many investors turned to exchange traded funds (ETFs) to help navigate choppy conditions. U.S. ETF trading volumes surged to a record $1.4 trillion last week.1

More volatility means more ETF trading

Years of evidence show that investors tend to use ETFs more in times of uncertainty because they make it simple to adjust positions and manage risk inside portfolios. ETFs accounted for 39% of all equity trading last week, compared with an 27% average for 2019.2 Put another way, nearly $40 for every $100 dollars traded on exchange was done through an ETF.

The most anxious trading days resulted in the heaviest ETF activity. On Thursday, March 12, the S&P 500 fell nearly 10%, its biggest daily decline since the stock market crash of 1987. That day U.S. ETFs traded $340 billion, nearly four times the $88 billion average daily volume for 2019.3

The value of price transparency

The transparency of on-exchange trading has proven valuable to active investors during times of stress, since ETFs help establish real-time prices when trading in the underlying market is impaired. This was especially the case last week as bonds, faced an unprecedented deterioration of liquidity and market quality around the globe. Investors found it difficult and expensive to execute large trades in U.S. Treasuries, corporate and emerging market bonds.

Most individual bonds trade differently than ETFs and stocks, which are bought and sold on exchanges with transparent bid/ask quotations. In contrast, pockets of the bond market--including corporate, municipal and emerging market debt--are relatively opaque and bid/ask quotations are not readily available.

As an alternative, many investors last week relied on bond ETFs for more transparent, on-exchange pricing and trading. In all, U.S.-listed bond ETFs traded $52 billion on March 9, compared with the 2019 average of $11 billion.4 For the week, bond ETF volume jumped to $217 billion.

Real-time trading, real-time prices

Disruptions in the fixed income markets last week led to differences between bond ETF prices and the values of their constituent bonds. So-called “discounts” to net asset values (NAVs) can occur because bond ETFs tend to trade more frequently than individual bonds, especially in times of stress.

It’s important to note that recent discounts in bond ETFs do not reflect a problem with the ETF structure itself. Rather, investors should think about an ETF as a leading indicator of market prices since it transmits real-time information about the quality and accessibility of the underlying markets.

ETF trading best practices

Should market volatility and impaired liquidity persist in the bond markets, investors may see continued discounts as a result.

Investors can help themselves by adhering to best practices when buying or selling ETFs. There are two key considerations:

  • Time: Given that markets can be more volatile near open and close it is best to consider trading after the first 20 minutes of the trading day and before the final 20 minutes. If possible, trade ETFs while the underlying market of the securities the ETFs track is open.
  • Order type: As with trading individual stocks, make sure your order type is consistent with your goals. Consider using limit orders for greater control over execution price during volatile markets. Market orders may be appropriate if speed of execution is paramount, but you may not receive the price that was available when you placed the order.

ETF Statistics to Watch in Volatile Markets

Investors are turning to ETFs during market volatility. We highlight four stats to keep an eye on in the latest episode of the BlackRock Bottom Line.