ETFs Pass Trading Test Every Day

Market hiccups will always happen, and ETFs are built for that.

Todd Rosenbluth is director of ETF and mutual fund research at CFRA.

Did you catch Monday’s total solar eclipse? If so, your next opportunity isn’t expected until October 2023, according to NASA. Yet when the sun is shining brightly and unblocked, headlines tend not to be written and people don’t line up staring at the sky with cool glasses.

This reminds us of the rarity of ETF trading on Aug. 24, 2015.  

Unlike mutual fund alternatives, ETFs are bought and sold at a price that can be different than their 4 p.m. market close net asset value (NAV). However, 420 ETFs ranked by CFRA traded within 0.25% of their NAVs in the five-day period ended Aug. 18, 2017.

Among those was the iShares S&P 500 ETF (IVV), which closed on that date at a price of $244.25 and a NAV of $244.31, a 0.02% difference. However, nearly two years before, on Aug. 24, 2015’s “flash crash,” IVV traded at a 22% discount to its NAV within the first three minutes of trading, before reverting to a more normal spread soon after.

More Than 1,000 Trading Halts

On that unusually high-volume August Monday morning two years ago, there were an abnormally high 1,278 trading halts in U.S. securities. Amid concerns about the Chinese economy, extraordinary volatility occurred in a broad swath of stocks due to unclear, inconsistent trading practices across U.S. stock exchanges.

IVV and many other ETFs that typically traded essentially in line with their NAV were negatively impacted as trading in some of their stock holdings were halted. This should be expected, since an equity ETF is a basket of stocks that offers diversification and typically high liquidity.

Since Aug. 24, 2015, the ETF industry has continued to gather significant assets. Investors have come to expect that the trades they are making are occurring at a fair price.

Indeed, despite a variety of articles written in the press and in market commentary from active mutual fund managers, last week’s annual ETF inflows broke the 2016 record of $287.5 billion with four-plus months to spare, according to ETF.com.

As of late August, ETFs managed $3.1 trillion in assets, and IVV alone pulled in $21 billion of net inflows, while trading on average 3.3 million shares on a daily basis in the past six months.

What Drives What?

Such success caused concerns that ETF flows were driving S&P 500 stocks higher. However, while IVV constituents Best Buy, Boeing and Nvidia are up sharply in 2017, Chesapeake Energy, Mylan and Under Armour are all in the red. CFRA believes these and other S&P 500 stocks are the primary driver of IVV’s performance, not the other way around.

Meanwhile, in the nearly two years since the fateful day when stock market and ETF trading went wonky, ETFs have faced a variety of tests—and passed.

For example, in 2016, the iShares iBoxx $ High Yield Corporate Bond ETF (HYG) traded an above-average 31 million shares the day after the surprising Brexit vote, and 25 million shares the day after the unexpected outcome of the 2016 U.S. presidential election.

The Go-To Tool

Indeed, seemingly every week, something happens in the stock or bond market, and investors are using ETFs as the vehicle to gain or reduce exposure. In the first seven months of 2017, Charles Schwab’s clients added $28 billion into ETFs, with $3.1 billion in July alone.

Regardless of that brokerage platform, in 2017, gaining exposure is the more common theme, and ETFs offering broad U.S. and international equity exposure as well as investment-grade bonds have led the way.

The iShares Core MSCI EAFE ETF (IEFA), the iShares Core MSCI Emerging Markets ETF (IEMG), the Vanguard FTSE Developed Markets ETF (VEA) and the iShares iBoxx $Investment Grade Corporate Bond ETF (LQD) have all  joined IVV in adding more than $10 billion of new money.

Such success in 2017 has occurred even as the largest and most frequently traded ETF, the SPDR S&P 500 ETF Trust (SPY), had $6.5 billion of net outflows over the same period.

CFRA believes that, unlike the next eclipse, it will be hard to accurately forecast when the next unexpected ETF event will happen. However, we think buyers of ETFs in 2017 will be pleased at how well the securities function when they want to ultimately sell.

At the time of writing, neither the author nor his firm held any of the securities mentioned. Todd Rosenbluth is director of ETF and mutual fund research at CFRA, an independent research firm that acquired S&P Global Market Intelligence's equity and fund business in October 2016. He can be reached at [email protected]. Follow him at @ToddCFRA.