Recent volatility in global markets provides a great opportunity to examine how ETFs trade during times of market stress—an increasingly important consideration given the rising popularity of ETFs.
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During the week of February 5, measures of broad equity market volatility nearly tripled after many months of relative calm.1
ETFs are no stranger to market volatility. They have survived several market disruptions, including the 2008 global financial crisis. During those periods, they tracked the value of their underlying portfolios, gained in assets and trading volume, and provided low-cost access to a variety of asset classes for millions of investors.
Still, concern among some investors over liquidity during volatile periods remains. To be sure, avoiding trading on days of heightened volatility is one way to steer clear of market uncertainty.
But for investors who must trade when markets are turbulent, let’s look first at how ETFs performed during the recent volatile period and then consider how advisors can help ensure a positive trading outcome for their clients during volatile times.
ETF trading surges during volatile times
ETFs, unlike conventional mutual funds, trade on an exchange, providing intraday liquidity for those investors who want or need to trade.
Intraday liquidity across the entire equity market has tended to spike during large swings in the market—and that includes episodes of volatility. For example, average daily volume in U.S.-listed equities soared to roughly $600 billion during the week of February 5, up from its previous three-month average of $315 billion.2
The figure below shows the spike in volume for equity and fixed income ETFs for that week. The takeaway is that investors who had to buy or sell ETFs during the recent turbulence found a deeper secondary market than usual— a clear positive.
ETFs act as shock absorbers
Vanguard research has shown that from 2012 to 2015, the median daily ETF volume that resulted in a creation or redemption was 6% for equity ETFs and 17% for fixed income ETFs.
In other words, for every $1 of trading volume, only 6 cents for equity ETFs and 17 cents for fixed income ETFs resulted in a creation or redemption. Most ETF transactions took place in the secondary market.3
Average daily value traded across U.S.-listed ETFs during the week of February 5, 2018, versus the prior three-month average
Source: Vanguard calculations, based on data from Bloomberg and Cboe.
Notes: The volumes for equity and fixed income ETFs do not sum to the total for U.S.-listed ETFs because the total includes asset classes not shown here. The week of February 5 includes data through February 9; the previous three months include data from November 3, 2017, through February 2, 2018.
1 The average value of the VIX Index, a widely referenced gauge of market volatility, was 11.1 in January 2018. During the week of February 5, 2018, it was 31.5.
2 Vanguard calculations, based on data from Cboe.
3 Vanguard, 2015. Exchange-traded funds: Clarity amid the clutter. Valley Forge, Pa.: The Vanguard Group.
Drilling more deeply into the recent experience, the figure shows that in volatile markets, ETFs act as “shock absorbers,” soaking up even more volume in the secondary market than usual, reducing the impact on the underlying portfolio. This spike in secondary volume keeps downward pressure on the bid-ask spreads that investors pay to transact, and it also helps prevent costly turnover in the underlying portfolio, which can occur when transactions require underlying stocks and bonds to fulfill creations and redemptions.
Read the full article here by Chuck Thomas and Adam DeSanctis of Vanguard, Advisor Perspectives
