On April 23, RIMES convened a virtual panel discussion on the topic of Exchange-Traded Funds (ETFs) and how the market has fared during the stressed market conditions caused by the COVID-19 pandemic. The event was moderated by Andrew Barnett, Global Head of Product Strategy at RIMES. Participants included Kevin McPartland, Head of Market Structure & Technology Research at Greenwich Associates; Nico Cortese, Vice President SPDR ETF Capital Markets at State Street Global Advisors; and John Lanaro, Global Head of ETF Data at RIMES. The following is a summary of the main points discussed in the session.
The flexibility of the ETF market
While ETFs started out as a vehicle to provide retail investors with easy access to certain indexes, today they are used widely by institutional investors as a means of gaining quick exposure to corporate bonds. They are also used by investors and their clients as a good way to lower costs, even in actively managed portfolios.
However, there is also a great deal of complexity in the ETF market. The structure of ETFs will differ according to whether it is operating in the fixed income, equities or commodities markets. There are also a broad range of end users with diverse needs and requirements. For ETFs comprised of other ETFs or other derivatives, compliance and risk teams, for example, will need to view the underlying components broken down to the stock or bond level to understand their risk profile, whereas traders may leave these within the portfolio as they trade intraday.
Both the complexity and flexibility of ETFs have come into play during the market volatility that resulted from the COVID-19 pandemic.
Pricing and market volatility
As the pandemic took hold, some of the biggest fixed-income ETFs were traded heavily. Concurrently, the paper value of the bonds underlying the ETF (i.e. the Net Asset Value) diverged significantly from their trade price. There was real concern that this divergence indicated that ETFs were not functioning as they should.
It now seems likely that many individual bond prices – especially less liquid issues – lagged the market since they were being evaluated on models not predicated to this scale of disruption. Throughout, ETFs were being traded accurately and were a lead indicator for bond prices.
There are three possible reasons why ETFs closing prices deviate from the NAV during times of volatility:
- Most corporate bond ETFs strike the NAV at 3pm, whereas ETFs are traded for a further hour. During this time price dislocation can occur and this dislocation is exacerbated in stressed markets.
- ETFs are highly liquid and reflect where liquidity providers can source or sell bonds on the market from a price standpoint. ETFs therefore start to function as a price discovery tool for their underlying bonds.
- Market makers only have limited amount of capital they can put at risk. With thinly traded ETFs, market makers may not be able to provide sufficient depth on screens for every single Fund to fully absorb the sort of relatively huge closing imbalances that were experienced throughout this volatility. Large prints around the close may therefore move the market.
Throughout the recent volatility ETFs functioned well. People needed to reposition quickly and ETFs provide the flexibility and speed through which to do this. Repositioning on the scale that was required would have been much more difficult in the underlying bond market, despite recent efficiency improvements that have been unlocked through the growth of e-trading.
ETF data imperatives
The more information available around ETF pricing the better able investors are to buy and sell efficiently. With regard to pricing accuracy, as creation and redemption baskets may not be built as a perfect pro rata slice of ETF holdings, firms must look at daily holdings data. The more data the better, and ETF issuers are moving to provide market makers with more information on underlying constituents so they can price fairly. This will help spur innovation and growth in the market as the more data available to buy-side investors the more attractive the ETF market will appear.
Data volume growth must come hand in hand with data quality assurance. To help ensure the quality and timeliness of the ETF data consumed by its clients, RIMES has built close relationships with ETF issuers. The approach allows it to build a comprehensive data set comprising the most up to date and detailed information. RIMES further helps clients by standardizing the data files provided by issuers and sponsors, providing the data clients need in a ready to use feed so they can focus on their core business tasks.
The future of the ETF market
Issuers realize that for their ETFs to trade as tightly as possible they need to provide high quality data. That means in the short to medium term there will be file format changes that buy-side firms will need to mitigate. By taking on these tasks for clients, RIMES can insulate them from these changes. That means firms can benefit from data quality improvements without having to manage any of the change disruption.
Standardization will continue as the market matures, increasing market makers’ confidence in pricing. This can also lead to a better experience for investors as they will be able to leverage tighter spreads.
Contact RIMES to find out how we can help you streamline ETF data capture, eliminate costly internal processes and enable daily exposure insight, aggregation and reporting.
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