Exchange-traded funds (ETF) do not exacerbate a crisis in share markets but provide transparency to investors and create efficiency, according to new analysis released by the Financial Services Council (FSC) which refutes criticism ETFs are responsible for skewing markets.
The analysis, undertaken by actuarial firm Milliman and published in “Exchange Traded Funds during COVID-19 – A Case Study”, looked at the performance of ETFs during the 2020 COVID-19-driven market downturn in response to concerns the investment vehicles had the potential to intensify market movements during those types of events.
“There has been a concern by a small cohort of critics that ETFs have the potential to exacerbate market movements, in particular caused by the systematic rebalancing of the underlying assets from geared ETFs,” the case study stated.
The study noted ETFs played a crucial role within markets during the COVID-19 financial crisis and that despite high levels of market volatility and pressure in equity and credit markets, “ETFs provided a level of stability, price discovery and liquidity that effectively allowed them to be a pressure valve during one of the largest and most extreme crises that global markets have ever experienced”.
“While the trading cost did increase, this was expected due to increased pricing/hedging risk and costs of creations/redemption. But the important point was that there was liquidity for investors to buy and sell on the exchange,” it said.
“ETFs act as a receipt of the sentiment surrounding their market exposure.
“During the COVID-19 volatility period, equity ETFs experienced inflows while the flows for Australian fixed income ETFs went the opposite direction. This is generally an indication of a ‘risk on’ investor sentiment with expectations of future gains in the Australian equity market, which given the recovery post March, this sentiment was correct.
“In assessing ETF market behaviour during the COVID-19 market turbulence, there remains little doubt that ETFs performed as expected, providing investors with a cost-effective vehicle to express their investment view during the crisis, and the period saw a big growth in ETF users.
“Policymakers and industry participants can take comfort from these positive outcomes and going forward recognise the key role that ETFs will likely play again during any future extreme market events.”
FSC chief executive Sally Loane said the study counteracts concerns from parts of the market regarding the role of ETFs and proved the criticisms were unfounded.
“It is clear from the Milliman analysis that ETFs are an overwhelmingly positive market instrument and played a vital role providing price discovery rather than adding further volatility during the significant market stress in 2020,” Loane said.
