News & analysis THE ETF PARADOX
Bond ETFs have been among the investment vehicles hard- est hit by the volatility sweeping the financial markets, so why are investors still buying them? Mona Dohle reports.
The UK’s capital markets have lost $500bn (£445bn) in value in September alone, according to Bloomberg. Among the worst performing funds throughout that period were bond ETFs, especially leveraged gilt ETFs. For example, Wisdom Tree’s 10-year, three-times leveraged Gilt ETF is down more than 55% this year. Funds offering passive exposure to linkers have also been pun- ished. The iShares Index Linked Ucits ETF had fallen almost 40% by the beginning of October with Vanguard’s Inflation- linked Gilt Index fund down -27%. Corporate bonds have also been affected. For example, the ster- ling-denominated iShares core Corporate Bond Index ETF is down more than 24%, year-to-date, according to Morningstar.
Net inflows But the paradox is that unlike the broader market and despite often poor performance, ETFs still enjoyed net inflows. In the weeks prior to the Bank of England’s intervention, there was a notable surge in inflows into gilt ETFs to £96.54m for the week commencing 14 September, followed by £1.6m in inflows the week after, according to Lipper.
This ties into a broader trend. The European ETF industry also benefited from €1.3bn (£1.1bn) in inflows for August, despite their assets falling to €1.28trn from €1.31trn in July, according to Lipper. This drop in assets was largely due to a fall in the value of the underlying markets, the data provider said. Meanwhile, bond ETFs attracted some of the biggest inflows of €5.2bn (£4.5bn). “Given the general market environment with rising interest rates, it was somewhat surprising that bond ETFs enjoyed inflows for the month,” noted Lipper’s monthly ETF fund flow report. Globally, investor appetite for bond ETFs has increased, according to the September Asset Allocation survey by Bank of America Merryl Lynch. It remains to be seen whether this trend will also be reflected among UK institutional investors.
Appetite for liquidity
One potential explanation could be growing investor appetite for liquidity in increasingly volatile markets. But this raises the question how reliable open-ended funds like ETFs are when it comes to facilitating the ease of buying and selling assets. Systemic risks from open-ended funds, including ETFs were a key focus of the IMF’s latest financial stability report. Open-ended funds now hold $41trn (£36trn) in assets, with
6 | portfolio institutional | November 2022 | Issue 118
ETFs accounting for more than a quarter of that, according to the IMF. “Open-ended funds holding illiquid assets can worsen fragility in asset markets through the liquidity mismatch between their asset holdings and liabilities,” the report said. “In the face of adverse shocks, open-ended funds that offer daily redemptions to investors but hold relatively less liquid assets are vulnerable to the risk of investor runs (or large outflows) that could force these funds to sell assets to meet redemptions. The sale of assets could in turn generate downward pressure on asset prices that may amplify the initial effects of the shocks by inducing additional redemptions.”
When comparing asset price fragility of open ended funds in general to that of ETFS in particular, the IMF concluded that other open ended funds showed higher levels of asset price fra- gility than ETFs. This is because investors are generally not able to redeem shares at net asset value. Instead, they are traded on secondary markets at varying prices. But the IMF also showed that ETF discounts tend to increase when market liquidity deteriorates as they continue to be traded. However, advocates of ETFs as providers of market liquidity would point out that the open-ended nature of those funds allows them to issue an unlimited number of shares to be traded in the secondary market, even if the primary market dries up. A case in point is Russia’s stock exchange, where pri- mary markets closed at the start of the invasion of Ukraine, but investors continued to trade in secondary markets. But in practice, this endless supply of liquidity is still depend- ent on authorised participants stepping in and creating those shares. So far, they appear to have done so, even in extreme events of market volatility, such as the crisis in gilt markets seen in Sep- tember. The test will now be whether they will also stand the test of monetary tightening, a concern which is now high on the IMF’s agenda.
Fund flows for Gilt ETFs (GBP) 96.54
100 80 60 40 20 0
-20 69.82 56.42 47.28
17.93 8.73 -2.56
31/08 2022
07/09 2022
14/09 2022
21/09 2022
1.61
28/09 2022
05/10 2022
12/10 2022
Source: Lipper 19/10
2022
Page 1 |
Page 2 |
Page 3 |
Page 4 |
Page 5 |
Page 6 |
Page 7 |
Page 8 |
Page 9 |
Page 10 |
Page 11 |
Page 12 |
Page 13 |
Page 14 |
Page 15 |
Page 16 |
Page 17 |
Page 18 |
Page 19 |
Page 20 |
Page 21 |
Page 22 |
Page 23 |
Page 24 |
Page 25 |
Page 26 |
Page 27 |
Page 28 |
Page 29 |
Page 30 |
Page 31 |
Page 32 |
Page 33 |
Page 34 |
Page 35 |
Page 36 |
Page 37 |
Page 38 |
Page 39 |
Page 40 |
Page 41 |
Page 42 |
Page 43 |
Page 44 |
Page 45 |
Page 46 |
Page 47 |
Page 48 |
Page 49 |
Page 50 |
Page 51 |
Page 52 |
Page 53 |
Page 54 |
Page 55 |
Page 56
