During a period of heightened volatility, SPDR ETFs served as an effective price discovery tool that enabled investors to assess the valuation and liquidity of the overall market.
Along with elevated trading volumes, bid-ask spreads increased globally across all asset classes and financial instruments amid challenging market conditions and liquidity constraints. ETFs around the globe experienced an increase in bid-ask spreads during March 2020 before reverting back toward their previous levels in April and May 2020.
In the US, increased volatility and liquidity constraints across underlying securities led to a temporary deterioration of traditional market quality metrics in ETFs.
Bid-ask spreads in ETFs widened, reflecting increased market risk and wider bid-ask spreads in underlying instruments.
For example, average spreads of constituents in the S&P 500 Index increased from 0.05% in January 2020 to 0.19% in March 2020. During that same time period, average spreads of U.S. Equity SPDR ETFs widened from 0.10% in January 2020 to 0.28%, reflecting the increased cost for market makers to transact in the underlying market. In some instances, ETF spreads traded within or less than those of their underlying constituents due to the following:
In addition to wider spreads experienced during the COVID-19 volatility, ETFs also traded at wider-than-normal premiums and discounts to Net Asset Value (NAV). Figure 3 indicates that during 2019, on average, U.S. Equity ETFs traded within a 1% premium or discount to their NAVs. However, in March 2020, ETFs experienced larger dislocations, which we can likely attribute to greater liquidity and market risk. That said, we believe the dislocations seen in U.S. Equity ETFs were further impacted by the following factors:
Even more so, turmoil in fixed income markets led to significant dislocations between ETFs and their respective NAVs, resulting in larger-than-usual premiums/discounts.
These dislocations may have been attributed to the following factors:
While some may question the performance of Fixed Income ETFs during March, we believe the discounts accurately reflected real-time market sentiment and liquidity of their underlying fixed income securities. Bond prices lagged real-time market sentiment and realistic trading levels. The surge in Fixed Income ETF trading volumes in March 2020 suggests that market participants gravitated toward ETFs as liquidity vehicles when individual bond liquidity became difficult. It is illustrated in Figure 5 — trading volumes of investment-grade and high yield corporate bond ETFs increased substantially as a percentage of cash bond trading during March 2020.
In recent years, institutional investors have more widely adopted the use of ETFs as assets and liquidity have grown leading investors to more often compare structure, cost, and efficiency between ETFs and other investment vehicles.
A common comparison amongst certain institutional investors is ETFs vs futures. This relationship came to the forefront during several days in March, when futures and ETFs that track the spot price of gold diverged.
On March 23, 2020, three major Swiss gold refineries in the world announced that they were suspending production entirely for at least a week due to the outbreak of COVID-19. With flights grounded and gold refineries closing, traders became concerned that it would become challenging to meet futures contract settlement obligations if they were unable to move 100-oz COMEX bars from Europe to New York.
As a result of supply chain concerns, on March 24, 2020, with the demand for gold still apparent due to the COVID-19 crisis, gold futures in New York and gold spot prices in London diverged significantly. The gold futures premium extended over several weeks in March and April 2020.
Figure 6 indicates that this premium rippled through the gold ETF market, with the largest gold ETF listed in the US trading at a premium on March 24, 2020. However, this ETF resumed trading closer to its fair value after only one day, on March 25, 2020. This is because this particular ETF tracks the gold spot market, which operates primarily out of the London gold market hub and continued without any reported issues.
The structure of this ETF played an important differentiating factor for investors seeking to track the gold spot price during this period of market stress.
In summary, despite some of the aforementioned market quality and price dislocations during the COVID-19 pandemic, ETFs have provided investors with liquidity when they needed it most. Read more about the road ahead.
1In some instances, ETF trading is not centralized. For example, in Europe, a majority of the ETF trading activity happens outside of stock exchanges.
Measures the volatility of a security or portfolio in relation to the market, with the broad market usually measured by the S&P 500 Index. A beta of 1 indicates the security will move with the market. A beta of 1.3 means the security is expected to be 30% more volatile than the market, while a beta of 0.8 means the security is expected to be 20% less volatile than the market.
The process by which ETF shares are created and redeemed. The creation process involves authorized participants (APs) buying underlying shares and delivering those shares to the fund sponsor in exchange for equally valued ETF shares. The redemption process is the reverse, wherein the AP removes ETF shares from the market and exchanges those ETF shares with the ETF sponsor for an equally valued amount of the ETF’s underlying shares.
Equitizing cash is putting cash or equivalent assets to work in the stock market, often temporarily, with relatively liquid vehicles, including ETFs.
A term that describes the extent to which investors have easy access to objective financial information about companies or funds such as ETFs. Those data include price movements, market depth and audited financial reports.
Investing involves risk including the risk of loss of principal.
State Street Global Advisors and its affiliates (“SSGA”) have not taken into consideration the circumstances of any particular investor in producing this material and are not making an investment recommendation or acting in fiduciary capacity in connection with the provision of the information contained herein.
The views expressed in this material are the views of SPDR Americas Research and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
ETFs trade like stocks, are subject to investment risk and will fluctuate in market value. The investment return and principal value of an investment will fluctuate in value, so that when shares are sold or redeemed, they may be worth more or less than when they were purchased. Although shares may be bought or sold on an exchange through any brokerage account, shares are not individually redeemable from the fund. Investors may acquire shares and tender them for redemption through the fund in large aggregations known as “creation units.” Brokerage commissions may apply and would reduce returns. Please see the fund’s prospectus for more details.
Performance of an index is not illustrative of any particular investment. It is not possible to invest directly in an index.
Bonds generally present less short-term risk and volatility than stocks, but contain interest rate risk (as interest rates raise, bond prices usually fall); issuer default risk; issuer credit risk; liquidity risk; and inflation risk. These effects are usually pronounced for longer-term securities. Any fixed income security sold or redeemed prior to maturity may be subject to a substantial gain or loss.
Equity securities may fluctuate in value in response to the activities of individual companies and general market and economic conditions.
While the shares of ETFs are tradable on secondary markets, they may not readily trade in all market conditions and may trade at significant discounts in periods of market stress. Diversification does not eliminate the chance of experiencing investment losses.