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SPDR ETFs: Liquidity Buffers in Volatile Markets

In 1993, State Street Global Advisors launched the first US-listed exchange traded fund (ETF) to help stabilize markets and improve liquidity during periods of market turbulence. During recent market volatility, ETF trading volume surged relative to overall market volumes, highlighting that ETFs continue to function as intended — as buffers and sources of liquidity in stressed markets.


ETFs: Born in crisis and serving their purpose through crises

In order to understand and evaluate the performance of ETFs during the COVID-19 crisis, it is worth taking a moment to remind ourselves of why and how ETFs first came into being.

ETFs were created as a response to the US stock market crash on October 19, 1987, commonly referred to as “Black Monday.” The US Securities and Exchange Commission’s (SEC’s) Division of Market Regulation, in its post-mortem report analyzing the market events of October 19, 1987, found that the systematic selling of stock-index futures by institutional investors had exacerbated the market selloff, and suggested examining whether market basket trading could help stabilize markets in the future. Specifically, the report suggested that consolidating stock basket trading to a single post “could provide an additional layer of liquidity to the system and cushion somewhat the individual stocks from the intraday volatility caused by program activity.”1 In collaboration with State Street Global Advisors, the American Stock Exchange harnessed this idea, which culminated in the launch of the first US-listed ETF in 1993.

More than 27 years later, ETFs have grown into a multitrillion dollar industry, with assets under management (AUM) more than $5.8 trillion as of May 2020.2 More than 7,000 ETFs — utilized by retail investors, institutional investors, asset managers, insurance companies, sovereign wealth funds, and private banks — now trade across many exchanges around the globe. Today, investors use ETFs for a variety of purposes including strategic or tactical asset allocation, cash equitization, transition management, and portfolio hedging, to name just a few. One of the most valuable characteristics of the ETF wrapper is its ability to provide transparent exposure and liquidity to the marketplace throughout the trading day.

The market volatility during the COVID-19 crisis tested, yet again, the efficiency of the ETF wrapper and its additive liquidity to the marketplace. In the US, on March 12 and 16, 2020, two of the worst days for the S&P 500® Index since 1987, SPDR ETFs traded more than $100 billion, accounting for more than 16% of US equity market trading volume, demonstrating their utility during a period of extraordinary market volatility.

Record ETF trading volumes

Globally, ETFs reached record trading volumes in March 2020. As illustrated in Figure 2, ETF trading volumes were heavily skewed toward US-listed ETFs, whose volumes reached record highs. US-listed ETFs traded more than $5.3 trillion in March 2020, well above the previous monthly record of $3.0 trillion set during the stock market selloff in October 2018. In addition, US-listed ETFs traded another $3.0 trillion in April 2020 and $2.4 trillion in May 2020. EMEA4,6-listed ETFs and APAC5-listed ETFs also experienced a surge in trading volumes in March 2020.

Important to note, ETF trading volumes represented more than 39% of US equity market volume in March 2020. In comparison, in 2019, ETFs represented 30% of trading volume, suggesting an increase in ETF usage as clients gravitated towards ETFs for exposure, liquidity, and potentially even price discovery during a period of extraordinary market stress. This increase in ETF usage was not limited to the US, with EMEA4,6 and APAC5 regions both seeing an increase in ETF volumes relative to common equities.

Correlation between ETF trading volumes and volatility

During the extreme market volatility in March and April 2020, investors turned to ETFs as efficient tools to express market views and implement trading strategies. Unsurprisingly, ETF trading volumes in the US were highly correlated with the heightened volatility.

This underscores the additive liquidity provided by ETFs during periods of market stress, leading to a significant increase in ETF trading volume across several market segments. The SPDR ETF suite traded, on average, more than $109 billion on days when the CBOE Volatility Index exceeded 60, a level not seen since the Great Financial Crisis of 2008–2009.

ETFs act as liquidity buffers

Although ETFs recorded record-high trading volumes in March 2020, only a portion of secondary market volumes resulted in primary market activity. For example, Figure 5 and 6 indicate that:

  • Gross primary market flows on these ETFs represented less than 7% of the trading volume of common stocks in the US on every US trading day in the first five months of 2020 
  • US-listed U.S. Equity ETF trading volumes represented, at times, more than 50% of the trading volume of common stocks in the US

Overall, the data suggests that ETFs trading volumes resulted in very little primary market activity. The secondary market provided market participants with an additive layer of liquidity, potentially resulting in less stress on individual securities.

It’s also important to take a look at fund flows during the market selloff in March 2020. As you can see in Charts 7 and 8, ETFs flows paled in comparison to those of Mutual Funds in the US, likely resulting in far less trading in the underlying securities.

Especially in volatile markets, SPDR ETFs have served as effective price discovery tools. Learn more about using ETFs to assess the valuation and liquidity of the overall market.

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