ETFs March On

ETFs March On

over 3 years ago2 mins

Mentioned in story

Some investors fretted that coronavirus would expose the weaknesses of exchange-traded funds (ETFs). But while a few were indeed left high and dry, the investments’ overall attraction may only have grown stronger… 😏

What does this mean?

A year back, the hedge fund manager immortalized in The Big Short warned that the fast-growing penchant for “passive” investing exemplified by ETFs risked distorting prices and creating a new bubble in financial markets.

And the volatility induced by the coronacrisis in March initially looked like delivering on those dire predictions. The prices of many large bond ETFs in particular began diverging from the value of the debt they owned, prompting fears people would lose faith in the ETFs’ ability to accurately track their underlying investments 😰

But it seems the funds’ liquidity was actually making them a better and more responsive reflection of changing bond values than the bonds themselves. Some specialist ETFs with suspect methodologies did fall apart; dozens of “leveraged” funds magnifying price falls and gains closed in the wake of market turbulence, while the United States Oil Fund changed its tracking approach after accidentally helping turn oil prices negative.

But ETFs in general have not only survived but have thrived: while “actively managed” funds have lost more investor money than they’ve gained in 2020, ETFs have simultaneously taken in tens of billions overall.

Fund flow comparison in 2020 (with apologies for scrambled x-axis)
Fund flow comparison in 2020 (with apologies for scrambled x-axis)

Why should I care?

ETFs’ robustness means they’re likely to get ever more widespread, even if sceptics claim the bond funds were only saved by the timely intervention of the US Federal Reserve. Over $1 trillion is currently held in bond ETFs alone – and according to investment manager and largest ETF provider BlackRock, a third of second-quarter inflows into such funds came from first-time buyers.

As readers of our Corporate Bonds Pack will know, investing in debt via ETFs brings both positives and negatives. One clear advantage over, say, buying into an active bond fund is price – and when it comes to ETFs in general, investors seem keenest on the cheapest.

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Still, cheaper doesn’t always mean better. Actively managed but nevertheless exchange-traded funds aim to deliver investors better returns than simple index-tracking even after higher fees; in the first five months of 2020, more such active ETFs were launched in the US than passive ones. And yet another approach aims to make such selectivity automated. To learn more about what might work best for you, check out our Pack on ETFs And Smart Beta… 😉

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