Financial Stability Board: Stale NAVs incentivise increased selling

During the March volatility, NAVs were in catch-up mode versus the bond ETFs which were offering real-time prices.

Tom Eckett

a large wave in the ocean

The Financial Stability Board (FSB) has warned mutual funds could incentivise increased selling pressure during periods of vanishing liquidity due to the net asset values (NAVs) not reflecting the true value of the underlying assets.

In a report, entitled Holistic Review of the March Market Turmoil, the FSB said investors would want to redeem during periods of rapidly vanishing liquidity if they anticipate the price of the fund is yet to be marked down to its true value.

“Investors in other open-ended funds may have faced incentives to redeem ahead of others,” the report said. “This is because investors in mutual funds could have redeemed their units at the old (stale) NAV, while the actual value of the underlying assets was more accurately reflected in ETF prices.”

This is in contrast to fixed income ETFs, the report said, which were incorporating real-time information about where the underlying bonds were actually trading versus the stale NAVs.

Driving price discovery was the increased in ETF trading volumes. For example, the iShares $ Corp Bond UCITS ETF (LQDE) traded 1,000 times on 12 March versus the underlying securities which changed hands 37 times.

“ETFs, which offer immediate liquidity because of their trading on secondary markets, became one of the key mechanisms for price discovery during the dash for cash,” the FSB continued.

“This suggests that ETF prices…reflect more accurately the liquidity and cost of selling those assets.”

What happens when the lights go out? An analysis of ETFs when liquidity vanishes

The FSB is the latest industry body to weigh in on the way ETFs traded during the March volatility.

The European Systemic Risk Board (ESRB), the Investment Association (IA) and the Bank for International Settlements have all released white papers highlighting the benefits of ETFs during periods of market stress.

The role of the secondary market in providing a buffer of liquidity to ETFs compared to other vehicles such as mutual funds was a key focus.

As the IA said in a note last week: “Throughout the crisis, market makers and APs were quoting bid prices for ETFs intraday based on the ‘real’ price at which the underlying bonds could be bought and sold. In other words, the arbitrage mechanism was working all along exactly as it should have been.”

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