News the UK’s most well known fund manager Neil Woodford extended the suspension on his Equity Income fund indefinitely this week has led to further questions on the issue of liquidity.
As Jason Xavier, head of EMEA ETF capital markets at Franklin Templeton, says, ETFs are inevitably going to find themselves in the “crosshairs” of this topic, given the consistent shots fired at the vehicle since exploding onto the market following the Global Financial Crisis.
Xavier’s main point is the ETF structure provides investors with extra layers of liquidity versus a traditional mutual fund as it trades in both the primary and secondary markets.
Naturally, ETFs, like any other vehicle, are subject to market risks during times of stress, he is quick to point out.
However, the key difference from the mutual fund structure is if investors can find no willing buyers in the primary market then they have the option to sell to an authorised participant.
“When there are more existing shareholders looking to sell than there are new investors looking to buy, market participants known as authorised participants and/or market makers would step in as buyers,” Xavier explains.
“The price at which those market participants would purchase the ETF would be driven by the price at which they could sell the underlying basket of securities, since they would most likely need to redeem shares. This dynamic only gets exacerbated when there is extreme selling pressure.”
Much has been made of the “structural weakness” of mutual funds since Woodford’s fund suspended trading in June.
Fitch at the time said open-ended funds with exposure to less-liquid assets have a liquidity mismatch given the daily liquidity they offer to investors.
“[Mutual funds] may, therefore, face liquidity pressure if there is a spike in redemptions, potentially leading them to block withdrawals so that they do not become forced sellers of illiquid assets, and to prevent a run on the fund.”
Xavier adds: “The argument goes that because ETFs offer investors a convenient, transparent way to enter or exit the market, they could create a vicious circle if a lot of investors decided to exit the market at the same time.
“But I have some news for you. Market dislocations still occurred well before ETFs arrived on the scene. For example, there were no ETFs in the Wall Street Crash of 1929, no ETFs on Black Monday in 1987 and a limited number of ETFs during the Global Financial Crisis of 2008-2009.
“ETFs have changed the investing landscape by democratising almost all aspects of the investment process, including access to asset classes, price discovery, trading and market timing and even volatility itself.”