The exchange-traded fund (ETF) ‘flash crash’ observed in the US last month should be the catalyst for changes to how the products are traded, industry commentators have suggested.
During the market drawdown on August 24, some US-listed ETFs saw falls well in excess of those suffered by the indices they were tracking.
On a day when the S&P 500 opened down 4 per cent, one in four ETFs tracking the index fell more than 20 per cent, with some dropping more than twice that amount – leading to significant losses for investors who had put in orders to sell their positions.
Ben Johnson, director of passive fund research at Morningstar, said holders of ETFs should avoid buying or selling the products at either the start or end of the day.
“It takes a while for them to ‘wake up’ in the morning. What I’ve advised in the past is not to trade ETFs in the first 30 minutes after markets open and avoid the last 30 minutes before markets close.”
An ETF’s ability to provide an intraday price has previously been touted as an advantage for the product over a tracker or an active fund, which price just once per day.
On August 24, US stocks repeatedly hit trading limits, in which prices moved so dramatically over such short periods that trading in many stocks was halted.
ETF providers say these limits prevented market participants from being able to price ETFs based on their underlying holdings, leading to the drastic divergence between the products and the S&P 500.
Morningstar’s Mr Johnson added the difficulty was due to blue-chip equities trading at “borderline insane prices”. Because some ETFs represented “a basket of these shares”, he added, they faced a challenge in attempting to weigh the “severe disconnect” between individual share prices and the index’s movements.
Calls for ETFs to be classified differently to conventional securities have now intensified.
Ben Seager-Scott (pictured), director of investment strategy at Tilney Bestinvest, said: “The regulations make sense for individual equities because they are in finite supply, but because ETFs are a collection of indices and [are] open ended, the rules should be slightly different.”
Mr Seager-Scott added that the ETFs’ slump may have provided a truer reflection of market activity.
He said: “You have to ask yourself whether it is the ETF that is trading outside the line or the underlying index. Is the ETF actually a better indicator for what’s happening in the market?”
