ETFs prove resilient under increased volatility from day trading community

Ben Slavin, BNY Mellon

The extraordinary trading scenarios from last week and this, which saw stocks such as the US’s GameStop, AMC and the physical asset, silver, caught in the cross hairs of the Reddit trading community and experience extreme volatility, has had an effect on ETFs.

Ben Slavin (pictured), Global Head of ETFs, Asset Servicing, BNY Mellon, comments that there is a lot to unpack in a story that keeps evolving.

“In all those cases we have seen impacts on ETFs,” he says. “From an ETF perspective it has been quite remarkable, but the macro headline is that in the markets where we have seen this volatility, ETFs have once again proved to be resilient including the ETFs who hold these stocks or the ETCs that hold silver.”

Throughout the period of volatility in these assets, Slavin reports that ETFs and ETCs holding the underlying targeted assets have functioned without incident. More than that, ETFs holding GameStop et al have effectively functioned as a source of supply on the underlying securities themselves. XRT, the S&P Retail ETF which has the largest position in GameStop, saw a significant redemption in the ETF, which was because dealers needed to get hold of GameStop shares in order to settle the accounts.

“It seems counter intuitive but shows the increasingly important role that ETFs play in the capital markets,” Slavin says. “Money came out of XRT and is now coming back in and the price has stayed in line and the long only shareholders have seen no adverse outcomes on the shareholder activity.

“It’s pretty amazing and also worth noting that short interest has built in some of these names on the ETF side, effectively providing a way to express the view either on GameStop or silver, to hedge or to take a directional bet,” Slavin says. “There has been quite a bit of increase in activity around the shorts so that is another piece or dimension to the story.”

In terms of shorting ETFs, Slavin feels that the ETF industry has done a good job, as ETFs have grown, to increase the education to individual investors.

“Short selling ETFs is simple,” he says. “The ETF takes on the same characteristics as a stock so if you can short a stock, you are able to take that view in ETFs.”

Some of the ‘shorting’ of ETFs is also conducted through the options market with options on ETFs having grown significantly in popularity over last few years, as retail traders can use the options markets to effectively express a view.

“It really has no direct impact on the underlying shareholder of the ETF,” Slavin says. “Those who borrow shares to express a short position have no impact on the underlying. In many ways the ability to short provides a tool for them to provide that liquidity and keep the price in line.”

Slavin also explains that from a fund issuer standpoint, as shares are shorted, it can have the net effect of boosting the assets under management of the ETF, as the ETF has to be able to create shares in order to let them out.

The ETF that is being shorted is priced as a function of the underlying and there has been no illustration where shorting has been seen to create any downstream effects on the shareholders.

GameStop was a relatively small weight within the ETFs that held it because its market cap, before all the excitement, was relatively small.

“When the price exploded, it became a large weight in those ETFs which had a direct impact on the performance,” Slavin explains. “As that weight scaled up inside the ETFs, obviously the performance followed along with it so, on the performance side, it impacted the investor who was long the ETF, with a big impact.”

The weight of investment in the ETFs increased the volatility in the short term.

“In these cases, the many ETFs which held these names are of the passive variety,” Slavin says. “So, the fund manager’s hands are tied because they are going to hold the index constituent and track the underlying constituents and they have to wait it out.”

It has been widely reported that silver is being targeted by the Reddit investment crew, but this is a different story as silver is much larger than GameStop, and fund managers as a whole are net long the metal, not necessarily short.

There have been attempts to dominate the silver market in the past, most notably with the Hunt brothers in 1980.

“This is a very different scenario but on the back of this story we have seen significant flow and trading volume in silver ETPs in the US and an uptick in the volatility of silver prices that have come along with that flow,” Slavin says.

“Operationally the funds have again performed without incidents so ETFs are a toolkit for expressing views.”

The benefit of ETFs is their transparency, Slavin says. “In this particular case, any investor can look up day to day to see if their fund holds any of the targets. You do not have that level of transparency in a mutual fund – they are on a lag. This is one of the major benefits of investing in ETFs and one of the attributes that have made ETFs so popular. That information to understand your risk as an investor is absolutely critical.”

Looking more generally, Slavin comments that the market in 2021 has picked up exactly where 2020 left off, with record inflows over January 2021, and a record number of product launches.

Slavin has observed an increase in interest in emerging market ETFs, a sector that has been sidelined a little over recent years. The driver for that, he believes, is twofold. “Investors view on the US dollar and also investors looking at relative valuations in emerging markets against the developed world and specifically the US.”

Slavin sees increased flows into ESG products over 2021 and that active will continue to gain momentum.

“2020 was the breakout year for active, specifically ARK ETFs with their phenomenal growth which continued into January, but also there have been a significant amount of product launches in the market for various flavours of actively managed ETFs,” he says.

He also believes that the trend for mutual funds to convert to ETFs will continue, probably into the second half of this coming year.

“The industry is watching very closely to see how it will work and to see what the road map looks like to make the transition from mutual fund to ETF, and managers are trying to understand what they need to do with their distribution model to support the ETF,” he says.

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