Mutual funds are at greater risk than ETFs of being at the heart of a liquidity crisis in the next downturn, according to Hector McNeil, co-Founder and co-CEO of HANetf, Europe’s first independent white-label ETF platform.
Mutual funds are at greater risk of a liquidity squeeze than ETFs, says HANetf.
McNeil notes that the vulnerability of mutual funds stems from their “archaic structures and unclear pricing”.
While much has been made of the supposed risks in ETFs, particularly suggestions that they could exacerbate a market sell-off, HANetf believes the real danger for investors will be in mutual funds where products can be gated in the event of a serious downturn.
McNeil said, “One only has to look back to events so far this year, or when there was a run on property funds in 2008, to see where the heart of any crisis could manifest itself.
“There is the common excuse that people will sell ETFs rather than mutual funds because it is easier to do so, but the reality is that there are a number of technical trading mechanisms for ETFs which reduce, rather than exacerbate, potential liquidity issues.”
McNeil highlights the ability of an ETF’s authorized participants (typically big banks or professional brokerages) to create and redeem shares as and when needed. Authorized participants can also aggregate buys and sells throughout the day for an ETF, reducing the friction (and downside impact) to the existing shareholders, unlike a mutual fund which cannot do so.
HANetf’s comments reflect those issued last week by EFAMA (The European Fund and Asset Management Association) which labelled concerns voiced by the European Central Bank’s semi-annual Financial Stability Review last year relating to potential liquidity risks in ETFs as ‘misplaced’.
EFAMA pointed to evidence which confirmed that, for both equity and fixed income ETFs, trading in the secondary market has historically “cushioned” the impact of sudden market shocks without affecting investors’ ability to redeem shares.
Investors should note that an ETF’s liquidity is impacted by the liquidity of its underlying assets (although almost all index-tracking ETFs benefit from a liquidity screen in the index methodology which serves to avoid highly illiquid assets).
However, HANetf notes that the ETF structure provides buyers and sellers with an accurate picture of the available liquidity in an ETF every day, unlike a mutual fund where this is another unknown on top of whatever issues there may be at an asset class level.
Working alongside issuers such as Invesco, iShares, SPDR, Lyxor and DWS, Bloomberg has been at the vanguard of recent efforts to improve investors’ understanding of true ETF liquidity. As well as printing a ‘consolidated tape’ of aggregate ETF trading data, the financial data giant offers an ‘implied liquidity’ tool that measures the liquidity of an ETF’s underlying constituents to determine the implied liquidity of the ETF itself.
According to McNeil, “The Bloomberg implied liquidity function for ETFs is incredibly useful and goes a long way to tackling fears over ETFs ceasing up in times of stress.
“This is in stark contrast to mutual funds, and the question investors should be asking more and more is why they continue to buy and sell a product without knowing the real price they pay for it. Indeed, the mutual fund market is one of the few things in existence where you buy or sell something without knowing the price you will be paying or the money you will be receiving back and you have to sell it back to the person you bought it from.”