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Dispelling Misconceptions On ETFs’ Place In The Market

By Max Chen and Tom Lydon As the exchange traded fund industry grows in size and accumulates over trillions of dollars in assets under management, some are concerned that the investment vehicle is beginning to sway markets or won’t hold up in times of severe stress, according to industry analyst ETF Trends . However, Joel Dickson, Head of Investment R&D at Vanguard Group, argued on the Financial Times that ETFs do not contribute to market volatility and will hold up in times of market stress, despite some concerns about the investment vehicle. First off, Dickson points out that the global ETF industry represents about $3 trillion in assets, compared to the $300 trillion in financial assets over all. Given the relatively small size compared to the rest of the financial market, Dickson argues that there would have to be something we aren’t seeing in ETFs for them to sway market volatility. ETFs, like stocks, trade on a stock exchange through a broker. This secondary market is responsible for most of the trading volume in ETFs. Dickson points out that in the U.S. daily data shows that the median ratio of ETF trading volume that took place on the secondary market was about 94% for equity and 83% for bonds. “The net result is that most ETF shares are traded between investors and do not result in any activity in the ETF portfolio,” Dickson said. “Based on this data it’s hard to argue that ETFs are a cause of market volatility. Niche products might have an impact in low-volume asset classes. But for the overall equity and bond markets, the answer has to be no.” Credit Suisses’s Victor Lin mirrored Dickson’s sentiments. In his research, Lin found that data shows ETF activity only drives a small percentage of volume for most stocks, reports Teresa Rivas for Barron’s . “Sampling data between January 2015 to January 2016, we found that increases in ETF flow driven trading (averaged over a month) for a stock did not consistently result in an increase in realized volatility for that stock (adjusted for market-wide changes in volatility) over a one-month timeframe,” Lin said in a note. With regard to ETFs struggling in times of market stress, which many pointed to during the events on August 24 last year, Dickson contended that the situation occurred due to structural problems of the exchanges rather than problems with the ETF wrapper. “Because ETFs are listed on an exchange, they are subject to the same demand/supply forces and circuit-breaker rules as ordinary equities,” Dickson said. “This is what happened on August 24: the spread between the bid and offer prices of listed stocks and ETFs widened and some were temporarily halted.” Since the structural problems were revealed in late August, many ETF providers have been in discussion with regulators and exchanges on ways to improve the market structure. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

The Best And Worst Of February: Nontraditional Bond Funds

Nontraditional bond funds lost an average of 0.47% in February, bringing the category’s one-year returns through the end of the month to -4.06% versus 1.50% for the Barclays U.S. Aggregate Bond Index. As a result, investors pulled a total of $21.7 billion out of the category for the year ending February 29, bringing total category assets down to $125 billion. Despite this, there have been some stellar performers in the category: Six funds generated one-year returns in excess of +2%, but this represented just a small fraction of the 129 funds in the category with track records of at least a year. Meanwhile, 84 funds in the category suffered one-year losses of at least 2%, with 13 of those posting double-digit losses. Best Performers in February The three best-performing nontraditional bond funds in February were: The BTS Tactical Fixed Income Fund was the only mutual fund in February’s top three, edging out a pair of ETFs to rank as the month’s top performer. BTFAX returned +3.30% in the shortest month of the year, bringing its one-year returns to +1.37% for the year ending February 29. This was good enough for it to rank in the top 6% of its category, which may be why the fund received more than $84.7 million in inflows for the year. The fund’s one-year beta of 1.49 is high, but with its bullish returns, investors don’t seem to mind. ETFs from ProShares and Deutsche X-trackers took the second and third spots for February, returning +1.89% and +1.51%, respectively. Only the former has been around long enough to have a one-year track record, and it returned +0.86% for the year ending February 29, ranking in the top 1% of all nontraditional bond ETFs. It suffered $3.95 million in net outflows for the year, though, compared to the Deutsche fund, which received $6.25 million in inflows. Worst Performers in February The three worst-performing nontraditional bond funds in February were: Highland’s Opportunistic Credit Fund was February’s worst-performing nontraditional bond fund, and it was very near the bottom of the category for its one-year returns. HNRZX lost 4.86% in February, bringing its one-year losses through February 29 to a painful 32.16%. The fund’s beta of -1.02 indicates nearly perfect inverse correlation to the Barclays US Aggregate Bond Index, but its -36.09% one-year alpha better explains its woeful returns. Over the three-year period, the fund lost an annualized 7.70%, ranking at the very bottom of the category. Thus, it’s more than a little surprising that it enjoyed more than $5.9 million in inflows for the one-year period ending February 29. PIMCO’s Capital Securities and Financials Fund only launched on April 13, 2015. It lost 3.83% for the month. Coming in as the third-worst performing nontraditional bond fund is the Putnam Premier Income Fund, which returned -3.68%. Its one-year return through February 29 stood at -10.04%. Past performance does not necessarily predict future results. Jason Seagraves contributed to this article. Note: MPT statistics (alpha and beta) are calculated relative to the Barclays U.S. Aggregate Bond Index.