“Providers are concerned because it’s our job, but I don’t think investors should be worried,” said Scott Ebner, head of ETF product development at State Street, in the report. “The competitive process is what drives efficiency in the market, not a single participant.”
Five lessons for investors
Whatever ends up happening to Knight, there are several key takeaways for financial advisors and investors in the wake of the fiasco:
1. When trading in a group of stocks goes haywire like what happened after the Knight glitch, you can bet that ETFs will be affected. Equity ETFs are comprised of baskets of stocks. When there are problems in individual stocks, it can spill over and impact the ETF. This also happened in the 2010 flash crash. However, it’s important to remember that in both cases, ETFs were a victim of the trouble rather than a cause.
2. Liquidity providers and authorized participants are extremely important to the ETF business. If a firm gets in trouble, ETFs in which it makes markets can be affected. Know who the authorized participants in your ETFs are.
3. Keep a close eye on spreads in ETFs. Of course, spreads are more of an issue for traders who are frequently buying and selling ETFs, rather than buy-and-hold investors. Traditional mutual funds are priced once a day at the close, so fund investors don’t have to worry about spreads.
4. Setting limit orders is more important than ever to protect yourself when spreads widen. Never use market orders. [What You Need to Know About ETF Trading and Orders]
5. The Knight situation will lead to more competition among ETF market makers, which could be a good thing for investors from a long-term perspective. Knight may be able to claw its way back and survive the storm. However, other third-party ETF liquidity providers will probably be working harder to capitalize on the disruption.