Ever since the so-called mini flash crash, observers have been wary of any potential fallout in the exchange traded fund space during severe market volatility. However, as witnessed in the recent Brexit-induced selling, the ETF industry quickly adjusted to the changing prices.
According to the Investment Company Institute, after an initial divergence in ETFs’ share price and those of their underlying assets in response to the United Kingdom’s surprise vote to exit the European Union, U.S. stock and bond ETFs returned to more normal pricing to their net asset value, reports Daisey Maxey for the Wall Street Journal.[related_stories]
Specifically, ICI found that arbitrage activity – the mechanism by which market makers create and redeem ETF shares to take advantage of price changes between the ETFs and underlying assets – worked as intended in the hours after the vote. When a price disparity manifested, arbitragers were able to bring the price of ETFs back to or near the net asset value of underlying holdings.
“What it shows is that for U.S. ETFs on that day, the arbitrage mechanism was able to function very smoothly and efficiently,” Shelly Antoniewicz, the ICI’s senior economist, told the Wall Street Journal. “You had a little bit of initial selling pressure, but quickly, the arbitrage function got right to work and that gap closed up really rapidly.”