ETFs get a bad rep from some.
Financial commentators blame them for crises and treat them like rejects when really that are saviors.
Today we touch on the argument that asset classes such as emerging markets, which typically have a liquidity fear hanging over them in crises, will see exacerbated downside in the next crisis because of the presence of ETFs in the system.
Always Remember: ETFs Saved Hides as Lehman Buckled
We often say that attacking ETFs for causing crises is like saying that online travel websites are the cause of hotel and airplane bookings. The argument that ETFs exacerbate crises is particularly preposterous because it comes after one of the few corners of the market in which many people seek out and find liquidity during panics, then spins the story around into one in which the very presence of the investment vehicle (like a junk bond ETF, etc.) somehow exacerbates illiquidity.
When making their argument, attackers usually focus on riskier assets classes, including just about everything in the emerging world, plus any kind of credit that is below investment grade, but we have seen the argument applied to all marketable securities.
As we look back at the global financial crisis and forward to inevitable future crises, we need to remember that every transaction has a seller and a buyer. In a crisis, ETFs can foster price discovery at the broad market level and allow bottom-up investors to have a point of reference for when they engage in classic individual security analysis. ETFs can provide the gift of reliable price transparency1 because of their intraday trading. They offer a real-time window into the true degree of panic or euphoria that may be occurring as a crisis unfolds.
DEM During Lehman’s Collapse
Perhaps the experience of the WisdomTree Emerging Markets High Dividend Fund (DEM) during the global financial crisis can provide a glimpse into what an ETF investor in a volatile asset class would have confronted during those dark days.
The intraday trading action in DEM on September 15, 2008, the day Lehman Brothers went bankrupt, is shown in figure 1. Optically, it appears that the largest drop-off in price from one trade to the next occurred between 11:42 a.m. and 11:47 a.m., in a move that took DEM from $44.6599 to $44.36.
However, it is tough to see with the naked eye, but there actually were two other trades in that window, one that also came at 11:42 a.m. and another at 11:46 a.m. Investors who were using limit orders and were looking for trade execution were finding a market for their trades with frequency throughout the trading session. Keep in mind too that this was occurring in an ETF that was brand new at the time, in an environment in which many investors were not yet using ETFs, in an asset class that could have theoretically frozen up completely as the system imploded.
Figure 1: The WisdomTree Emerging Markets High Dividend Fund, 9/15/08
Please click here for DEM standardized performance.