ETFs: Saviors in Crises Treated Like Rejects

Also, when we compare DEM’s ostensibly volatile moves that day, that wasn’t something that was unique to the WisdomTree Emerging Markets High Dividend Index or to DEM, which tracks it. The MSCI Emerging Markets Index that the WisdomTree index is often compared to was moving to and fro in a similar manner that day (figure 2).

Figure 2: MSCI Emerging Markets Index, Day of Lehman Bankruptcy (9/15/08)

Related: Strategic Versus Tactical Asset Allocation

Many investors were able to turn to ETFs during Lehman’s collapse because they were finding bids and offers when they needed them most. In  Figure 3, we see that DEM’s average daily volume rose from 51,357 shares in August 2008 to 97,915 shares in September. In the week after the Lehman news, an average 143,598 shares were changing hands every day. For small investors, they could enter the market and have limit orders filled in the teeth of a crisis, every day, while creation/redemption was, of course, available for larger players and institutions.

Figure 3: WisdomTree Emerging Markets High Dividend Fund, August/September 2008

In short, one could say ETFs clear the market. We know their net asset value at a moment in time, and they provide a real-time glimpse at broad pricing, especially if they trade every second or two. Such action on the tape provides critical information to the individual buyer of riskier or more esoteric asset classes.

In turn, the availability of that information allows the transaction of individual bank loans, individual high-yield bonds, individual emerging market stocks and bonds, individual everything, to be exchanged with more confidence. Both buyer and seller are armed with knowledge—and that knowledge comes from ETF activity.

This breeds confidence and brings forth a critical mass of players on both the buy and sell sides of a market, much more so than before the advent of ETFs, when many securities would change hands “by appointment.” Those days are fewer now.

ETFs provided this information to all of us. They allowed individuals and money managers to buy (or short) individual securities with more confidence, knowing that on a moment’s notice they can go into the market and hedge their position by taking the other side of a trade across a broad market basket. Mutual funds did not give us this transparency, a reality that is all too evident to anyone who has been caught on the wrong side of a volatile market while they sweat the clock in anticipation of 4 p.m. EST. In the meantime, mutual fund owners have to count down as they are impotent to protect themselves intraday. Those days are fewer now.

It’s high time for this industry to ask the mutual fund complex why exactly it wishes in vain for this critical source of liquidity and valuable market information to disappear.

This article has been republished with permission from Wisdom Tree.