by Jason Xavier, Franklin Templeton Investments
Our Head of EMEA ETF Capital Markets Jason Xavier explains the role of exchange-traded funds in enabling price discovery during these volatile times.
We are living in truly unprecedented times.
At the time Iâm writing this, US markets have plunged, marking their worst one-day decline since 1987! Many European markets were also down more than 10% on the morning of 16 March after the US Federal Reserve cut interest rates to almost zero and launched a US$700 billion stimulus programme. Todayâs close marked the first time a generation has seen daily equity market losses of this magnitudeâdeclines that havenât been seen since Black Wednesday in 1992 and the crash of 1987. And while painful and severe in the near term, just like volatile periods of past, opportunities will be created for the long term.
The comparison with 1987 is very relevant for exchange-traded funds (ETFs), as it was post this crisis that the US Securities and Exchange Commission (SEC) consulted the market to develop a product that would facilitate the addition of liquidity, allowing large blocks of equity to be bought/sold in a single trade. Not too long thereafter, the ETF was born!
Since the first ETF was launched 30 years ago on the Toronto Stock Exchange and then a few years later in the United States, itâs clear ETFs have long passed their initiation! Even up until recently, concerns that ETFs will cause the next downturn or that ETFs create and exacerbate volatility have been topics for discussion in some corners.
As a reminder, volatility is a function of investor flows, and is driven by human behaviour. Even as market volatility skyrocketed, last week was proof that ETFs have not only enabled the democratisation of asset classes, but are also now being actively used as a price discovery mechanism, particularly within fixed income.
Appreciating market uncertainty in relation to the trading of ETFs is key to appreciating the price discovery mechanism ETFs offerâand many investors utilizeâduring these volatile times.
The last few days have seen underlying securities trade at extreme levels and at times trade limit down during the trading day. During these limit-down periods, trading is halted and price discovery in the underlying securities is limited. At these moments, market uncertainty is at its peak and the lack of clarity around prices have caused ETF spreads to widen.
However, the ability for ETFs to trade in the secondary market as well as for ETF market makers to setup proxy hedging and correlated pricing models has allowed price discovery and liquidity to be upheld, even during these stressful and uncertain periods.
Three decades since the inception of the first ETF, the product is now more relevant than ever. As more and more investors embrace its abilities and potential benefits, a new generation of them is already taking full advantage of intentions laid out from yesteryearâs volatile periods.
To get insights from Franklin Templeton delivered to your inbox, subscribe to the Beyond Bulls & Bears blog.
To comment or post your question on this subject, follow us on Twitter @FTI_Global and on LinkedIn.
Important Legal Information
This material is intended to be of general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice.
Any companies and case studies shown herein are used solely for illustrative purposes; any investment may or may not be currently held by any portfolio advised by Franklin Templeton Investments. The opinions are intended solely to provide insight into how securities are analysed. The information provided is not a recommendation or individual investment advice for any particular security, strategy, or investment product and is not an indication of the trading intent of any Franklin Templeton managed portfolio. This is not a complete analysis of every material fact regarding any industry, security or investment and should not be viewed as an investment recommendation. This is intended to provide insight into the portfolio selection and research process. Factual statements are taken from sources considered reliable but have not been independently verified for completeness or accuracy. These opinions may not be relied upon as investment advice or as an offer for any particular security. Past performance is not an indicator or a guarantee of future results.
The views expressed are those of the investment manager and the comments, opinions and analyses are rendered as of publication date and may change without notice. The information provided in this material is not intended as a complete analysis of every material fact regarding any country, region or market.
Data from third party sources may have been used in the preparation of this material and Franklin Templeton (âFTâ) has not independently verified, validated or audited such data. FT accepts no liability whatsoever for any loss arising from use of this information and reliance upon the comments, opinions and analyses in the material is at the sole discretion of the user.
Products, services and information may not be available in all jurisdictions and are offered outside the U.S. by other FT affiliates and/or their distributors as local laws and regulation permits. Please consult your own professional adviser or Franklin Templeton institutional contact for further information on availability of products and services in your jurisdiction.
Issued in the U.S. by Franklin Templeton Distributors, Inc., One Franklin Parkway, San Mateo, California 94403-1906, (800) DIAL BEN/342-5236, franklintempleton.comâFranklin Templeton Distributors, Inc. is the principal distributor of Franklin Templetonâs U.S. registered products, which are not FDIC insured; may lose value; and are not bank guaranteed and are available only in jurisdictions where an offer or solicitation of such products is permitted under applicable laws and regulation.
What Are the Risks?
All investments involve risks, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Brokerage commissions and ETF expenses will reduce returns. ETF shares may be bought or sold throughout the day at their market price on the exchange on which they are listed. ETFs trade like stocks, fluctuate in market value and may trade above or below the ETFâs net asset value. However, there can be no guarantee that an active trading market for ETF shares will be developed or maintained or that their listing will continue or remain unchanged. While the shares of ETFs are tradable on secondary markets, they may not readily trade in all market conditions and may trade at significant discounts in periods of market stress.
This post was first published at the official blog of Franklin Templeton Investments.
