Market function held up again on Wednesday, even as massive volatility swept across U.S. equities for the third day this week and investors flocked to exchange traded funds.
The VIX volatility index peaked at 44.41 yesterday, and the Dow Jones Industrial Average plummeted 520 points. Volume remained strong, with about 15.2 billion shares changing hands, down from 16.9 billion on Tuesday. Still, liquidity remained strong and traders had few problems filling their orders.
“The markets–although you might not enjoy the price action–are absolutely functioning efficiently,” said Rob Karofsky, global head of equity trading for AllianceBernstein. “You haven’t had delays and you haven’t had disruptions, and that’s a real positive.”
Whenever there is a major stress in the system, correlation in the marketplace tends to increase, Karofsky said. Stocks are moving together, and investors are being particularly drawn to ETFs, he added.
Historically, ETFs make up about 30 to 35 percent of daily volume, but recently that has increased to around 40 to 50 percent, Karofsky said. Investors want to take bets on the entire market, not just on individual stocks.
“People are making risk-on, risk-off decisions, and ETFs are a really convenient and cheap way to implement risk,” said Dan Mathisson, a managing director and head of electronic trading at Credit Suisse.
What is more, he said investors are looking beyond large-cap ETFs like SPDRs and putting money in funds that include small caps. According to Mathisson, when Credit Suisse looked at the numbers, they found small-cap volume was up by approximately the same ratio as large-cap volume.
Mark Travis, president and portfolio manager of the mutual fund firm Intrepid Capital Funds, which specializes in small-cap stocks as well as high-yield debt, said liquidity has been less of a problem for small caps than it has been in the bond market.
Still, small-cap investors have to be patient, he said. His firm invests in companies with market caps as low as $100 million, so it can be difficult to deploy large amounts of money to those small-cap names.
And deploying his fund’s money is precisely what Travis wants to do. He said valuations are highly attractive, though he is mindful to leave some cash on the sidelines. That’s so he can fund redemptions from investors who are unable to stomach the market.
“I do think it’s become a challenge here in the last week, trying to manage our desire to create long-term value for shareholders with our requirements to provide liquidity when asked for it,” Travis said. “In a perfect world, I would be consuming my cash with attractive investments, not with requests for redemptions.”
