May 2020, BOSTON—Covid-19 is putting fixed-income exchange-traded funds (ETFs) to the test. According to the latest Cerulli Edge—U.S. Asset and Wealth Management Edition, one of the most widely cited concerns by advisors—the possibility of a deviation in the price of the traded product from the net asset value (NAV)—occurred several times in March. Cerulli believes that the deviations underscore the importance of educating advisors about the distinctions associated with both the ETF and mutual fund vehicles with the goal being advisors’ use of both in concert.
As the markets began to react to coronavirus in late February, some of the largest fixed-income ETFs traded with increased bid-ask spreads and, at times, significantly below their NAVs. This deviation from the NAV may result in ETF investors having to sell their shares below the reported value of holdings at a time of crisis, making the vehicle appear to be a poorer option than a comparable mutual fund that transacted at the NAV. While this may suggest that investors in the mutual fund vehicle were better served, associate director Daniil Shapiro urges that, “This deviation in NAV should be interpreted with nuance and should impact how both ETFs and mutual funds are positioned to advisors.”
There are several explanations for ETFs falling below the NAV during the latest period of market stress. At the highest level, ETF trading is supported by market makers and authorized participants who need to ensure that their activities are profitable and will add a margin of safety, resulting in lower ETF prices and investors effectively paying some price for access to liquidity. It is also possible that because NAVs for many fixed-income positions will be marked-to-model, they may take some period of time to catch up to the true value of the underlying holdings—a friction that market makers will seek to price in.
“For advisors, the takeaway should be that no vehicle is perfect, but that each has unique advantages,” says Shapiro. He adds: “If discounts exist in an ETF vehicle offering similar exposure, it is possible that advisors purchasing a mutual fund as a long-term holding are overpaying and would be better served in an ETF. At the same time, investors who do not need intra-day liquidity but may need to sell at a specific date may well be best served by the mutual fund to the extent that they may avoid paying some liquidity charge should they have to sell during a tumultuous period.”
While these are more nuanced approaches, it is evident that, in crisis, such decisions can impact outcomes and warrant advisor education on the benefits of each vehicle, with the goal of using both in line with the needs of their investors.
