ETF's vs. Mutual Funds During Market Panics

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Post Reply
Topic Author
Kevin K
Posts: 119
Joined: Sun Aug 26, 2007 7:47 pm

ETF's vs. Mutual Funds During Market Panics

Post by Kevin K » Sat Mar 10, 2018 11:12 am

I've read the long Wiki here on the ETF vs. Mutual Fund topic and at least some of the other threads but haven't seen the topic of divergent performance between the two investment types addressed in detail (and if I missed a thread on this very issue, which is certainly possible, I apologize).

The quote below is excerpted from a longer comparison of DFA vs. Vanguard, Schwab, etc. on the Evanson Assset Management web site. I am in no way trying to rekindle one of the endless DFA vs. Vanguard debates but rather am interested in thoughts about mutual funds vs. "mirror" ETFs during market crises. I have been under the impression that Vanguard's unique approach (at least until 2023 when their patent runs out) of having ETF shares work as a class of their mutual fund counterpart might offer some level of protection against the massive swings described below.

"ETF's are legal and operational structures which differ from open-ended mutual funds. DFA offers only open-ended funds while Vanguard offers both open-ended funds and ETF's. ETF's are created from pledged (promised) shares by authorized participants to ETF fund managers. ETF shareholders own a pledged asset, not a fractional share of an asset as is the case with open-ended mutual funds. It is a contractual pledge to provide the shares but does not provide true share ownership and during a crisis contracted pledges could be abrogated. ETF investors do not own the pledged shares, the value of what they own is whatever the exchange traded shares trade for and that may be well far above or below the actual market value of the underlying pledged securities in the ETF portfolio. ETF share owners own shares in a derivative structure though the ETF industry has argued ETF shares are not derivatives in the sense that futures and options are derivatives. This is true because futures and options derive their prices mathematically from the value of the underlying assets, not whatever the market prices a pledge at. ETF investors do not own an asset but a number based on a promise and contract. The ETF industry controlled about $3 trillion of assets as of 2017.

ETF promoters have advanced the narrative that arbitrageurs will quickly close the spreads between traded share prices and the underlying value of the assets, the net asset value. And, ETF promoters emphasize that, unlike open ended mutual funds, ETF's allow intraday trading and instant liquidity with stops. However, a casual perusal of the historical share prices of ETF's versus their net asset value often reveals that ETF's have traded at very substantial discounts to the underlying pledged securities for periods of months or years. And, ETF's are heavily traded by high frequency trading computers which can change buying into selling in nanoseconds. ETF share prices can differ dramatically from the pledged underlying securities as the examples below illustrate.

In December 2014 the New York Federal Reserve Bank, Wall Street's top regulator, announced that extreme price movements in ETF's holding stocks, bonds and other assets had prompted it to take a closer look at the inner workings of ETF's. Nothing has been done as of 2017. The Fed was concerned that ETF share prices do not always reflect underlying securities values and that authorized participants who pledged the shares might not honor their pledges during periods of heavy redemption requests.

This risk in ETF's was clearly illustrated in the so-called "flash crash" on May 6, 2010. The Dow fell almost 800 points in 25 minutes. The Wall Street Journal reported that while the Dow lost 9.2% of its value at its worst, many ETF shares lost almost all their value, some dropping to pennies per share. Stop losses triggered massive selling and due to the rules imposed by regulators, investors who had lost between 10% and 60% were not compensated. The Nasdaq canceled over 10,000 trades that took place more than 60% below the pre-crash price. When the damage was tallied about 70% of the canceled trades during the flash crash involved ETF's (CBS Marketwatch). The Wall Street Journal (10-10-10) also reported that hundreds of ETF's performed differently than the indexes they were supposed to track and had an average annual tracking error of 1.25% in 2009 and 2010. On June 20th, 2013, a day where equity indexes declined substantially, the Financial Times reported, "The losses for ETF's today were far beyond what the most sophisticated financial risk models could have predicted for worst case scenarios".

In August 2015 ETF declines were again serious and more than a fifth of all US ETF's were forced to stop trading. ETF liquidity disappeared instantly thanks to HFT computers. HFT ETF traders, however immediately blamed NYSE Rule 48 and pushed for its removal. Pressure to remove regulations on ETF's remains to this day. The Financial Times commented that HFT traders did not have enough information to run their algorithms, backed out of the market instantly and withdrew liquidity in August 2015. Trading was littered with more than 1000 trading halts that inhibited the alleged essential arbitrage mechanisms of ETF's and caused their prices to fall well below the indices they were designed to track. Futures, cash and ETF's are priced and arbitraged off each other and according to the Financial Times HFT showed "evidence of cracks in the plumbing that underlies the world's largest equity market." The Bank of England warned that "the risks associated with ETF's are not being made clear."

Vanguard founder John Bogle has warned about ETF's even though some Vanguard funds are ETF's. In 2016 (Financial Times, 12-13-16) he called for politicians to re-examine ETF's and noted that ETF investors trailed returns in conventional open-ended index mutual funds by a large 1.6% annually. He also complained that annual turnover in the largest ETF tracking the S&P 500 sometimes reached a stunning 3000% of assets, driving up trading costs. This was occurring even though the S&P committee doesn't change all that many securities when they meet to update the index periodically.

The Financial Times (7-25-13) reported that high levels of settlement failures in ETF's were reviving debates about their structure and liquidity. Settlement failures occur when banks pledge assets to ETF's and then fail to deliver them. The powerful Bank of International Settlements, the global central banker's bank, warned that settlement failures in ETF's pose potential systemic problems to the global financial system. Hint: Think 2008. Said one critic, "This is an unrealized risk which could morph into an operational risk in nanoseconds. What is the actual risk of a security if it takes five days to find the security to make settlement?" In May 2015 Reuters reported that the country's largest ETF providers were arranging billion dollar credit lines just in case an ETF sell-off turned into a credit market melt-down and they need to come up with money for shareholders since they won't be able to sell their pledged shares.

It should also be noted that one common narrative for promoting ETF's is that they don't pass through yearly capital gains to investors since they are derivatives. Investors don't actually own shares, they own a number representing shares. Although DFA does pass-through capital gains in its funds, DFA's capital gains pass-throughs typically are very low, running in the 0% to 2% range annually in most funds though volatile markets and smaller illiquid foreign markets can increase capital gains and increase pass-throughs. DFA's tax-advantaged core-vector funds are so tax-efficient that they sometimes pass through no gains in a given year.

To summarize, ETF's create many risks which do not exist in open-ended mutual funds, particularly a liquidity risk, and most ETF's are based on indexes which have their own inherent costs and flaws described above. Evanson Asset Management® does not recommend ETF's or indexes though if our clients wish to hold them we do so for them."

Here is the link to the full article in case of interest:

https://www.evansonasset.com/are-dfa-st ... ior-20.htm

MotoTrojan
Posts: 7559
Joined: Wed Feb 01, 2017 8:39 pm

Re: ETF's vs. Mutual Funds During Market Panics

Post by MotoTrojan » Sat Mar 10, 2018 11:39 am

I don’t need liquidity during downturns/crashes, although I may try to capitalize on artificially cheap shares. Bogle’s concern of less return has to do with easier trading, not the vehicle itself.

I’m happy with my ETFs.

User avatar
artthomp
Posts: 327
Joined: Tue Feb 20, 2007 4:44 pm
Location: Ballwin Missouri

Re: ETF's vs. Mutual Funds During Market Panics

Post by artthomp » Sat Mar 10, 2018 12:02 pm

I hold most of my equity funds at Vanguard in ETFs because of Vanguard's frequent trading policy. If one buys or sells a mutual fund, one is not allowed to buy or sell the same mutual fund within 30 days so as not to disrupt fund management.This policy could lock me into the wrong allocation if I make a mistake during my annual re-balancing. It does not apply to ETFs.
Art

User avatar
nisiprius
Advisory Board
Posts: 39725
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: ETF's vs. Mutual Funds During Market Panics

Post by nisiprius » Sat Mar 10, 2018 12:41 pm

The following fine-print remarks are not offered as a list of valid reasons to avoid ETFs, but as an indication of my bona fides as personally being a mutual fund fan.I dislike ETFs. I don't own any. I've owned them three times in the past. I didn't like buying them. I don't like the motives behind their creation. I don't like what I believe are the purposes for which they are most commonly used. I don't like Ric Edelman, Ric Edelman likes ETFs, ergo I don't like ETFs. I don't like the way so many of them concentrate on narrow market segments. I don't like the (intentionally?) blurred distinction between ETFs, which, like mutual funds, are investment companies regulated by the Investment Company Act of 1940, and ETNs, which aren't. I don't like leveraged ETFs, inverse ETFs, commodities-linked ETFs, cryptocurrency-linked ETFs. I didn't like the Flash Crash. I don't like the fact that an ETF actually must be sold, as a package, to a willing buyer who wants to buy that specific package.

All that said...

I don't think that risks, in ETFs of the kind most Bogleheads would use, in the way most Bogleheads would use them, amount to much, nor that they can be accurately assessed. It falls in the same category as fussing over whether NCUA-insured credit union accounts are riskier that FDIC-insured bank accounts, or whether the plaque that says "FDIC insurance is backed by the full faith and credit of the United States government" mean that FDIC insurance is backed by the full faith and credit of the United States government.

These are all "black swan" risks that come into play only under circumstances which can't be predicted or foreseen, even though they may not be all that unlikely. Merely to say "I have enumerated a list of ETF risks that don't apply to mutual funds," without probabilities or consequences, does not prove that ETFs are riskier than mutual funds--certainly that they are riskier enough to justify avoiding them.

The reverse is true, too. Any ETF fan can point to collapse scenarios in mutual funds (the Reserve Primary money market mutual fund, the Third Avenue Focused Credit fund) that probably don't exist in ETFs.

Finally, a mutual investor is insulated from market illiquidity by the right to redeem mutual fund shares from the fund company at NAV. However, sooner or later the mutual fund company does have to sells shares of the underlying assets on the market to meet those redemptions. Some kind of general, widespread drying up of market liquidity might cause problems for ETF investors sooner. But if it persisted for very long (more than a few days?) it would become a problem for mutual fund managers and their investors, too. Reputedly this came very close to happening for bond mutual funds in 2008-2009.
Last edited by nisiprius on Sat Mar 10, 2018 2:10 pm, edited 1 time in total.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

livesoft
Posts: 69575
Joined: Thu Mar 01, 2007 8:00 pm

Re: ETF's vs. Mutual Funds During Market Panics

Post by livesoft » Sat Mar 10, 2018 12:54 pm

Vanguard ETFs have been affected by so-called flash crashes.

For investors who are buying ETFs, such flash crashes are an interesting benefit. For speculators and others who submit stop-limit orders to sell or stop-loss orders to sell, such flash crashes are a good way to lose money.

I have certainly bought ETF shares during a flash crash. One issue could be though if one is selling a bond ETF that has dropped in price in order to buy an equity ETF that has dropped even more in price, then one should be aware of how to submit limit orders. Or one should know not to sell a bond ETF at ridiculously low prices. This might be a reason to have some bond mutual funds in order to do an exchange order.

Stock markets can drop in big ways (see October 1987) and that will affect mutual fund prices posted at the end of the day, but that is not what the quoted text is about. But the quoted text is more about sowing Fear, Uncertainty, and Doubt since I imagine that a prudent advisor would not be caught with their pants down selling mis-priced ETFs in a flash crash. Even normal investors with a modicum of common sense would not be caught with their pants down.

I think only the naive who have previously submitted stop-limit and stop-loss orders are taken advantage of.
Last edited by livesoft on Sat Mar 10, 2018 12:56 pm, edited 1 time in total.
Wiki This signature message sponsored by sscritic: Learn to fish.

User avatar
nisiprius
Advisory Board
Posts: 39725
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: ETF's vs. Mutual Funds During Market Panics

Post by nisiprius » Sat Mar 10, 2018 12:55 pm

[Added] My suspicions have been challenged by other posters, below.

P.S. I am suspicious of possible self-interest on Evanson Asset Management's part, since 1) if I am reading their website correctly, Evanson Asset Management is an advisory firm and their FAQ suggests that they are closely tied with Dimensional Fund Advisors (DFA), and 2) DFA does not offer their products as ETFs.
Last edited by nisiprius on Sun Mar 11, 2018 12:41 pm, edited 1 time in total.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

livesoft
Posts: 69575
Joined: Thu Mar 01, 2007 8:00 pm

Re: ETF's vs. Mutual Funds During Market Panics

Post by livesoft » Sat Mar 10, 2018 12:57 pm

^FWIW, I know of an advisor who puts his clients in DFA funds and Vanguard ETFs custodianed at Fidelity.
Wiki This signature message sponsored by sscritic: Learn to fish.

User avatar
triceratop
Posts: 5838
Joined: Tue Aug 04, 2015 8:20 pm
Location: la la land

Re: ETF's vs. Mutual Funds During Market Panics

Post by triceratop » Sat Mar 10, 2018 12:59 pm

nisiprius wrote:
Sat Mar 10, 2018 12:55 pm
P.S. I am suspicious of possible self-interest on Evanson Asset Management's part, since 1) if I am reading their website correctly, Evanson Asset Management is an advisory firm and their FAQ suggests that they are closely tied with Dimensional Fund Advisors (DFA), and 2) DFA does not offer their products as ETFs.
I mean they kinda' do, in that they are the investment advisors on John Hancock Multifactor ETFs.
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."

User avatar
triceratop
Posts: 5838
Joined: Tue Aug 04, 2015 8:20 pm
Location: la la land

Re: ETF's vs. Mutual Funds During Market Panics

Post by triceratop » Sat Mar 10, 2018 1:01 pm

I don't like the motives behind their creation. I don't like what I believe are the purposes for which they are most commonly used.
That isn't an argument for or against using them in concordance with your investment policy statement, which presumably has nothing to do with those motives.
I don't like Ric Edelman, Ric Edelman likes ETFs, ergo I don't like ETFs.
I'm not sure this is intended to be facetious, but is obviously not logical.
I don't like the way so many of them concentrate on narrow market segments
I would not buy such products. By the way, there are many mutual funds which do the same.
I don't like the (intentionally?) blurred distinction between ETFs, which, like mutual funds, are investment companies regulated by the Investment Company Act of 1940, and ETNs, which aren't.
How are they blurred? ETFs own underlying assets and are useful vehicles for investing in diversified stock and bond index funds. ETNs....are not; they're obligations.
I don't like leveraged ETFs, inverse ETFs, commodities-linked ETFs, cryptocurrency-linked ETFs.
I would not buy those funds.
I didn't like the Flash Crash
I didn't mind. At most it was a nonevent. I didn't intend to sell any stocks because stocks declined (no person following Boglehead principles would)
I don't like the fact that an ETF actually must be sold, as a package, to a willing buyer who wants to buy that specific package.
This is a fair point; of course at the end of the day when you really dig into it, of course the same must also be true for mutual funds when their redemptions exceed purchases: they'll need to find willing buyers on the market, possibly with market impact costs, on the mutual fund NAV. It's not often mentioned that ETF investors pay the price, their own transaction costs, for wanting to execute at times of market stress. This is a fairer distribution of costs, rather than mass investor exodus hurting other investors who stay invested.
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."

Topic Author
Kevin K
Posts: 119
Joined: Sun Aug 26, 2007 7:47 pm

Re: ETF's vs. Mutual Funds During Market Panics

Post by Kevin K » Sat Mar 10, 2018 1:45 pm

nisiprius wrote:
Sat Mar 10, 2018 12:55 pm
P.S. I am suspicious of possible self-interest on Evanson Asset Management's part, since 1) if I am reading their website correctly, Evanson Asset Management is an advisory firm and their FAQ suggests that they are closely tied with Dimensional Fund Advisors (DFA), and 2) DFA does not offer their products as ETFs.
The article I provided the quote from and link to makes it very clear that Evanson is indeed an advisor in the DFA universe but having read all of the articles on their site over the years as well as being a client for a couple of years going back nearly a decade my experience has been that they (like DFA itself and, say, Larry Swedroe, a much more famous DFA FA who posts here often) are pretty darn measured and evidence-based in their claims. So rather than indulge in ad hominem suspicions I look at the case being made. As the article makes clear, DFA not only doesn't offer ETF's, they don't offer index funds and their advisor-only network further limits market timing. Again I am not saying that makes them better than Vanguard, worth their higher expenses, likely to outperform going forward, etc. Those topics have been endlessly debated elsewhere on these forums.

Your other comments about relative risk between ETFs and mutual funds and just how much we don't know are very wise and helpful. I am still unclear aa to whether Vanguard's ETFs are a better "bunker" than others but I guess the reality is we haven't had enough market crashes since the advent of ETFs to know.

Thanks to all who have posted for the great comments.

User avatar
Earl Lemongrab
Posts: 7270
Joined: Tue Jun 10, 2014 1:14 am

Re: ETF's vs. Mutual Funds During Market Panics

Post by Earl Lemongrab » Sat Mar 10, 2018 2:18 pm

I had sort of vaguely heard of Evanson. Here's part of their "mission statement":
Evanson Asset Management® (EAM) offers low-cost fixed quarterly retainer fees and specializes in index and passive investment management. EAM derives its investment strategy from academic research and makes use of passive portfolios from Dimensional Fund Advisors (DFA) and Vanguard and ETF index funds, as well as cash equivalents, maturity laddered bond portfolios and individual securities.
Under fees it notes that they charge a quarterly fee roughly at the hours necessary to service the account, so not AUM. I have to say that I don't see much objectionable about the firm at a shallow glance. It's not one that I would use, but none are.

User avatar
Epsilon Delta
Posts: 8090
Joined: Thu Apr 28, 2011 7:00 pm

Re: ETF's vs. Mutual Funds During Market Panics

Post by Epsilon Delta » Sat Mar 10, 2018 2:25 pm

Kevin K wrote:
Sat Mar 10, 2018 11:12 am
I've read the long Wiki here on the ETF vs. Mutual Fund topic and at least some of the other threads but haven't seen the topic of divergent performance between the two investment types addressed in detail (and if I missed a thread on this very issue, which is certainly possible, I apologize).

The quote below is excerpted from a longer comparison of DFA vs. Vanguard, Schwab, etc. on the Evanson Assset Management web site.

"ETF's are legal and operational structures which differ from open-ended mutual funds. DFA offers only open-ended funds while Vanguard offers both open-ended funds and ETF's. ETF's are created from pledged (promised) shares by authorized participants to ETF fund managers. ETF shareholders own a pledged asset, not a fractional share of an asset as is the case with open-ended mutual funds. It is a contractual pledge to provide the shares but does not provide true share ownership and during a crisis contracted pledges could be abrogated. ETF investors do not own the pledged shares, the value of what they own is whatever the exchange traded shares trade for and that may be well far above or below the actual market value of the underlying pledged securities in the ETF portfolio. ETF share owners own shares in a derivative structure though the ETF industry has argued ETF shares are not derivatives in the sense that futures and options are derivatives. This is true because futures and options derive their prices mathematically from the value of the underlying assets, not whatever the market prices a pledge at. ETF investors do not own an asset but a number based on a promise and contract. The ETF industry controlled about $3 trillion of assets as of 2017.

I don't think this paragraph is true. Certainly Vanguard's annual reports show the underlying shares as assets and the only pledging is for repurchase agreements and loaned securities. SPDR Russel 3000 annual reports show exactly the same thing. There is no indication that the custodian is not in actual possession of the shares. So certainly either the SPDR annual report or the above rates a "Pant's on Fire". I'll side with the annual report at this time.

User avatar
nisiprius
Advisory Board
Posts: 39725
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: ETF's vs. Mutual Funds During Market Panics

Post by nisiprius » Sat Mar 10, 2018 2:38 pm

[Added] I didn't know what I was talking about, and the situation with ETFs is more complicated than I thought. See triceratop's other postings, below.
triceratop wrote:
Sat Mar 10, 2018 1:01 pm
I don't like the motives behind their creation. I don't like what I believe are the purposes for which they are most commonly used.
That isn't an argument for or against using them in concordance with your investment policy statement, which presumably has nothing to do with those motives...
I've added a note to my post, indicating that he fine print was not presented as a list of valid arguments again ETFs, but merely to show that I am a mutual fund fan, and my remarks about reasonable ETFs not being actionably riskier were not being made from an ETF-fan point of view.
triceratop wrote:
nisiprius wrote:I don't like the (intentionally?) blurred distinction between ETFs, which, like mutual funds, are investment companies regulated by the Investment Company Act of 1940, and ETNs, which aren't.
How are they blurred? ETFs own underlying assets and are useful vehicles for investing in diversified stock and bond index funds. ETNs....are not; they're obligations.
They are blurred by the very common practice of referring to ETNs as "ETFs," and by their very similar names for utterly different things.

It happens all the time.

For example, on a website whose only purpose in life is to provide information on exchanged-traded products:

http://etfdb.com/type/commodity/preciou ... /gold-etf/

Image

GLD is definitely not an ETF, and I don't think the others listed on the page are, either.

Investopedia:

Image
XIV is not an ETF.

The Seattle Times:

Image

Reuters:

Image

And I hope you can educate me on this, because here is a product whose provider calls it an "ETF" while saying "This fund is not an investment company regulated under the Investment Company Act of 1940 and is not afforded its protections."

How is this possible? Either ProShares is misrepresenting their own product, or the term ETF does not mean what I thought it meant. Likely the latter.

http://www.proshares.com/funds/svxy.html

Image
Last edited by nisiprius on Sun Mar 11, 2018 12:42 pm, edited 2 times in total.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

User avatar
jhfenton
Posts: 4398
Joined: Sat Feb 07, 2015 11:17 am
Location: Ohio

Re: ETF's vs. Mutual Funds During Market Panics

Post by jhfenton » Sat Mar 10, 2018 2:57 pm

Epsilon Delta wrote:
Sat Mar 10, 2018 2:25 pm
Kevin K wrote:
Sat Mar 10, 2018 11:12 am
I've read the long Wiki here on the ETF vs. Mutual Fund topic and at least some of the other threads but haven't seen the topic of divergent performance between the two investment types addressed in detail (and if I missed a thread on this very issue, which is certainly possible, I apologize).

The quote below is excerpted from a longer comparison of DFA vs. Vanguard, Schwab, etc. on the Evanson Assset Management web site.

"ETF's are legal and operational structures which differ from open-ended mutual funds. DFA offers only open-ended funds while Vanguard offers both open-ended funds and ETF's. ETF's are created from pledged (promised) shares by authorized participants to ETF fund managers. ETF shareholders own a pledged asset, not a fractional share of an asset as is the case with open-ended mutual funds. It is a contractual pledge to provide the shares but does not provide true share ownership and during a crisis contracted pledges could be abrogated. ETF investors do not own the pledged shares, the value of what they own is whatever the exchange traded shares trade for and that may be well far above or below the actual market value of the underlying pledged securities in the ETF portfolio. ETF share owners own shares in a derivative structure though the ETF industry has argued ETF shares are not derivatives in the sense that futures and options are derivatives. This is true because futures and options derive their prices mathematically from the value of the underlying assets, not whatever the market prices a pledge at. ETF investors do not own an asset but a number based on a promise and contract. The ETF industry controlled about $3 trillion of assets as of 2017.

I don't think this paragraph is true. Certainly Vanguard's annual reports show the underlying shares as assets and the only pledging is for repurchase agreements and loaned securities. SPDR Russel 3000 annual reports show exactly the same thing. There is no indication that the custodian is not in actual possession of the shares. So certainly either the SPDR annual report or the above rates a "Pant's on Fire". I'll side with the annual report at this time.
You are correct. The author is conflating Exchange-Traded Notes, which do have counterparty risk, and 1940 Act Exchange Traded Funds, in which the fund does own the assets.

User avatar
triceratop
Posts: 5838
Joined: Tue Aug 04, 2015 8:20 pm
Location: la la land

Re: ETF's vs. Mutual Funds During Market Panics

Post by triceratop » Sat Mar 10, 2018 3:04 pm

And I hope you can educate me on this, because here is a product whose provider calls it an "ETF" while saying "This fund is not an investment company regulated under the Investment Company Act of 1940 and is not afforded its protections."

How is this possible? Either ProShares is misrepresenting their own product, or the term ETF does not mean what I thought it meant. Likely the latter.
Ah, I see. The problem is your understanding that all ETFs are subject to the provisions of the Investment Company Act of 1940. That is not true.

There is a lot of good information here: ICI: Frequently Asked Questions About ETF Basics and Structure
Investment Company Institute wrote:What is the history of ETFs?

ETFs have been available as an investment product for a little more than 20 years in the United States. The first ETF—a broad-based domestic equity fund tracking the S&P 500 index—was introduced in 1993 after a fund sponsor received U.S. Securities and Exchange Commission (SEC) exemptive relief from various provisions of the Investment Company Act of 1940 that would not otherwise allow the ETF structure. Until 2008, SEC exemptive relief was granted only to ETFs that tracked designated indexes. These ETFs, commonly referred to as index-based ETFs, are designed to track the performance of their specified indexes or, in some cases, a multiple of or an inverse (or multiple inverse) of their indexes.

In early 2008, the SEC granted exemptive relief to several fund sponsors to offer fully transparent actively managed ETFs that meet certain requirements. Among other requirements, these actively managed ETFs must disclose each business day on their publicly available websites the identities and weightings of the component securities and other assets held by the ETF. Actively managed ETFs do not seek to track the return of a particular index. Instead, the investment adviser of an actively managed ETF, like that of an actively managed mutual fund, creates a unique mix of investments to meet a particular investment objective and policy.

By the end of 2016, the total number of index-based and actively managed ETFs had grown to 1,716, and total net assets were $2,524 billion. Of these, 148 were actively managed ETFs with $28.8 billion in total net assets.

How are ETFs regulated?

The vast majority of exchange-traded funds are registered with the SEC and, like mutual funds, must comply with the applicable provisions of the Investment Company Act of 1940 and exemptive orders issued under that Act. Different regulations apply to commodity-based ETFs, which hold about 3 percent of ETF assets. Those commodity-based ETFs that invest in commodity futures are regulated by the Commodity Futures Trading Commission (CFTC), while those that invest solely in physical commodities are regulated by the SEC under the Securities Act of 1933.
So: SVXY and GLD can absolutely be ETFs and yet not subject to the 1940 Act.

To further conclude: I still don't see the blurring of lines between ETNs and ETFs.
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."

User avatar
nisiprius
Advisory Board
Posts: 39725
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: ETF's vs. Mutual Funds During Market Panics

Post by nisiprius » Sat Mar 10, 2018 9:55 pm

[Added] My comments below are wrong. However, I believe there is a real and serious problem with blurring of lines between exchange-traded products which are, and are not, subject to the Investment Company Act of 1940. See further discussion in other postings below.
triceratop wrote:
Sat Mar 10, 2018 3:04 pm
To further conclude: I still don't see the blurring of lines between ETNs and ETFs.
ETFdb called GLD an ETF, but it is an ETN, not an ETF.
Investopedia, the Seattle Times, and Reuters called XIV an ETF, but it an ETN, not an ETF.

You don't see this as a "blurring of lines?" Wouldn't it bother you if publications began to start customarily referring to hedge funds as "mutual funds?"

The issue of SVXY, which is, I learn, an ETF that are not covered by the Investment Company act of 1940, is a different blurring of a different line.
Last edited by nisiprius on Sun Mar 11, 2018 12:44 pm, edited 2 times in total.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

patrick
Posts: 1701
Joined: Fri Sep 04, 2009 3:39 am
Location: Mega-City One

Re: ETF's vs. Mutual Funds During Market Panics

Post by patrick » Sat Mar 10, 2018 10:41 pm

nisiprius wrote:
Sat Mar 10, 2018 9:55 pm
triceratop wrote:
Sat Mar 10, 2018 3:04 pm
To further conclude: I still don't see the blurring of lines between ETNs and ETFs.
ETFdb called GLD an ETF, but it is an ETN, not an ETF.
Investopedia, the Seattle Times, and Reuters called XIV an ETF, but it an ETN, not an ETF.

You don't see this as a "blurring of lines?" Wouldn't it bother you if publications began to start customarily referring to hedge funds as "mutual funds?"

The issue of SVXY, which is, I learn, an ETF that are not covered by the Investment Company act of 1940, is a different blurring of a different line.
How is GLD an ETN? GLD holds the assets (gold bars) in trust for the investors just like any other fund. Exchange-traded notes are debt instruments where the issuers merely promise to pay the value of the assets, exposing investors to credit risk of the issuer. That doesn't happen when the assets are held in trust for investors. GLD is for some reason not subject to the 1940 Act but it still should count as a fund because it holds assets for investors rather than just promising to pay them.

The same goes for SVXY, except the assets it holds are derivatives contracts rather than gold bars.

User avatar
jhfenton
Posts: 4398
Joined: Sat Feb 07, 2015 11:17 am
Location: Ohio

Re: ETF's vs. Mutual Funds During Market Panics

Post by jhfenton » Sat Mar 10, 2018 10:50 pm

patrick wrote:
Sat Mar 10, 2018 10:41 pm
nisiprius wrote:
Sat Mar 10, 2018 9:55 pm
triceratop wrote:
Sat Mar 10, 2018 3:04 pm
To further conclude: I still don't see the blurring of lines between ETNs and ETFs.
ETFdb called GLD an ETF, but it is an ETN, not an ETF.
Investopedia, the Seattle Times, and Reuters called XIV an ETF, but it an ETN, not an ETF.

You don't see this as a "blurring of lines?" Wouldn't it bother you if publications began to start customarily referring to hedge funds as "mutual funds?"

The issue of SVXY, which is, I learn, an ETF that are not covered by the Investment Company act of 1940, is a different blurring of a different line.
How is GLD an ETN? GLD holds the assets (gold bars) in trust for the investors just like any other fund. Exchange-traded notes are debt instruments where the issuers merely promise to pay the value of the assets, exposing investors to credit risk of the issuer. That doesn't happen when the assets are held in trust for investors. GLD is for some reason not subject to the 1940 Act but it still should count as a fund because it holds assets for investors rather than just promising to pay them.

The same goes for SVXY, except the assets it holds are derivatives contracts rather than gold bars.
I think GLD is a grantor trust ETF, not an ETN, and not a 1940 Act ETF.

This Vanguard advisor summary on the "five types of ETFs" is pretty good, except I don't consider ETNs to be ETFs at all, because there is no actual ownership of the underlying securities or commodities. I agree with nisiprius on the importance of not blurring the lines between ETFs and ETNs.

But there are non-1940 Act ETFs, namely grantor trusts and partnerships. They do own the underlying commodities or futures, but they don't qualify under the 1940 Act.

User avatar
triceratop
Posts: 5838
Joined: Tue Aug 04, 2015 8:20 pm
Location: la la land

Re: ETF's vs. Mutual Funds During Market Panics

Post by triceratop » Sat Mar 10, 2018 11:00 pm

nisiprius wrote:
Sat Mar 10, 2018 9:55 pm
triceratop wrote:
Sat Mar 10, 2018 3:04 pm
To further conclude: I still don't see the blurring of lines between ETNs and ETFs.
ETFdb called GLD an ETF, but it is an ETN, not an ETF.
Investopedia, the Seattle Times, and Reuters called XIV an ETF, but it an ETN, not an ETF.

You don't see this as a "blurring of lines?" Wouldn't it bother you if publications began to start customarily referring to hedge funds as "mutual funds?"

The issue of SVXY, which is, I learn, an ETF that are not covered by the Investment Company act of 1940, is a different blurring of a different line.
In general the people who write headlines are not the people who write articles and cannot be relied on for technical accuracy. Let's look at what the journalist wrote, did they say all three were ETFs?
Reuters wrote:Trading in the VelocityShares Inverse Vix Short-Term ETN XIV.P, ProShares Short VIX Short-Term Futures ETF (SVXY.K) and VelocityShares Daily Inverse VIX Medium-Term ETN (ZIV.O) was halted and all three products had a short sell restriction placed on them, Thomson Reuters data showed.
No, it looks like they appropriately labeled the products as notes/funds (ditto Seattle Times, which just re-used the Bloomberg News article). So some newspaper headline editors called them ETFs. Okay. No excuse for Investopedia though, which wrote a clearly incorrect article. This is incredibly incorrect: "XIV uses futures contracts based on the VIX. It seeks the inverse of the S&P 500 VIX Short-Term Futures index. This ETF also uses exchange-traded notes (ETNs), which are similar to bonds in that they are unsecured debt." :oops:

I don't see how you've shown GLD is an ETN at all. Indeed, from the GLD prospectus:
...Mutual funds and other investment vehicles that are “regulated investment companies” within the meaning of
Code section 851 should consult with their own tax advisors concerning (1) the likelihood that an investment in
Shares, although the Shares are “securities” within the meaning of the Investment Company Act of 1940, may be
considered an investment in the underlying gold for purposes of Code section 851(b), and...
The GLD Key Info page lists the risks of ETFs as risks inherent in the fund.
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."

ClaycordJCA
Posts: 320
Joined: Sun Aug 09, 2015 11:19 pm
Location: SF Bay Area

Re: ETF's vs. Mutual Funds During Market Panics

Post by ClaycordJCA » Sat Mar 10, 2018 11:16 pm

artthomp wrote:
Sat Mar 10, 2018 12:02 pm
I hold most of my equity funds at Vanguard in ETFs because of Vanguard's frequent trading policy. If one buys or sells a mutual fund, one is not allowed to buy or sell the same mutual fund within 30 days so as not to disrupt fund management.This policy could lock me into the wrong allocation if I make a mistake during my annual re-balancing. It does not apply to ETFs.
I don’t believe this statement accurately describes Vanguard’s frequent trading policy. The policy applies only when one sells or exchanges a fund. You can make multiple purchases of a fund within 30 days so long as you don’t sell or exchange it.

User avatar
grabiner
Advisory Board
Posts: 25623
Joined: Tue Feb 20, 2007 11:58 pm
Location: Columbia, MD

Re: ETF's vs. Mutual Funds During Market Panics

Post by grabiner » Sun Mar 11, 2018 12:09 pm

ClaycordJCA wrote:
Sat Mar 10, 2018 11:16 pm
artthomp wrote:
Sat Mar 10, 2018 12:02 pm
I hold most of my equity funds at Vanguard in ETFs because of Vanguard's frequent trading policy. If one buys or sells a mutual fund, one is not allowed to buy or sell the same mutual fund within 30 days so as not to disrupt fund management.This policy could lock me into the wrong allocation if I make a mistake during my annual re-balancing. It does not apply to ETFs.
I don’t believe this statement accurately describes Vanguard’s frequent trading policy. The policy applies only when one sells or exchanges a fund. You can make multiple purchases of a fund within 30 days so long as you don’t sell or exchange it.
This could still lock you out of a fund for 30 days if you sell too much while rebalancing. However, it won't lock you into the wrong allocation; if you sell too much of your international fund, you could buy a different international fund or an ETF, and switch to the correct fund after the 30 days are up. (There are also ways around the 30-day rule, and you could ask Vanguard for a waiver if you made a mistake.)

Meanwhile, the same error could have a direct cost with ETFs, because of transaction costs. If you intend to sell 200 shares of an ETF, and actually sell 2000, then buy back 1800, you will lose 1800 times the spread on the round trip; that's $18 at the minimum one-cent spread, and $180 at a ten-cent spread. It could be worse for low-volume ETFs, when you might have a market impact cost.
Wiki David Grabiner

User avatar
nisiprius
Advisory Board
Posts: 39725
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: ETF's vs. Mutual Funds During Market Panics

Post by nisiprius » Sun Mar 11, 2018 12:36 pm

Clearly, I do not understand the differences between exchange-traded products. Apologies for posting misinformation. Earlier posts have been amended.

I believe that there are important differences--specifically between ETFs that are regulated by the Investment Company Act of 1940, and thus broadly similar to mutual funds in what might be called "black swan" and "shenanigans" risk, and those that are not.

I don't believe these differences are being made clear to the general public.

I now believe one of the risks of investing in "ETFs" is the risk of not understanding what basic kind of vehicle you've invested in.
Last edited by nisiprius on Sun Mar 11, 2018 12:45 pm, edited 1 time in total.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

User avatar
triceratop
Posts: 5838
Joined: Tue Aug 04, 2015 8:20 pm
Location: la la land

Re: ETF's vs. Mutual Funds During Market Panics

Post by triceratop » Sun Mar 11, 2018 12:44 pm

Bogleheads would never even consider buying such funds or notes anyway, so I do not see it as a real "risk".
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."

Post Reply