A very interesting article in Barrons about the role ETFs — Extremely Troublesome Funds — played in the May 6th flash crash. It seemed the usual liquid, widely traded funds had a sudden and unexpected vulnerability, as liquidity dropped steeply, and bids faded away.

“ETFs represented 70%, or 227, of the 326 securities for which trades were cancelled by the exchanges, owing to a price drop of 60% or more, according to a recent joint report issued by the SEC and the Commodity Futures Trading Commission. That was after many exchange-traded funds lost ground, along with stocks, earlier in the day because of the problems in Europe caused by Greece.

Investment Technology Group, an electronic broker and tech firm, says that, at the height of the flash crash, the returns of some ETFs decoupled from the underlying basket of stocks that they track. Some underperformed the underlying portfolios by more than 60% . . .

So how bad is the damage to the reputation of exchange-traded funds? Consider some ETF trading details:

• The ETF sector saw net inflows last month of $6.3 billion, half of April’s $12.7 billion.
• Total ETF assets fell to $798.4 billion on May 31, from $847.4 billion a month earlier.
• Biggest loser was PowerShares QQQ (QQQQ), the Nasdaq 100 ETF, which suffered worst-in-show outflows of $2.4 billion, lowering its assets to $18.4 billion.
•  SPDR Gold Shares ETF (GLD) gained $4.2 billion in assets last month total = $49.2 billion).
• Pimco’s Enhanced Short Maturity Strategy Fund (MINT), an actively managed money-market proxy pulled in $596.4 million. (total assets = $1.55 billion; a 50% increase over April’s total)
• Pimco now is the 15th-biggest ETF firm, up from 19th in April.
• Vanguard gained $2.49 billion in net assets (total = $103.1 billion) they are third in total assets.
• MSCI Emerging Markets ETF (VWO) added $2 billion of assets (total = $23.94 billion, 5th-biggest U.S. ETF).
• BlackRock (BLK), iShares’ parent, saw redemptions of $1.3 billion in May (Total = $368.24 billion in assets; #1 in the exchange-traded fund world).

Interesting stuff . . .


ETFs Get an “F” for May 6 Liquidity
Barron’s June 5, 2010

Category: ETFs, Trading

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13 Responses to “ETFs: “F” for Liquidity”

  1. torrie-amos says:

    pretty obvious imho, if you go back too when etf’s started to take off, derivative contracts march lock step in expansion,

    imho, alot of the derivative push back, is the skim they take on these derivatives because on average they probably do not correlate with the underlying product 10-20% of the time, the etf manager doesn’t care, it doesn’t come out of his pocket

    also, alot of etf’s are just complex option strategies, which are just a money machine for the owner and holders, on an exchange there margin would be exposed and gamed by others

  2. randomletters says:

    Biggest loser was PowerShares QQQ (QQQQ) [...]

    Four Q? Seems a little vulgar, especially if you have a Brooklyn or Jersey accent.

    An unfortunate name, if chosen accidentally.

  3. Sircornflakes says:

    As the first poster wrote, this is hardly surprising given that ETF’s are only as liquid as the underlying.

  4. @random

    That was the joke going around when they first changed the name to 4Q. I think it was intentional

    That aside I’m surprised to see the gold ETF is almost three times the size of the Nasdaq ETF. I would have thought that would have been 10 to 1 in the other direction.

  5. rktbrkr says:

    BR, We need a contest – pick the first European bank to go Lehman.

  6. X on the MTA says:

    Hmmmmm. aren’t the computers supposed to arb those things whenever they start deviating from the underlying? Seems like a solid case where the algos could have A.) made money and B.) provided the liquidity they claim to provide and C.) kept prices matched to the underlying

    The ETF deathwatch has long been a favorite thing of mine to watch. I keep an eye on it and run a report against my firm’s current positions to make sure any reps with positions are aware of the limited or diminishing liquidity in the products they own.

    As for the derivatives thing you are spot on. I keep large, frequently rebalanced prop positions with double shorts on levered and inverse levered ETFs. It’s definitely not the money-machine people claim it to be, but if you keep your deltas neutral or close to it, it’s essentially an automatic daily-adjusting gamma scalp where you can stick someone else with the friction costs. It’s definitely a drag on dropping volatility or steady and strong directional markets, but the piece of change it leaves behind when it gets choppy or volatility blows up works well as a hedge for the rest of the portfolio and to smooth out returns.

  7. utiliguy says:

    could this be the start of a trend away from levered and inverse levered ETFs toward the plain vanilla index tracking ETFs?

  8. torrie-amos says:

    thanks for the kudos X,

    most of my analysis is just observations of actions and putting the pieces together

    you might like my latest…….”Follow The Money Bear Market Analysis”

    this is just back of the envelope work so a person can get an understanding of the market, presently if we take the total market value of equities at 10 trillion, here’s the PROFIT BREAKDOWN

    again, all of these are on average guestimates

    A. Market Makers hold inventories of 200 billion, make about 20 billion in profit, they have zero risk for most part, they are toll takers and backed by banks etc.

    B. Smart Money, the super successfull hedge fund guys who come from banks and mutual funds, hold about 300 billion produce a profit of 90 billion, they can follow anything at any time with quickness and speed, they have deep pockets and can have long holding times, these guys know it all and have seen it all and have people who’s job is too produce historical facts for the trading strategies for the traders

    C. Banks, hold 1.5 trillion in inventory, produce 175 billion in profits, these are the back bone of the sysem they will do whatever it takes to stay in business, influence policy, they see and know all cause they have insights into everyone’s books, they move with complete force, they are extremely productive in the boom, and extremely vulnerable in the bust is where all of theres risks lie, lobbyists and lawyers are there vest friends, they protect there is on the downside with fine print

    D. Institutional Money, 4 trillion of inventory, 300 billion in profits, generally they go with the flow and there strength in money inflows over long time frames, goal is not too be extremely bad

    E. Small Investor, 2 trillion, 100 billion in profits, ie, 5%, 80% of small businesses go bust in 4-5 years

    In summary the beast eats 600 billion in profits a year, the government has essentially replaced the small investor, 2 trillion in stim, replaces the busted small business’s, this would account for lower volumes we see…………..

    When there is not enough profit too support debt, excess money does not flow into the market, and profits decrease………………….

    The market maker is neutral, we are watching wars between banks, smart money, institutions for less and less profits………………….in good times they all kneel at the same alter, in a bear market it is war, we have yet too see the whites of anyones eyes except the small investor who is gone gone gone

  9. VennData says:

    I assume anyone working at an AP who turned off their access has already joined Debralee Lorenzana at the unemployment collective. …as that is how you make oodles of money: buy the basket, short the stocks …or vice versa.

    When prices are volitile that’s just an opportunity for AP’s.

    If iShares, Vanguard et al see the APs leaving money on the table, they’ll fire the ones they’ve got an get new ones who want to make money. Problem solved. ETFs are brilliant.

  10. mcg says:

    Way off topic,so I apologize, but check out page 6 in this weeks Barrons, the Alan Abelson commentary.
    It seems he is communicating his thoughts with large letters as well as words.I don’t think he sees a “V” shaped recovery under way

  11. [...] liquidity is now a known issue.  (Big Picture, [...]

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