In the post mortem that has followed Monday’s opening plunge of more than 1000 points on the Dow Jones stock market index, attention is focusing hard on ETFs. It didn’t take long – a CNN article published Monday evening had section headings titled “Alarming ETF meltdown” and “Large ETFs mysteriously dive”.
There were big price moves in many ETFs that weren’t warranted by the price movement of the underlying shares. This isn’t the first time that this has happened. A quick search of the internet revealed a 2013 article about a bond market sell-off causing ETF shares to trade below the value of their assets. I also remember articles discusing this problem during the last financial crisis although I couldn’t track down these press clippings.
The CNN article points out how both Exchange Traded Funds backed by large and small providered experienced the turbulence. The moves have been compared to those that have been anticipated in the bond market where bond fund investor outflows might overwhelm their ability to keep up with redemptions since the underlying assets may not be immediately liquid. Yet, these mini-flash crashes were seen in ETFs with assets confined to stocks which are not supposed to be facing the same issues as are going on in bond market liquidity.
The problem may have been exacerbated by a computer glitch at BNY Mellon, which has had problems calculating the Net Asset Values (NAVs) of mutual funds and ETFs. The Wall Street Journal says that the outage isn’t related to Monday’s market turbulance. However, funds are required to provide accurate fund values daily and I expect there will be an SEC investigation into the matter. Because of the volatility in trading this week, some funds have had errors in NAVs that are more 1%, which would be considered material.
A zero hedge article placed some of the blame for the lack of liquidity on High Frequency Traders. They appear to provide the market liquidity during normal conditions but when there are large market moves they stop trading and so there is much less liquidity then expected.
How did this come to our attention? An article in Bloomberg republished an earlier article on the one-man, $1.2 billion ETF shop that is Andrew Chanin’s HACK, a cybersecurity ETF. The article just seemed one of those too good to be true stories that you see when there is a bubble in the market. Perhaps unsurprisingly, it turns out that HACK was one of the ETFs that plunged on Monday.
If you work with ETFs and have evidence of misconduct, the Securities and Exchange Commission offers whistleblowers a reward when they sanction companies more than $1 million for violations of federal securities laws. Feel free to contact us if you would like to discuss it. If this is the start of another mortgage-like crisis, we think the Government should know.