A caveat about ETFs

[Ed_The_Gypsy]

I always wondered if there might be a gotcha with ETFs, as they are a derivative of sorts. You are one step removed from actual ownership of the stocks, just like mutual funds. Even though ETFs are traded like stocks, there will be times when you CAN'T trade them, when trading will be suspended. This happens when trading is suspended on ONE stock in the ETF.

A quote from the article (my emphasis):

For example, on Aug. 24, 2015, trading was halted in eight of the stocks in the Standard & Poor’s 500 Index. This freeze triggered stoppages in over 40% of all U.S. equity ETFs. And on that same day, 20% of all U.S. equity ETFs had price movements of at least 20%, compared to less than 5% of stocks. As long as there are institutions that are willing to take positions against each other in the market, then ETF will not be an issue. But what happened on August 24 of last year shows that that can disappear in an instant. It is not possible for an ETF to be more liquid than its underlying securities, and most individual investors do not realize this.

Are ETFs Liquid Enough for a Bear Market Exodus? | Investopedia

If the market crashes, holders of ETFs will be last in line for the exit. This does not bother me, but it would be a rude surprise to an active trader.

 

[Sunset]

Interesting effect if you hold an etf that contains the frozen stock.

Of course all mutual fund owners are by definition last in line for the exit on a market crash day, since buy and sell are done at the end of the day price.

 

[ziggy29]

Right. An ETF is, in a panic, potentially less liquid than than an individual security, but still more liquid than a traditional mutual fund. Unless one is frantically day trading, this is likely a non-issue.

 

[splitwdw]

Ed, Thanks for the information. I don't own any ETF but have been looking at them. It's logical when you think about individual stocks held in an ETF being frozen....if you think about it. I certainly never did. That's one of the reason I like this forum. Still working but learning lots here.

 

[Ed_The_Gypsy]

This is still only a small wrinkle for me. ETFS still have lower costs and are more liquid than mutual funds most of the time. I was fully invested all through the 80's. I am moving into ETFS as I find ones I like.

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[mathjak107]

Stocks and etf's are arbitraged very carefully and any spread is usually quickly resolved . 8/24 was the mini flash crash and it created pricing issues while it was happening . surprisingly out of all the stock etf's it really effected very few .


Did ETF investors just live through another flash crash this morning? That’s the question some advisors are trying to answer after massive selling in early trading hours saw some ETFs flirt with 50-plus-percent losses—all while the SandP 500 registered a 4 percent decline.

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"These weren’t illiquid, small ETFs either. The iShares Select Dividend (DVY | A-69) traded some 36 percent lower; the Guggenheim SandP 500 Equal Weight (RSP | A-83) hit a 42 percent drop and the iShares Conservative Allocation Fund (AOK) traded roughly 50 percent below its Friday close.


In addition, the iShares SandP Mid-Cap 400 Growth (IJK | A-77), the iShares U.S. Broker-Dealers (IAI | C-76), the PureFunds ISE Cyber Security ETF (HACK | C-26) and the Emerging Markets Internet and Ecommerce Fund (EMQQ | F-20) were also among the ETFs hit the hardest, according to sources.

Big Discounts To NAV
ETF investors basically sold these funds at massive discounts to their fair net asset value, just to see those security prices bounce back in a matter of minutes. Paul Weisbruch, of Street One Financial, said the problem could have stemmed from pent-up sell stops that hit the market after investors struggled to log in to their online brokerage accounts for about 20 minutes around the market open.


“It's feasible to me, that since the futures were down roughly 5 percent on the open, and there were clear sell imbalances across the board and potentially ‘pent up’ ‘GTC’ sell stops on the books across many brokerage firms, that a cave-in effect may have occurred, resulting in artificially low prints and prices,” Weisbruch said."

http://www.etf.com/sections/features...tfs?nopaging=1

 

[LOL!]

I actually do not mind buying ETF shares 20% off actual value during a flash crash, so I see this liquidity problem as something very positive and beneficial that mutual fund share holders don't get to take advantage of since mutual fund shares trade at net asset value figured out after the market closes.

And I can write from experience, that not very many people actually get shares of ETFs at those bargain prices because people don't sell them stupidly. But that is the liquidity problem: Everything locks up. Bid/ask spreads will be quoted, but it is very likely that no one is stupid enough to actually sell any significant number of shares at a those prices.

But it doesn't hurt to own mutual fund shares in case one needs to sell something in order to buy those depressed ETFs. Unfortunately, one would have to know that "tomorrow morning there will be a flash crash", so that one could sell the mutual fund shares ahead of time to raise cash. Or maybe one could just use a margin account.

 

[Sunset]

Also, it's rare but a mutual fund can simply refuse to redeem your shares, it has happened in the past and will happen again. All while the rest of the entire stock market is humming along fine.

Here is one example:
Third Avenue Blocks Redemptions From Credit Fund Amid Losses

 

[mathjak107]

i had it happen to my money market in 2009 when they broke the buck . our money was frozen .

 

[ERD50]

It's interesting, but what is the alternative?

You'd probably need to own 30+ stocks for decent diversification, and to liquidate you'd be setting up 30 trades. Seems rather cumbersome for a possibility of a problem that would likely happen at a time I wasn't buying/selling that ETF anyhow.

Even for short term traders, seems like a pretty rare occurrence?

-ERD50

 

[Ed_The_Gypsy]

Flash crash. When the price of an ETF does not reflect the value of the underlying stocks. This is a big gotcha. The curse of derivatives again.

I am leaving ETFs. Carefully.

And going back to mutual funds.

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[Lakedog]

I actually do not mind buying ETF shares 20% off actual value during a flash crash, so I see this liquidity problem as something very positive and beneficial that mutual fund share holders don't get to take advantage of since mutual fund shares trade at net asset value figured out after the market closes.

Agree that these events are more of a positive for ETFs. I haven't owned a mutual fund in years as I prefer to be able to buy/sell while the market is open and know at what price I am buying or selling. I only own Vanguard ETFs with most of them being free to trade.

 

[ERD50]

Flash crash. When the price of an ETF does not reflect the value of the underlying stocks. This is a big gotcha. The curse of derivatives again.

I am leaving ETFs. Carefully.

And going back to mutual funds.

Any price discrepancy is going to get corrected in short order. I guess I don't get why this is such a concern for you?

I've seen stock prices misreported for maybe an entire day after a split. Is that a reason to not buy stocks?

Obviously, do as you see fit - I'm just wondering what's behind your concern. Limit orders ought to protect you in any case (addressing your 'carefully' comment). A limit order to sell won't hit unless your desired price is hit. Who cares if it was 'miss-priced' at that moment, it was the price you were happy with? Same on the buy side - set a limit, and you'll get the ETF at that, or lower price.

The only issue would be a stop loss order - but this 'never-say-never' guy has repeatedly said NEVER set a stop loss order on anything. So that is a non-issue.

-ERD50

 

[Ed_The_Gypsy]

ERD50, I will look into it. Derivatives spook me. Let me consider.

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[Sunset]

If you own only stocks, you cannot trade the ones that get frozen when they are frozen either, and maybe that is the exact one you wanted to trade

Stocks can also have flash crashes, and really is more likely and often than an ETF, because it just takes some sell orders and zero buy orders in the system to cause a stock price to plummet.

That is why I ALWAYS use limit orders for my stocks, etf's, and options.
I'd rather not buy/sell than buy/sell at some crazy price.