ETFs: When Investor Worlds Collide

When retail investors get hit by big block trades.

May 28, 2012

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car crashLast week I ran this blog post about the growing role of institutional money in the ETF space as pension funds and other large investors find new ways to use them in their portfolios.

The advent of institutional money is seen as the hallmark of a maturing asset class. Take hedge funds for example – back in 2002 when I attended Canadian Investment Review’s first Investment Innovation Conference, those presenting on hedge funds were speaking to an audience of pension funds that was largely inexperienced with them. Not so today – in just a decade, institutional money has seen the hedge fund industry grow and change dramatically, as big investors bring big demands for transparency, liquidity and better regulation.

While institutions have proven transformative in the hedge fund space, big money is now making waves in the ETF space. The problem is that some smaller investors are getting caught in the surge as that same institutional cash moves around in the form of big block trades. Indeed, credit rating agency Moody’s is now warning that institutional trades in ETFs can hammer their value, pushing prices down as investors like pension funds (and even some hedge funds) seek to shed their positions in these passive vehicles.

We saw this happen last month Moody’s says, as one institution made a significant in-kind redemption from a junk bond ETF and caused its price to fall to 1.3% below NAV. This happened on May 10 as State Street Global’s SPDR Barclays Capital High Yield Bond ETF saw a $780 million redemption to the tune of 19.7 million shares. Another 14.4 million shares were eliminated and the share price of the ETF fell 2.7%, a discount of 1.27% to NAV by May 17.

Not an insignificant sum given that for the rest of the year the ETF delivered a small 0.4% premium.

Moody’s argues that ETFs should broadly mirror markets they follow and not trade at a large premium or discount to NAV. “This collapse in premium would have cost an investor a substantial portion of the year-to-date total return of the ETF, which was 5.9% through 30 April,” Moody’s said.

But it also highlights a key point about the growth of the ETF industry – in most asset classes, institutional money should benefit all investors as new demands for transparency and fair practices come from the fiduciaries on the other end of the trade. To get there, however, ETF providers must make sure their products are built to handle a large institutional load of money. If not, it’s the retail investors that will suffer – and that’s not good for the future of the asset class.

This article was originally published on Benefitscanada.com.

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