Violent downturns could test new ETF strategies, warns MFS Investment
New innovations in the exchange-traded fund industry can come at a cost to investors under extreme circumstances.
ETFs dealing with increasingly complex derivatives and less transparent markets may be in uncharted territory when it comes to severe crises, according to Jamie Harrison of MFS Investment Management.
“These may be things you want to pay attention to as volatility increases,” the firm’s head of ETF capital markets told CNBC’s “ETF Edge” this week. “As innovation in the ETF suite continues to accelerate, [it’s] “It’s certainly something we advise our clients to be cautious about… If we start to see deep selling, lack of transparency could definitely be an issue.”
His firm has been in business since 1924 and is known for inventing the open-end mutual fund. Last year, ETF.com named MFS Investment Management the best new ETF issuer.
“It is important to do due diligence on the portfolio,” he said. “Having a firm with deep partnerships, a deep roster of subject matter experts playing with the Street A-team, and existing liquidity providers [are] very important.”
Is liquidity the main issue?
Harrison suggested that the real issue is liquidity, especially during hard selloffs.
“We’ve all seen the news and headlines about potential private credit ETFs. This picture is getting much darker,” he added. “That’s up to advisors and investors.” [and] “We help clients really dig deep, examine confidential information, and engage with their issuers.”
Investors will need to ask some tough questions, he noted.
“What does that look like on a 20% decline? How does this liquidity facility work? Will I be able to get in? Will I be able to get out? And if I can, will I be able to get out at a price close to NAV?” [net asset value]and what is the infrastructure in your store in terms of managing that evaluation for me,” Harrison said.
Christian Magoon of Amplify ETFs also worries that these new ETF strategies could weather a massive decline. He listed private credit as a red flag.
“If your ETF has private credit, I think it’s worth looking at what the standards are around liquidity and how the ETF is trading, because there has to be some mismatch between the trading speed of the ETFs and the underlying asset,” the firm’s CEO said in the same interview.
Magoon also noted potential problems in the environment equity-linked notes. Notes provide fixed income security while potentially offering higher returns relative to stocks or stock indexes.
“These could potentially be stressed by repayments and underlying credit risk. This is another type of unique derivative,” Magoon said. “If we have a big downturn or there is a contagion in private credit or something to do with the banking system, I would look very closely at any ETF that has equity-linked bonds.”
