New innovations in the exchange-traded fund industry could come at a cost to investors under extreme conditions.
ETFs involved in increasingly complex derivatives and less transparent markets may find themselves in uncharted territory when sharp downturns occur, according to Jamie Harrison of MFS Investment Management.
“That’s something to keep an eye on as volatility increases,” the firm’s head of ETF capital markets told CNBC’s “ETF Edge” this week. “As innovation within the ETF industry continues to grow rapidly, [it’s] We definitely encourage our customers to be at the forefront…Lack of transparency could well be an issue if there are big sell-offs.”
His company has existed since 1924 and is known for inventing the mutual fund. Last year, MFS Investment Management was named Best New ETF Issuer by ETF.com.
“It is important to examine the portfolio carefully,” he said. “We have a company with deep partnerships, a wide range of subject matter experts who play with the A-Team on Street and available liquidity providers.” [are] super important.”
Liquidity as the real problem?
Harrison said the real issue is liquidity, especially during a sharp selloff.
“We’ve all seen the news and headlines surrounding potential private credit ETFs. The picture is getting much murkier,” he added. “It’s up to the advisors, it’s up to the investors [and] giving customers the opportunity to really look under the hood and engage with their issuers.”
He noted that investors need to ask some tough questions.
“What does that look like at a 20% drawdown? How does this liquidity facility work? Will I be able to get in? Will I be able to get out? And if I can get out, I can get out at a price close to the net asset value.” [net asset value]“And what does the infrastructure look like in your business to manage those considerations for me,” Harrison said.
Christian Magoon of Amplify ETFs also fears that these newer ETF strategies could survive a huge drawdown. He called personal loans a warning sign.
“If your ETF has private loans, I think it’s worth taking a look at what standards apply in terms of liquidity and how that ETF is traded, because there should be some mismatch between the trading speed of ETFs and the underlying asset,” the company’s CEO said in the same interview.
Magoon also pointed to potential issues related to equity-linked notes. The notes provide fixed income security while offering potentially higher returns related to stocks or stock indices.
“These could potentially come under pressure due to redemptions and underlying credit risk. This is another type of unique derivatives,” Magoon said. “I would look very closely at any ETF that has equity-linked bonds in case we go into a major decline or there is a contagion in private credit or something related to the banking system.”
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