Why ETFs Withstood the Coronavirus Crash

This article orginally appeared in Capital Magazine here.


“ETFs don't do well in times of crisis,” we were all warned. But during the coronavirus crash, they didn't just do well – investors also bought bond ETFs. Enrico Bruni, head of Europe and Asia at the trading platform Tradeweb, explains why. - By Stefan Schaaf

The rise in popularity of exchange-traded funds (ETFs) was accompanied until recently by warnings about their risks. However, these may have been exaggerated. When capital markets were brought to their knees in February and March due to the rapidly spreading coronavirus pandemic, overall market infrastructure not only held up, but ETF trading also functioned quite smoothly. In this interview, Enrico Bruni, head of Europe and Asia at the trading platform Tradeweb, explains why investors increasingly turned to bond ETFs during the crash, despite the criticism they had received earlier.

“We are a listed operator of online marketplaces for financial products,” he states, describing the company’s activities. That said, Tradeweb is a fully regulated trading platform that competes on an equal footing with traditional stock exchanges, such as the London Stock Exchange (LSE) or Deutsche Börse. According to data published by the firm, the daily average turnover on Tradeweb platforms was USD 791.7 billion (bn) in May, up 7.2% from the same month last year. Yet, things have calmed down a little; in March, the average daily trading turnover in equities, ETFs, bonds, derivatives, and money market products was more than USD 1 trillion. This was around a third more than the annual average in 2019.

For years there has been controversy over the risks of passive investment products, which are becoming increasingly popular with both institutional and retail investors. Those warning against risks mainly focus on the issue of liquidity: they argue that an ETF cannot be more liquid than the assets it represents, i.e. equities or bonds. This applies, in particular, to corporate bonds or riskier fixed-income products such as high-yield bonds. Only a small proportion of trading activity in these instruments is conducted on regulated exchanges; instead, it takes place bilaterally between banks and brokers. However, the sell-off of an ETF could trigger a slump in prices even if only small portions of a bond are executed on the stock exchange.

But according to Bruni, there were no significant problems in ETF trading when the markets crashed in March. “It is quite clear that the market infrastructure has functioned reliably and consistently during a period of high uncertainty,” says Bruni. “This is not a financial crisis; it’s a public health crisis.” The expectations from the stricter regulation of trading venues – governed by MiFID II rules in Europe – were fulfilled. “The markets remained transparent and investors were protected; this is important in times of stress.”

Strong rise in trading volume

The crash was, of course, noticeable, and this was reflected in the spreads, which indicate the difference between willingness to buy (bid) and willingness to sell (ask) prices. The bigger this difference – or, in market jargon, the wider the spread – the less liquid the respective financial product tends to be. “In the case of ETFs, spreads widened in March,” reports Bruni. “However, this was consistent with the widening of bond spreads; and the same is true for equities.” Furthermore, all data prior to the intervention of the central banks (Tradeweb monitors, for instance, the time it takes to process a trade) suggested “a liquidity bottleneck in corporate bonds”.

Overall, Tradeweb, much like other stock exchange operators, recorded a sharp rise in trading volumes at the peak of the crisis. Bruni speaks of a “substantial increase”, which eased off somewhat in April and May. That being said, ETF trading activity remained high. In the first quarter, the average daily turnover in US and European-listed ETFs totalled USD 9.2bn, more than twice as much as in the same quarter last year. While volumes were lower in May, at USD 3.8bn (USA) and USD 1.6bn (Europe) they were still 60.6% and 5.1%, respectively, up on the same month last year.

Run on bond ETFs

“We saw substantial growth in ETF trading,” explains Bruni. “In relative terms, the biggest increase was in bond ETFs.” According to Bruni, bond products accounted for 46% of ETF trading in April, whereas under normal circumstances it would probably have been only 30 to 35%. The same goes for the month of May.

So during the crisis, bond ETFs – the very products that had been expected to pose the biggest problems – actually gained in popularity. “At the height of the crisis, investors wanted to express or hedge their views on certain macro issues,” says Bruni. A flight of investors into US government bonds was observed in March. Apparently, many of them use ETFs to this end. In April, although volumes declined somewhat, the relative overweight of fixed-income ETFs persisted.

However, trading in individual bonds also grew significantly in April. Average daily volumes in US government bonds on the Tradeweb platform climbed by 16.7% year-over-year to USD 89bn. Turnover in European government bonds even rose by 23.5% to USD 27.3bn. “We saw increased activity in March and April,” says Bruni. “The markets for government bonds in the developed countries were strongly influenced by central bank activities in March, and then also by increased government issuance in April.”