Will exchange-traded funds ever live down their contribution to the Aug. 24 market plunge? Securities and Exchange Commission member Kara Stein doesn’t think they should.
Stein, an SEC commissioner, repeated Friday at the Practising Law Institute’s annual SEC Speaks conference in Washington her belief that the SEC must take a “holistic” look this year at ETFs’ transparency and how these products interact with the capital markets, as even the plain-vanilla types of ETFs can be risky to investors.
Stein warned in her remarks that ETFs have expanded “far beyond their equity index origins to include far more complex offerings.”
While retail investors are being introduced to “innovative ETFs that may offer attractive yield,” these products “also feature more complex and other higher risk strategies,” including currency hedged ETFs, smart-beta strategies, and bank-loan ETFs. Some of the new products are being hailed as “exotic or innovative within the industry,” but others “have been described as ‘toxic,’” Stein said.
The risk presented by some of these new products, she continued, “may not be fully understood by those who have invested in them.”
Indeed, even plain-vanilla, equity index ETFs may present risks that are not always anticipated or fully understood, as evidenced by the events of Aug. 24, when the stock market dropped 1,000 points in early morning trading.
While Commission staffers and market participants continue to assess what happened, Stein said, “one fact” about that day is “crystal clear … many ETFs behaved in an unpredictable and volatile manner.”
ETFs experienced greater increases in volume and more severe volatility than corporate stocks, Stein noted, with nearly 20% of all ETFs trading on the morning of Aug. 24 exhibited abnormally high volatility. More than 40% of the 499 ETFs invested in U.S. equities experienced a trading pause, Stein noted, with the pauses varying depending on an ETF’s focus, size and capitalization.
Noah Hamman, CEO of AdvisorShares, told ThinkAdvisor in an email message that “it seems that there has been a ‘blame the ETFs’ type of attitude” for market volatility “from many outside of the investment management space.” However, the ETF industry “has been able to proactively educate on the differences among the risks of trading on an exchange, as well as versus product structure and versus investment strategy risk.”