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Pandemic puts pressure on ETF spreads

The spreads on many exchange-traded products were wider than usual amid the COVID-19 market crash, with price discovery becoming increasingly more difficult.

That's according to ETF Securities co-head of sales Kanish Chugh, who pointed to global equity vehicle iShares S&P 500 ETF as an example.

The spread on this product increased to 15 basis points in March from an average spread of four basis points in February, he said, reflecting that on several occasions in March, US stock futures stopped pricing.

"This was a result of futures falling more than 5% and going 'limit-down' meaning they are not allowed to move any more," Chugh said.

The increase in spreads in the ETF market was expected, he said.

"If the bid/offer spread on any index widens, that of an ETF based on it will react," Chugh explained.

"Say it's the MSCI Emerging Markets Index, and the spread surges from 30 basis points (0.3%) to 90 basis points (0.9%), you would expect a tripling of the ETF's spread too, at a minimum. This is what the ETF is meant to do."

During the "coronavirus crash" many ETF sectors and asset classes' spreads widened, as price discovery became increasingly more difficult.

In fixed interest sectors, such as corporate bonds and high-yield bonds, the market leaders had to take on risk to maintain buy-sell spreads as prices gapped, pushing spreads wider.

"Whenever spreads widen, it's because of the difficulty of price discovery in the underlying assets," Chugh said.

"We saw the market-makers - which are firms that are some of the biggest buyers and sellers of bonds in the world, and they are probably better-placed than anyone to understand what the prices are of some of these fixed-interest products - take risk on their balance sheets to maintain a market.

"And in those cases, we then see the ETFs actually providing a more accurate reflection of the pricing than the underlying market is providing."

Despite widening spreads, Aussie ETF trading soared during March, with the number of transactions, volume and value of trading figures reaching all-time highs.

"The ASX ETF sector on average traded about $770 million a day - that's nearly four times the high of the previous peak," Chugh said.

"The 748,000 transactions for March was about two-and-a-half times higher than the previous month.

"There were a lot more people being more active in the market, because the versatility of ETFs allowed them to do what they wanted to do."

Investors have recognized the versatility of the ETF market during periods of volatility, he argued.

"We saw a sharp spike in activity, as more investors realised that they could use the ETF market in a much more varied way than they may have thought - for buying, selling, hedging and tactically trading, whatever they wanted to do, in a variety of asset classes," Chugh said.

"Activity in February and March showed that Australian investors are increasingly comfortable with using ETFs to express their investment views."

Read our full COVID-19 news coverage and analysis here.

Read more: COVID-19Kanish ChughETF SecuritiesiShares S&PMarketsexchange traded fundsexchange traded products
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