CONTRIBUTORS
David Mann
Head of Capital Markets, Global Exchange-Traded Funds (ETFs), Franklin Templeton Investments
While new-year festivities are over in the Western world, the celebrations for Chinese New Year are just getting started. David Mann, Head of Capital Markets, Global Exchange-Traded Funds (ETFs), discusses what he thinks investors need to know about prolonged periods of market closures like we’ll see in many Asian markets to mark the coming of the year of the Rooster.
During this annual celebration, many Asian markets are closed for multiple consecutive days. For example, the Chinese markets are closed for five straight sessions (Friday, January 27–Thursday, February 2). One of the questions I am often asked as we approach this extended break is what should be expected regarding the trading of ETFs that hold Chinese (or Taiwanese or South Korean) securities.
The answer is price discovery, and this is especially true for US-listed ETFs that hold international securities. When those underlying markets are closed, the US ETF serves as a gauge of what the US market thinks will happen in those closed markets when they reopen. In fact, I wrote about this in my recent flash crash article.
To do their job effectively, ETF market participants need to be able to value the ETF’s underlying basket of securities. If those underlying securities are closed for trading in the US time zone (for example, international equity) or are less-liquid securities (such as fixed income), then they need to be able to value other correlated (similar) instruments to those holdings, such as equity index futures contracts, which can act as proxy vehicles for equity markets. When market participants are unsure of both of those values, it can lead to uncertainty regarding the price of the ETF, and potentially cause wider spreads.
Now typically, this discovery process plays out on a daily basis. For example, on a typical Monday in the United States, ETFs that hold international stocks will move higher or lower based on the collective expectation of what will happen on Tuesday in those underlying markets. When the US market opens on Tuesday, the ETF will adjust for what actually did happen overnight (Tuesday) in those international markets as well as the expectation of what will happen the next day (Wednesday).
This happens over and over again, and as a quick side note, is often the cause of premiums or discounts between the closing price of the ETF and its official net asset value (known as NAV). As I mentioned above, market participants can use correlated instruments to manage their risk until those markets open the next day.
In the case of market closures in celebration of Chinese New Year, the exact same principle applies, except now that price discovery happens for multiple days in a row rather than just overnight.
In principle, it should not matter that China’s market is closed for five days, Taiwan’s market is closed for four days or Hong Kong’s market is closed for two days. The US ETF will trade based on the expectation of where those markets will be when they reopen.
The takeaway is that the ETF still should trade in an efficient manner, even if the underlying markets are closed for more than one day. Hopefully, that will allow everyone the opportunity to celebrate the year of the Rooster—and provide a sense of ease over other holiday periods around the world!
David Mann’s comments, opinions and analyses expressed herein are for informational purposes only and should not be considered individual investment advice or recommendations to invest in any security or to adopt any investment strategy. Because market and economic conditions are subject to rapid change, comments, opinions and analyses are rendered as of the date of the posting and may change without notice. The material is not intended as a complete analysis of every material fact regarding any country, region, market, industry, investment or strategy.
This information is intended for US residents only.
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WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal. Brokerage commissions and ETF expenses will reduce returns. ETF shares may be bought or sold throughout the day at their market price on the exchange on which they are listed. ETFs trade like stocks, fluctuate in market value and may trade above or below the ETF’s net asset value. However, there can be no guarantee that an active trading market for ETF shares will be developed or maintained or that their listing will continue or remain unchanged. While the shares of ETFs are tradable on secondary markets, they may not readily trade in all market conditions and may trade at significant discounts in periods of market stress.