Viewing Volatility Versus Uncertainty Through an ETF Lens

Examining the difference between volatlity and uncertainty through the lens of ETF trading.

    David Mann

    David MannHead of Capital Markets,Global Exchange-Traded Funds (ETFs)Franklin Templeton

    Investors certainly have had to face both volatility and uncertainty these past few weeks given coronavirus concerns and other geopolitical risks. David Mann, our Head of Capital Markets, Global Exchange-Traded Funds (ETFs), talks about the difference between the two through the lens of ETF trading. 

    In times of increased market volatility, ETFs will tend to trade at their typical bid/ask spreads even if the broader markets are up/down multiple percentage points. The reason is that market makers quote our funds based on the value of the underlying securities, and even during big market moves, they will still have confidence in those values. As an example, during last week’s large market selloff, our equity-based funds that typically have spreads in the 2-4 cent range still had those spreads even with broader market down more than 3%. Investors should feel confident trading them, even during days with significant market moves.

    On the other hand, market uncertainty, such as the unexpected 50 basis point1 interest-rate cut by the Federal Reserve recently, can and usually does cause a temporary widening of spreads. Whenever there is pending or unexpected news, ETF market makers will have doubts as to the value of the underlying securities and will thus widen out their ETF spreads accordingly.

    This is true of all ETFs (not just ours). Investors should consider avoiding trading ETFs during times of market uncertainty. It is typically short-lived, and once the market makers have had time to digest the news and how it might impact the underlying security valuations, spreads typically fall back in line with the norms.

    We continue to monitor our funds at all times and will gladly send updates as needed as to our opinions of the best times to trade.

    ENDNOTES

    1. A basis point is a unit of measurement. One basis point is equal to 0.01%.

    What Are the Risks?

    All investments involve risks, including possible loss of principal. Generally, those offering potential for higher returns are accompanied by a higher degree of risk.  Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. For actively managed ETFs, there is no guarantee that the manager’s investment decisions will produce the desired results.

    ETFs trade like stocks, fluctuate in market value and may trade above or below the ETF’s net asset value. 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. 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.