Because they were unable to sell underlying holdings fast enough to meet investor demand for withdrawals, Standard Life Investments, Aviva Investors and Aberdeen Asset Management’s active property funds were among those to shut their doors or set sky-high exit charges for investors hoping to make redemptions.
ETFs, meanwhile, were sheltered from such problems since they hold listed real estate investment trusts and securities, rather than invest directly in the underlying physical property.
Jose Garcia-Zarate, senior ETF analyst at data provider Morningstar, said: “If everybody is in a panic and they want to redeem from direct property funds, the fund manager has to sell the buildings, and that’s not going to happen in 24 hours. If you’re invested indirectly, the liquidity issue is not as troublesome.”
But it is in ETFs’ interest to have direct funds open. Laurent Deville, professor of finance at EDHEC Business School, said: “You cannot run an ETF market without companies investing directly in the sector. So ETFs cannot replace everything; they are an additional investment possibility with their own pros and cons.”
And although they continued to trade, ETFs did not avoid the problems of the wider market. As in any market, liquidity is dependent on having potential buyers, meaning investors in ETFs in unpopular sectors could see the value of their holdings fall as they try to sell.
Dave Nadig, director of ETFs at FactSet Research, said: “If people want to get out before the underlying funds can be liquidated, you’re going to get poor pricing and assets will trade at a discount. You can’t get away from the fact that the underlying asset – in this case, a house – is illiquid.”
The share price of the iShares UK Property Ucits ETF, the largest UK property ETF listed in Europe, fell 13.9% on June 24, the day the Brexit decision was announced, and was still down more than 10% over 12 months on August 3. The ETF also fell to a discount of 0.26% below its net asset value by June 28.
Some believe this effect is amplified by the fact that ETFs are, by design, not diversified. The iShares ETF invests in just 33 holdings – the top three being Land Securities Group, British Land and Hammerson REIT.
Lack of diversification
Deville said: “Indices based on a small number of constituent stocks or indices focused on a particular industry are likely to be riskier since a greater fraction of idiosyncratic risk is not diversified away. With greater risk should come lower liquidity.”
Nevertheless, investors still have the option of selling out of ETFs, even if it is for a lower price.
ETFs continued to trade throughout the Asian financial crisis in 1997, in Egypt in 2011 and in China and Greece, when either their stock exchanges closed or stocks were suspended from trading. During these times, ETFs were used as tools of so-called price discovery – they were the last the window through which investors could see a price and trade.
However, these incidents do not mean ETFs are immune to closure. During the financial and economic disruption in Greece in 2015, several stock exchanges across Europe suspended trading of the Lyxor Ucits ETF FTSE Athex 20. This halted both primary and secondary market trading due to the lack of pricing information. The Greek stock market itself was suspended on June 27, 2015.
Nadig said: “Normally it would keep trading but what happened there would not have been to the benefit of investors. In those situations, ETFs normally would have provided a market when there was none.”
Lyxor’s Europe-listed ETF did not open for trading until August 7, some four days after the Greek stock market reopened, although the Global X MSCI Greece ETF, which is listed in the US, continued to trade.
But such situations are rare, even for the sectors that are most illiquid. High-yield and junk bond ETFs are the closest illiquid equivalent to direct real estate active funds, according to Eric Balchunas, ETF analyst at Bloomberg Intelligence. He added, however, that the US-listed iShares iBoxx $ High Yield Corporate Bond ETF, the largest in its sector, has not stopped trading since its launch in 2007.
He said: “If you had trouble getting out of your junk debt, it means literally nobody is buying those bonds. That would mean World War III is going on.”