How Have ETFs Fared During This Bear Market?
Ben Johnson explains what happened with value and growth and discounts and premiums.
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Christine Benz: Hi, I'm Christine Benz from Morningstar.com. Stocks recently closed out their worst quarter since 2008, and some bond-fund investors encountered turbulence, too. Joining me to provide a recap of what went on with ETFs during the recently closed quarter is Ben Johnson. He's Morningstar's director of global ETF research in Morningstar Research Services. Ben, thank you so much for being here.
Ben Johnson: Thanks for having me, Christine.
Benz: Ben, let's start by going over some of the key performance trends. Obviously it was a bad quarter for stocks, but some equity ETFs did better than others. Let's talk about that ongoing bifurcation between growth and value ETFs.
Johnson: Yeah, there is an ongoing bifurcation between growth and value as you've described it, Christine, and the pain has been particularly acute within the small-cap value space, where you've seen sharp drawdowns, certainly much sharper than we've seen more broadly in other segments of the Morningstar Style Box. So really, if you were to zoom out further, stock markets around the world have generally done bad. It's really been a matter of which ones have done less bad than others.
So if you're to migrate up to the upper right-hand reaches of the Morningstar Style Box, large-cap growth has fared relatively well. The U.S. has fared relatively well to certain international markets, certainly fared better than emerging markets. And ultimately what this speaks to is a degree of variation across sectors as well. So if you look at any equity segment that has anything to do with the oil patch, it's been an absolute bloodbath, certainly over the course of March as sort of the proverbial perfect storm has hit the energy markets. Demand is all but gone away. Supply has been more than abundant. They're running out of places to store oil.
So that's an area of the market that's been hit particularly hard, and explains to some extent the relative underperformance of value as a style more broadly and certainly small-cap value relative to all other segments of the Morningstar Style Box.
Benz: Another phenomenon that crept up during the first quarter was some action with exchange-traded fund premiums and discounts. Let's talk about where we saw some of these premiums, and especially discounts, crop up, and what caused them, and what is an investor in ETFs to think about what you and the team observed with discounts and premiums in the first quarter?
Johnson: What we saw more generally was that the floor fell out from under the markets, in the bond markets in particular, it was difficult to find a bid for just about any bond. And I think what was most surprising certainly to me was that floor fell out under some relatively stable, relatively liquid segments of the bond market. You know, investment-grade corporates, even certain segments of the Treasury market. So this manifests in fairly significant, indeed unprecedented discounts, so the prices of certain ETFs, including those tracking broad-based benchmarks like the Bloomberg Barclays Aggregate Index, traded well below their net asset values.
Now this, ultimately, and certainly in hindsight, is more so I think a matter of optics than anything else. The ETFs are just much more fast-moving. They contain much more information than their underlying net asset values, which almost definitionally are always stale. So trying to clock the bond markets using NAVs is really akin to trying to clock the Olympic 100-meter dash using a stopwatch that only moves in 10-second instruments. It's not calibrated for the task at hand. So what we saw is that ETFs prices and ETF price discovery ultimately led what transpired in the underlying bond markets. The NAVs were slow to catch up and ultimately--especially after the Fed stepped in with the announcement that it was going to take any number of measures, including the unprecedented measure of purchasing not only corporate bonds but also corporate bond ETFs--is that ETFs NAVs and their prices were ultimately reunited.
So we've seen normalization, broadly speaking, though there are certainly some pockets, notably in high-yield munis, where these disconnects persist. But across the board, what I would say is that ETFs have really passed this test with flying colors, especially given that we've seen episodes where the markets have briefly hit circuit breakers, they've been shut down, they've reopened efficiently. ETFs is a means of achieving liquidity, not just in fixed-income markets, but across a variety of markets. It's served investors capably, but they've created some interesting questions, some interesting challenges for people who, generally speaking, would rightfully say that these things have tended to trade very closely to their underlying net asset values.
These are unprecedented circumstances. These are exceptional times, and all told as the dust has started to settle, I would say ETFs fared exceptionally well.
Benz: Let's take a look at fund flows. A lot of volatility obviously. How did investors behave?
Johnson: If we look just at ETF flows during the month of March, what we saw is actually net inflows into equity ETFs, broadly speaking. A lot of that is attributable to net new inflows into ETFs that fall into Morningstar U.S. large-blend category. Notable among them are (SPY), the SPDR S&P 500 ETF, which is the granddaddy of all the ETFs, as well as (VOO), which is Vanguard's S&P 500 ETF, and (VTI), the Vanguard Total Stock Market Index ETF. So investors generally within U.S. equities look to have been continuing to add net new money into the market. And if you were to drill down and look at it in the individual issuer level, this is notable too among the identities of the issuers who continued to see net new flows--most notable among them being Vanguard and Schwab, which tend to have investor bases that skew more so towards steady-Eddie investors. These are advisors, these are individuals that are, as Vanguard would put it, continuing to stay the course. They're hanging tough. They're investing at regular intervals during the midst of unprecedented sort of melees within the broader market.
Benz: Ben, it's always great to get your perspective, especially in turbulent times like these. Thank you so much for taking the time to be here.
Johnson: Thanks again for having me, Christine.
Benz: Thanks for watching. I'm Christine Benz from morningstar.com.