Both types of fund, exchange-traded and mutual, had issues throughout last week in calculating their per share net asset values .
For fund management firms, the lack of end-of-day mutual fund pricing was a real pain. For us as investors, however, the ETF consequences were far worse.
The best feature of mutual funds, in my view, is the guarantee that under all but the most extreme circumstances owners can buy in or cash out every trading day after the close at net asset value. Last week, because of the computer failure at BNY Mellon, the funds that it prices didn’t have NAV information. So they had to estimate NAV to do daily transactions.
Once they have precise NAV information, they can adjust the number of shares that buyers from last week actually have. For people who have cashed out, though, it’s not so easy. If a fund paid too little in a redemption, it must forward the extra to the seller once it finds out. If, however, it pays out too much in redemptions, most sellers won’t voluntarily return the excess. The fund may not even ask, either because it doesn’t want embarrassing publicity or because it knows the cost of suing the seller to get the money back will doubtless exceed the potential return. The fund will presumably try to get BNY Mellon to make good any losses. Failing that, the fund management company has to pony up.
ETFs are basically mutual funds that let designated brokerage firms handle the buying and selling for them. This makes ETF expenses noticeably lower than those of a traditional mutual fund. It also allows the ETF to trade all day, rather than once after the close. These are the main ETF pluses. The offset is that potential buyers and sellers have no assurance that brokers will be willing to transact at any given time and in the amounts they wish to. We also have no guarantee that transactions will be at, or even near, NAV. For those of us who are long-term holders or who place limit orders, neither shortcoming should be a big worry.
Then there was last week.
Last week, the ETFs normally priced by BNY Mellon had no current NAVs, only guesstimates. This had two related consequences for investors:
–Brokers became reluctant to trade, since they couldn’t be 100% sure any bid-asked spread they made would be profitable on both sides (for most ETFs, they had to have had a reasonable idea, I think).
–And they widened the market they made from, say, + / – 0.5% around NAV to a lot more. On Monday, for example, I decided to throw a long-time clunker in my portfolio overboard and replace it with an ETF. I soon found that I could only buy at NAV +3%. And even a small transaction at that price took half an hour to complete.
A lot worse than that happened, however.
The Wall Street Journal offers this account of ETFs during trading early Monday of last week:
“…the $2.5 billion Vanguard Consumer Staples Index ETF …plunged 32% within the opening minutes of trading. The Vanguard Consumer Staples ETF was halted six times over the course of 37 minutes early in the day, according to trading records.
The declines…were notable in that they exceeded the declines in the prices of their underlying holdings. In the case of the Vanguard Consumer Staples ETF, the value of the underlying holdings in the fund fell only 9%, according to FactSet. (my emphasis)”
Yes, Monday was a bad day. But it wasn’t a terrible, horrible, no good, very bad day, of the type that occurs occasionally in a bear market. This characteristic of ETFs–that market makers swing the bid price waaay down in times of stress–is one that all of us as investors should be aware of. As far as I can see, it’s also something the ETF industry has deliberately de-emphasized. I don’t think it’s a reason not to own ETFs in the first place. But there will surely be times in the future like last Monday where the price for cashing out is 20%+ of the value of your holding. So I think most people shouldn’t be holding only ETFs. Trying to sell them in a market downdraft should only be a last resort.