A. We have published several blog posts comparing ETFs and Mutual Funds, but with what happened on August 24, 2015, people have reasons to ask again - are ETFs really better than mutual funds?
What Happened on Aug 24, 2015?
ETFs are supposed to trade in lockstep with the stocks they own. However, on Aug 24, during the opening minutes of the market, S&P 500 fell as much as 5.3%, the $65 billion iShares Core S&P 500 ETF (IVV) fell as much as 26%, almost 20% below its fair value!
What's more scary is, IVV's big drop is not alone! Other big drops from some of the big name ETFs' include:
- The $18 billion Vanguard Dividend Appreciation ETF (VIG) dropped 38%
- The $12 billion SPDR S&P Dividend (SDY) plunged 38%
- The PowerShares S&P 500 Low Volatility ETF (SPLV) fell as much as 46%
Indication of A Bigger Problem?
Although these ETFs' prices went back to normal after an hour of the market open, this sudden drop and big swing away from its fundamental value give investors a reason to ask: are ETFs really better than Mutual Funds?
Mutual funds only trade once a day, they tend to match the value of the underlying holdings at the market closing time. For ETFs, because they trade like stocks, many investors buy or sell at market price, these people learnt a big lesson (or caught an unexpected gift for the bargain hunters) on Aug 24!
What Caused the Big Problem?
A current explanation of such big drop is like this:
When S&P 500 index futures contracts (trade on the Chicago Mercantile Exchange) fell sharply before 9:30am on Aug 24, it triggered a trading pause. These futures contracts are used by ETF market makers as hedging tools. Also, NYSE invoked a procedural change that allows floor traders to delay the opening in a number of stocks (while Electronic exchanges opened as usual). 327 ETFs were hit with five-minute trading halts on the morning of Aug 24. 11 were halted 10 or more times. Lacking clear information about futures prices and consistent indications for where many stocks might open, market makers kep ETF bid-ask spreads wide.
A large number of trading halts in both stocks and ETFs led to even more trading halts, hindering the price recovery for many ETFs for about an hour.
As of now, the SEC has formed a special committee to review the problem and propose resolutions. ETFs are probably still a favorite for many investors, but one key learning from Aug 24 event is: always use limit orders when you buy or sell ETFs.