New Challenges in the ETF Market

Recent developments in the exchange-traded fund (ETF) sector may pose risks for investors, particularly in times of severe market fluctuations. Jamie Harrison from MFS Investment Management noted that ETFs which involve more complex derivatives and operate in less transparent markets could face challenges during significant downturns.

“These factors warrant attention as market volatility increases,” stated Harrison during an interview on CNBC’s “ETF Edge.” He emphasized that the rapid pace of innovation within the ETF market makes it crucial for investors to remain alert. “Lack of transparency could indeed become problematic if we experience substantial declines,” he cautioned.

Founded in 1924 and known for creating open-end mutual funds, MFS was recognized as the Best New ETF Issuer by ETF.com last year. Harrison highlighted the importance of conducting thorough research on one’s portfolio. “Collaboration among subject experts and deep-rooted partnerships with liquidity providers is vital,” he remarked.

Concerns About Liquidity

Harrison indicated that liquidity, particularly during sharp sell-offs, might be the most pressing issue. He pointed out the recently highlighted risks associated with private credit ETFs, suggesting that uncertainty surrounds those types of investments. “It’s up to advisors and investors to evaluate these risks,” he added while encouraging clients to engage in discussions with their fund providers.

Investors must pose challenging questions, he advised: “What if there’s a 20% drop? How does the liquidity system function? Are exits feasible? And if so, will the exit price align closely with net asset value?”

Christian Magoon from Amplify ETF echoed similar concerns regarding the survivability of new ETF strategies during major downturns. He raised a red flag about private credit, stating, “If an ETF includes private credit, investors should scrutinize its liquidity criteria and trading behavior, as discrepancies can arise between ETF trading rates and the asset’s inherent liquidity.”

Magoon also brought attention to possible issues linked to equity-linked bonds, which aim to offer bond security while being tied to stock performance. “Such bonds might face pressure from redemptions and credit risks,” he observed. “It’s critical to carefully evaluate ETFs that involve equity-linked bonds, especially during potential large-scale outflows or pressures related to private credit and the banking sector,” he concluded.