(PUB) Investing 2015

15

September 2015

Morningstar FundInvestor

a large driver of what ultimately manifests itself in the form of these disconnects between the ETF price and the underlying net asset value. Market makers were facing an extreme amount of risk, knives were falling everywhere, and I think what you saw is that, in all likelihood, many of the market makers either stepped away from the market, stopped quoting prices, or they widened out their bid-and-offer spreads. “Now all of this ultimately resolved within the course of an hour or so, but what you saw was extreme risk, and in the face of extreme risk and in extreme uncer- tainty, in a fast-moving environment, it was probably really ultimately a multitude of different factors that led to these yawning disconnects between the ETF price and the price of the underlying security. If you absolutely must trade an ETF during times like those that we experienced on Monday, use a limit order, because it allows you to name your price. If you use a market order or if you use, say, a stop-loss order, which are the orders that tend to be affected and ulti- mately executed in times like these, you are subject to the whims of whatever is being quoted during these times of distress. “So what we saw on Monday and what indeed we saw during the flash crash is that, with a stop-loss order, it becomes a market order once that stop-loss price is crossed. So when the market drops, it becomes a market order and executes at whatever the going price is, which, in the case of Monday morning, were some very poor prices. “Now, it’s not clear if any trades were executed at those prices, [and], if they were executed, whether or not they will ultimately be reversed or busted. But using a limit order allows you to avoid all of these considerations entirely, to name your price. “This is a reminder that it takes ETF s a while to wake up in the morning because it takes a lot of their underlying securities to wake up and be really actively traded in their early morning trading hours. So that first half hour of trading tends to be not necessarily volatile, but volumes tend to be thin, takes a while for a lot of the underlying stocks to really begin actively trading hands. So, the best pricing, the greatest depth,

the most liquidity you are going to see tends to take place between the time one half hour after the market opens and one half hour before the market closes because, as the market moves toward its close, many market makers tend to settle up their books, they’ve hedged their risk for the day, and they tend to step back from the market. “So if you can kind of carve those two half hours out of your trading window if you are looking to trade an ETF , that’s also advisable, and certainly on Monday trading during the first half hour was again extremely chaotic.” Redemptions Accelerate in August Initial reports suggest fund investors pulled out about $10 billion from U.S. equity funds in the next to last week of August as the China swoon spurred some to rush for the exit. Investors were starting to head for the exits in July. For U.S. equity funds, net outflows were $14 . 5 billion for open-end and ETF s combined. That was offset by the $21 . 3 billion in net inflows for foreign-equity funds. Allocation funds were also in net redemptions with $2 . 2 billion in outflows in July. Muni bonds and taxable bonds had slight inflows of less than $1 billion. The firms with the greatest inflows in July were Vanguard ( $15 B), State Street ( $7 . 4 B), iShares ( $6 . 9 B), Bridge Builder ( $5 . 4 B), and DFA ( $2 . 8 B). The firms with the most outflows were Fidelity ( $9 . 1 B), PIMCO ( $4 . 6 B), Franklin Templeton ( $3 . 1 B), Oppenhei- emer ( $1 . 7 B), and T. Rowe Price ( $1 . 3 B). Among actively managed open-end funds, PIMCO Income PONDX ( $1 . 2 B), Metropolitan West Total Return Bond MWTRX ( $636 M), Fidelity Select Bio- technology FBIOX ( $563 M), American Funds Europacific Growth AEPGX ( $522 M), and JHancock Global Absolute Return JHAAX ( $477 M) had the most inflows. PIMCO Total Return PTTRX continued to have the most outflows. The fund had $3 billion in net redemptions in July. K