Friday, June 21, 2013

FT: "ETF Losses Today Were Far Beyond What The Most Sophisticated Risk Models Could Have Predicated" (BLK)

What....the....hell?
From ZeroHedge:
There was a time when portfolio insurance guaranteed that events like Black Monday would never happen. Then Black Monday happened precisely due to portfolio insurance. Some years later, the credit-driven housing boom made modeling of declining home prices at rating agencies (and everywhere else) redundant.

Then the (first) housing and credit bubble popped leading to the biggest housing market crash in US history. Fast forward to today, when ETFs were supposed to be the "greatest thing since sliced bread" and providing an ultra-low cost alternative to mutual fund and other market exposure "for the people", were supposed to revolutionize investing.

Until days like yesterday. To wit from the FT: "The losses for ETFs today were far beyond what the most sophisticated financial risk models could have predicated for worst-case scenarios," said Bryce James, president of Smart Portfolio, which provides ETF asset allocation models.
Turns out yet another cost-cutting, computerized contraption was only as strong as its weakest link: which in this case turned out to be a completely unexpected, Bernanke-driven bond market sell off, which led to unprecedented stress in the $2 trillion ETF industry.
More from the FT:
A wave of selling caused many exchange traded funds to tumble below the value of their underlying assets as a bond market sell-off caused stress in the $2tn ETF industry.

ETFs track baskets of underlying assets, such as emerging-market stocks or municipal bonds, but discounts widened sharply on Thursday as dealers struggled to keep up with the sell orders.

Emerging-markets ETFs were among the worst affected, as investors took fright that the end of Federal Reserve monetary easing would lead to outflows from developing countries.
Please welcome the ETF gates....MORE
And from FT Alphaville:

ETF providers take the sell-off heat
...It’s hard to say what’s really going on, but in the past heavy market sell-offs have always been associated with ETF inflows. Indeed, ETF investors have continuously proved to be terrible market timers, stocks usually rise just after ETFs suffer major outflows.

FT Alphaville has speculated that these counterintuitive inflows may result from the market arbitrage opportunity that is presented when stocks/underlying fall or rise faster than ETFs, incentivising authorised participants to buy stocks as they are falling to create new ETFs which can be sold at a premium (INFLOWS during down days), or vice versa, buy ETFs to redeem stocks which can be sold at a premium (OUTFLOWS during up days). This has the counterintuitive effect of creating inflows on market declines and outflows on market rallies....MORE