Freefall Reveals ETF Price Issue

9/21/2015


Investors in exchange-traded funds (ETFs) learned a potentially cruel lesson on Aug. 24.

Early that morning, many ETFs tumbled far below the underlying value of their portfolios after markets plunged on worries about China. Many investors who issued sell orders at the depth of the retreat got soaked. 

The freefall was widespread. The 50 largest U.S. stock ETFs all slumped that morning, with the average fund trading down nearly 18% before bouncing back to finish down about 4% for the day. Some funds saw jaw-dropping declines, with 20 falling at least 20% and three down more than 40%.

Even the biggest and most liquid ETFs were hard hit. Consider the three giant ETFs tracking the S&P 500 Index. The $65 billion iShares Core S&P 500 ($201; IVV) — the second-largest ETF — slumped 25.9% at one point in early trading. For comparison, the $165 billion SPDR S&P 500 ($200; SPY) dropped by as much as 7.7%, while Vanguard S&P 500 ($184; VOO) retreated as much as 7.2% that day. For the record, the S&P 500 Index itself fell as much as 5.3%. 

U.S. securities regulators and stock exchanges are reviewing the events of Aug. 24. With stock prices tumbling and many shares not trading that morning, some ETF market makers — traders responsible for setting fund prices — widened their bid-ask spreads on ETFs to mitigate risk. During the panic, some 1,250 trading halts were triggered in more than 450 ETFs and stocks. Those halts, designed to make trading more orderly, actually contributed to the wild prices and disrupted the pricing of ETFs, blindsiding many investors. Those who sold at depressed prices likely have little, if any, recourse.

Trading advice

In fast-moving markets, investors should not assume an ETF's market price will move in lockstep with its net asset value (NAV), the fair value of its holdings. During heightened volatility, investors should avoid market orders, which are executed at the prevailing price.

Note that stop-loss orders are also converted to market orders, meaning a selling price could be much different than expected. Investors are encouraged to use limit orders, which are executed at a specific price.

OUR RECOMMENDED MUTUAL FUNDS
Year-To-Date *
--- % Of Portfolio ---
 
Fund (Price; Ticker)
Return
(%)
Rank
Conser-
vative
(%)
Growth
(%)
Fund
Rating †
Artisan International ($28; ARTIX)
(5.8)
E
9
9
46
Baird Core Plus Bond ($11; BCOSX)
0.1
B
9
4
89
Dreyfus Midcap Index ($37; PESPX)
(1.2)
B
0
0
54
Dreyfus Small Cap Stock Index
($28; DISSX)
(2.1)
B
0
0
86
Homestead Small Company
($38; HSCSX)
(3.1)
C
5
6
84
iShares MSCI EAFE Small-Cap ETF
($49; SCZ)
5.6
A
4
6
89
PRIMECAP Odyssey Stock ($23; POSKX)
(1.5)
A
10
10
98
T. Rowe Price Divers. Small-Cap Growth
($27; PRDSX)
4.4
B
7
7
97
T. Rowe Price Value
($33; TRVLX)
(4.8)
B
10
11
84
Thompson Bond ($11; THOPX)
(0.3)
E
9
4
40
Vanguard 500 Index ($183; VFINX)
(2.6)
B
7
8
82
Vanguard GNMA ($11; VFIIX)
0.6
B
0
0
91
Vanguard Growth Index
($54; VIGRX)
0.7
C
10
11
76
Vanguard High-Yield Corp. ($6; VWEHX)
1.6
B
5
6
98
Vanguard Inter.-Term Tax-Exempt
($14; VWITX)
0.6
B
0
0
92
Vanguard Selected Value
($28; VASVX)
(0.3)
B
5
8
76
Vanguard Short-Term Invest.-Grade
($11; VFSTX)
0.9
A
0
0
96
Vanguard Total Bond Mkt. Index
($11; VBMFX)
0.0
C
0
0
55
Vanguard Wellesley Income
($25; VWINX)
(1.5)
C
0
0
98
Vanguard Wellington ($38; VWELX)
(2.4)
C
10
10
93

* Year-to-date ranks through Sept. 15 from Morningstar, comparing performance among funds with same objectives. A = top 20%; B = next 20%; C= middle 20%; D = next 20%;
E = bottom 20%. † Fund ratings are percentile ranks based on our fund-rating system.


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