Markets and asset classes continue to fall and rally on the back of measures designed to both limit the spread of the coronavirus and mitigate its economic impact.
As such, the index-tracking products – such as exchange-traded funds (ETFs) – that have soared in popularity since the global financial crisis and its subsequent bull run have endured something of a rocky ride.
As the below chart shows, the VIX – Wall Street’s so-called ‘fear gauge’ and an indicator of investor expectations for volatility in the S&P 500 index during the coming 30 days – has spiked in recent weeks.
Performance of VIX in US dollar over 1yr
Source: FE Analytics
The highly uncertain market backdrop has seen trading volumes in Europe surge to a record $120bn in the week commencing 9 March, according to asset manager BlackRock, beating previous records set in the prior two weeks and well above the 2019 weekly average volume of just over $44bn.
However, investors in index trackers shouldn’t be alarmed by the current volatility in markets.
In fact, it is a function of the products.
“Index-based products helped to ensure equity liquidity was available at a reasonable price,” said Craig Lazzara, managing director and global head of index investment strategy at S&P Dow Jones Indices.
“Index funds have been part of the investment landscape for nearly 50 years, during which time superior performance and low cost have earned them a growing share of investor assets.
“What’s less well-appreciated has been the growth of a trading ecosystem linked to indices, most importantly to the S&P 500.”
Lazzara said the vast majority of trading in index-linked vehicles is carried out by active investors and traders, which explains the recent levels of volatility in trading.
“The coronavirus-induced bear market which we’re now enduring illustrates the logic of index-linked trading well,” he explained.
“A pandemic of still-unknown duration and severity can be expected to affect every business adversely. But investors who want to adjust equity exposures quickly will be far better served by trading an entire index than by trying to sort out relative winners and losers in the traditional way.”
Jason Xavier – Franklin Templeton’s head of EMEA ETF capital markets – said that volatility was a function of investor inflows and outflows and, as such, is driven by human behaviour. 
Xavier (pictured) said the spike in volatility was “proof that ETFs have not only enabled the democratisation of asset classes but are also now being actively used as a price discovery mechanism”.
“Appreciating market uncertainty in relation to the trading of ETFs is key to understanding the price discovery mechanism ETFs offer – and many investors utilise – during these volatile times,” he explained.
“The last few days have seen underlying securities trade at extreme levels and at times, trade limit down during the trading day.
“During these limit-down periods, trading is halted and price discovery in the underlying securities is limited. In these moments, market uncertainty is at its peak, and the lack of clarity around prices has caused some ETF spreads to widen.”
Nevertheless, Xavier said that secondary market trading has allowed price discovery and liquidity of the products to be upheld “even during these stressful and uncertain periods”, adding that the products are “now more relevant than ever”.
Indeed, there is little evidence to suggest that ETFs have become forced sellers in the event of high volumes of redemptions as had been feared, according to BlackRock.
“Redemptions have been orderly and generally accounted for a fraction of the overall trading that has taken place in the ETF, with significant trading taking place in the secondary market for the ETF units,” the firm noted.
There have been concerns surrounding ETFs in fixed income, particularly given longstanding issues surrounding credit quality.
And while this did lead to differences between ETF prices and the values of their constituent bonds – a ‘discount’ – it did not reflect a problem with the structure itself, BlackRock noted.
Rich Powers, head of ETF product management at passive giant Vanguard, said that premiums and discounts are always present with bond ETFs and that widening during market volatility tends to be short-lived.
“Though discounts and premiums of this breadth and magnitude are rare, bond ETFs have been tested during prior bouts of volatility and actually do a good job of reflecting in real time the value of the underlying fixed income securities,” Powers explained.
“In times of volatility with rapidly evolving macroeconomic, interest rate and credit environments, investors should expect premiums or discounts in bond ETFs.”
Powers added: “When comparing an ETF's market-price return with its return based on its NAV, focusing on a single day or week as a relevant snapshot of performance may be misleading.
“It's also worth remembering that, because outperforming the market is a zero-sum game, not all investors are selling at (or into) the discounts. In fact, investors on the other side of recent trades have been buying at a relative discount.”