(Dow Jones) Exchange-traded funds don't appear to have been the cause of Thursday's flash crash. But a disproportionate number of these stock baskets saw trading snarled as a result of it. The day could stand as a blemish on the products' reputation for reliability as trading vehicles.
Theories about why the stock market dropped nearly 1,000 points and then sharply rebounded are still being formulated. But ETFs clearly played a role in the panic, with Securities and Exchange Commission Chairman Mary Schapiro noting Tuesday that one fourth of all ETFs saw suspicious declines after the market began its slide at about 2 p.m. EDT. While many questions remain unanswered, for many investors the dynamic highlights how these trading vehicles can lead to surprises.
"ETFs were hit hard," says Matt Hougan, editor of index investing Web site IndexUniverse.com. "They are more complex than mutual funds. You have to know how to trade."
To be sure, ETF companies reacted quickly to the chaos, in many cases calling and emailing investors like financial advisors with instructions on how to break clearly erroneous trades and offering quick accounts of how some funds' pricing mechanisms might have been affected by a wave of faulty-seeming price quotes.
ETFs "were certainly swept up in what happened," says Noel Archard, managing director at BlackRock Inc., the largest ETF firm. "But it shouldn't be about the ETF structure, it's a market structure issue. It was the same for individual securities."
One victim of ETFs' trading glitch was Ted Feight, a financial advisor in Lansing, Mich. Among the investments he manages for clients was about $4.2 million in three well-known ETFs iShares Russell 2000 Index Fund (IWM), iShares Russell 3000 Growth Index Fund (IWZ) and iShares Russell 3000 Value Index Fund (IWW). Because Feight had placed an order to sell those funds if prices fell to a certain level, on Thursday he found his positions cashed out automatically at prices ranging from 10 cents to 12 cents a share. The position's new value: about $4,200.
"My stomach was rolling," says Feight, who called his wife into the office to make sure he was reading the computer screen correctly. Feight says the trade was canceled the next day. But he wasn't as lucky with another position, iShares FTSE China Index Fund (FCHI), whose price also dropped about 10% before snapping back, not a clearly erroneous swing. His losses in the China fund were about $11,000. Despite the experience, Feight says he'll continue to use ETFs.
"To me it proved they do work," he says. "There was a problem. The problem was corrected."
Still ETFs didn't turn out to function in the same seamless way they did during past market glitches. One story ETF executives are fond of telling was their performance after the terror attacks on September 11, 2001. The stock market was closed for several days. When it re-opened, trading prices logged by the original ETF, known as the SPDR (SPY), looked low relative to its benchmark, the Standard & Poor's 500, sparking worries it was facing trading problems.
As it turned out, while most of the stocks in the market had begun to trade, airline stocks had been held back. But since SPDR held these stocks alongside many other names, investors were factoring airline-related jitters into the ETF's price before those same worries were registered elsewhere. The incident has been held up as evidence that ETF prices can be an even more reliable reflection of investor sentiment than some traditional sources. No one made that argument Thursday.
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