ETFs deep in the red for March

Risk still high with elevated implied volatility

Stock market gains made during the longest bull run in history have shrunk considerably owing to the impact of the coronavirus pandemic and accompanying global shutdown of almost all economic activity. February was merely the starting point for market stress, as even more severe lows were tested throughout March. April and May, however, illustrated the intense volatility of markets, with the S&P 500 Composite Index climbing 31% from its March lows, as of May 8.

Chart 1 compares positive and negative returns in the Canadian ETF market (a total of 849 ETFs in this study), excluding daily reset and inverse funds.

In March, the number of ETFs with negative returns increased drastically. Only four ETFs with an equity mandate had a positive return, while the number of fixed-income ETFs with positive returns dropped to only 37. Alternative ETFs seem to be doing well during this period of volatility, especially market neutral mandates, which hold up much better in significant downturns like this one. At this point, Balanced ETFs, whether they had a significant equity bias or not, did not fare well as corporate debt downgrades were widespread.

In summary, only 59 out of the 849 ETFs in my study had a positive return for the month of March, making it the most stressful month for investors since the financial crisis of 2008-09.

Table 1 takes a deeper dive into the investment mandates ETFs in the study. The “Average” column illustrates the carnage wrought by the market meltdown, with all strategies, excluding the cash and fixed-income government mandates, showing significant declines.

History was made when expiring futures contracts for West Texas Intermediate crude oil crashed into unprecedented negative territory. The average decline for commodity energy ETFs was more than 20%. Cash and government debt seemed to be the only safe havens in March, and these categories were also not completely shielded from the drawdown.

Equity strategies experienced major declines, with equity sector mandates down an average 18%. The more worrisome numbers come from the performance of bond ETFs, as traders began pricing in further downgrades from credit rating agencies. Investors in these categories generally do not have higher risk tolerances, and might not have expected such large declines in unit values.

Table 2 shows the average returns for equity mandate ETFs based on geographic region. The results may give investors some hope for better days ahead. Governments initiated lockdown procedures, shuttering economic activity and pushing GDP growth into nearly negative territory. Region and country-focused ETFs saw declines across the board as a consequence, but the wide dispersion of negative returns, ranging from -2% to -28% for different regions may be cause for some optimism.

China, the epicenter of the new coronavirus outbreak, has showed some progress in its equity markets, as stock returns stabilize. The average loss for ETFs with a Chinese equity mandate was only 2% in March. At the lower end, Australia-focused mandates showed a 28% loss for the month.

As many economists and market analysts predict further retests of March lows, some are also predicting that a widely-expected “V-shaped” recovery (the letter that a steep decline and equally steep recovery resembles when plotted on a graph) to turn into one that is more U-shaped for the remainder of the year as lockdown precautions are eased.

For active investors, it’s both a waiting game and a guessing game. The timing and shape of any potential recovery are subject to a host of variables. The CBOE Volatility Index (VIX) – often called the “fear gauge” as it tracks the expected level of S&P 500 index options (implied volatility) – is down from its recent high of 85 in March. But it’s still hovering around 28, a far cry from its historical average between 12 and 20. High volatility emphasizes the need for active investors to take a proactive approach and be especially vigilant for sudden mood swings in the market.

Notes and Disclaimers

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