In 2017 I wrote a blog on an obscure subject: Japanse Exchange Traded funds. I said at the time:
ETFs are quoted funds that are in effect tracker funds of other quoted investments. So what's the issue? There are two.
The first is the folly of the Bank of Japan: QE may have a role buying government bonds (although even that can be questioned unless the funds are used to create new asset investment) but it definitely has none in my view in buying corporate bonds, let alone shares. This is just market game playing and I cannot see any role for a central bank in doing that. The BoJ position is artificial and distortionary as a result and I can see no benefit from that.
The second is broader, and is a liquidity issue. If there is a run on these funds in the event of a stock market downturn I can see them adding to liquidity pressure as they effectively leverage the underlying assets by double quoting them. This could ratchet a downturn in market sentiment and add to instability, effectively reflecting the burst of a double bubble. Anything that can do that is dangerous. The fact that ETFs have had a good track record simply says they have reflected the market recovery (as opposed to the real market recovery) from 2008. Nothing suggests that they add real value, and I strongly suspect that in a period of instability they would do the exact opposite.
I was roundly criticised by many on the right for supposedly not understanding these funds. It was claimed they could never create illiquid situations or cause market disruption.
Move on to this morning's FT, and they report:
The Bank of Japan has launched an unusual lending facility for exchange traded funds as it tries to mitigate the market impact of its ultra-aggressive monetary policy.
Under the new facility, brokers will be able to borrow some of the central bank's ¥28tn ($256bn) holdings in equity ETFs for up to a year, at interest rates to be determined by auction.
The new facility, first announced in April, is intended to boost liquidity in a Japanese ETF sector dominated by the central bank, which owns two-thirds of the total outstanding stock and has come under fire for allegedly distorting the market.
So, they admit the policy was a mistake.
And they admit that there is a real problem with liquidity.
I rest my case.
Those who devote themselves to dogma cannot see real issues arising. Thankfully, some of us can.
Thanks for reading this post.
You can share this post on social media of your choice by clicking these icons:
There are links to this blog's glossary in the above post that explain technical terms used in it. Follow them for more explanations.
You can subscribe to this blog's daily email here.
And if you would like to support this blog you can, here:
Buy me a coffee!
I listen to Radio 4 quite a bit and particularly enjoy hearing scientists explaining their research in an easy to understand way. They come across as clear and informative and despite massively simplifying things you are always aware that they know their stuff.
It would be great to hear you on Radio / TV explaining some of the financial stuff in a way that the average person can comprehend.
I understand the favoured 8.10am slot on Radio 4, Today, has become more available since JC and Bojo have been unwilling to take the slot.
Perhaps you can think of something seemingly outrageous to grab their attention?
I could try…
I would steer away from publicizing this as much as possible. It’s really not saying what you think it is saying
I have made my point.
Fact: The bank of Japan have bought a lot of etf’s
Fact : the bank of japan are offering a repo facility against etf holdings , of which they are large holders
The exact thing you want in times of market stress are large, non price sensitive, sellers. The fact that the bank of japan hold large etf positions which they can release into the market in times of stress to provide liquidity, is actually a feature of the market, not a bug. What you dont want is a large amount of small holders all rushing to sell at the same time.
You’re criticism of the situation is actually an endorsement I’m afraid.
No it isn’t
It says they are providing the liquidity ETFs cannot provide
That’s it
And it proves my warning was right
Richard I would let this go..what you are stating isn’t correct and isn’t worth getting into a dispute about in any case
I disagree with you
@Tipper/Charlie/Jason
Please indulge me. I’m a complete novice regarding bond markets, and I find the jargon obscures meaning from time to time (as jargon often does).
Taking account of my relative ignorance, can you explain how:
1 – “The BoJ position is artificial and distortionary ” -RM
– “Japanese ETF sector dominated by the central bank, which owns two-thirds of the total outstanding stock and has come under fire for allegedly distorting the market.” – FT
and
2 – “If there is a run on these funds in the event of a stock market downturn I can see them adding to liquidity pressure” – RM
– “The new facility, first announced in April, is intended to boost liquidity in a Japanese ETF sector dominated by the central bank” – FT
are not equivalent.
I am perfectly enumerate, so feel free to chuck in a bit of maths if it helps. Please try to use plain language, explaining jargon with jargon is not helpful.
Thanks in advance 🙂
Thanks
I could not be bothered because I sensed trolling
I will be interested to see the responses
Johan g
No problem.
Richard’s representation of the BoJ’s etf holdings as being ‘artificial’ is nonsense.
The reason why they have purchased equity and bond etf’s is exactly the same as the reason they bought government bonds I.e to provide liquidity to the financial system (sellers give the boj their etf holdings, and in exchange the boj give the sellers cash). There’s nothing artificial about that, and it was simply to widen the range of assets they held because they were approaching limits on the level of gov bonds they could hold.
What you want in a time of panic selling is a big holder who doesn’t have to sell, and that s what the boj is, so to claim that this is likely to result ‘ ratchet a downturn in market sentiment and add to instability’ (Richard’s words) is nonsense. A big holder of etfs who DONT need to sell in the event of a market panic doesn’t add to instability, the very opposite is true.
As to ‘double quoting’ the holding ? Complete nonsense I’m afraid. There is only ever one owner of the shares, the price paid for ‘temporary ownership’ being the Repo rate, but the ownership is transferred from on one party to another. There is no double counting.
Richard’s characterization of etfs ‘Nothing suggests that they add real value’ is also nonsense. Etf’s Enable investors to gain access to markets at a much lower management fees, and at much lower risk on index underperformance, than actively managed funds.
I am pleased you acknowledge your bias as an ETF trader
That is all of note in what you say. The rest is waffle.
I do know what QE is. So do many here. We know assets are effectively withdrawn from the market.
And we know that the BoJ won’t be selling ETF funds.
But this exacerbates matters. Why then do they need liquidity? You don’t say. What you do suggest very strongly is because they are synthetic, which does compound issues.
With respect, all you evidence is your own incomprehension.
You were cautioned by an earlier poster to Steer away from this subject because it might make you look foolish, and perhaps you should have taken their advice.
You acknowledge that the boj won’t be selling the etf’s, and then in the next para you ask why they need liquidity ? They don’t need liquidity, as you have acknowledged by your prior statement.
Secondly, their largest etf position is in the TOPIX ETF (ticker code 1306 if you want to look it up). Market cap is 11.3 trillion yen. 100% invested in actual shares, not leveraged, not swap based, not derivative based.
But most importantly, where do you think the liquidity that the boj has provided by buying the etf’s in the market has gone ? And where do you think all the liquidity they will provide through repo operations will go ? That’s correct, into other financial assets which can liquidated if need be, to provide liquidity in the event of a market correction.
As usual, your inability to comprehend second order consequences is leading to you making pronouncements on topics you really know very little about.
I look forward to your next reply evidencing ‘somebody’s’ incomprehension
Answer the questions set yesterday, I suggest
It is apparent that the FT agrees with me
And if I’m so wrong why does the BoJ need to provide ETFs with liquidity?
They’re not providing it to themselves
And if the markets needed it you would bit dekuver it via ETFs
So ETFs need it because they are illiquid
Now why is that?
Answer the question.
Err, they don’t need to provide etf’s with liquidity. They need to provide external parties with access to the etf’s holdings, that has nothing to do with etf’s requiring liquidity.
ETF’s are open ended vehicles that can create and cancel shares at will. They are not illiquid.
Any comment on my statement that the boj’s largest position Is in an etf that is not synthetic ?
So there is illiquidity in ETFs is what you’re saying…..
@ Charlie Harper
Why haven’t you addressed my questions? I’m asking because I’m genuinely interested.
I’m a bit annoyed actually, because rather than engaging with me, you’ve decided to go after RM.
p.s. You’re not the front man of the UK Subs are you?
p.p.s. tenner on EFT trader and Charlie Harper being the same person. Some rather distinctive typing habits/errors 😉
🙂
Hi ETF Trader
Thank you for your reply. I’m not convinced you’ve answered my question.
Regarding the first equivalence – you said “Richard’s representation of the BoJ’s etf holdings as being ‘artificial’ is nonsense.”
I can accept that the use of the word ‘artificial’ might be technically incorrect (I’m not really sure, I don’t actually know what artificial means in these contexts), but you ignore the rest of it.
So please, humour me. How are:
“The BoJ position is … distortionary”, and
“Japanese ETF sector dominated by the central bank, … has come under fire for allegedly distorting the market.” not equivalent?
The second equivalence I highlighted seems a little more fuzzy on second reading.
But picking up on what you wrote, it seems to me (and again, please feel free to correct me if I’m wrong) that your argument is actually at cross-purposes with what the FT has reported.
In that, you have said “What you want in a time of panic selling is a big holder who doesn’t have to sell, and that s what the boj is”*
but the FT reports “brokers will be able to borrow some of the central bank’s Â¥28tn ($256bn) holdings in equity ETFs for up to a year”
So what? The BoJ can hold lots of ETFs which is good, but they’re offering to loan out some of their ETFs to smaller holders who might have to sell (?), which, following the logic, is bad? It doesn’t stack for me.
*Just as an aside, isn’t the BoJ holding lots of ETFs, and not selling them in time of panic, distortionary by very definition. Please excuse my possibly incorrect logic, but if the BoJ just holds on to the ETFs, then their price remains artificially high, because the BoJ has cushioned the fall in ETF price caused by panic selling?
If this is the case, then I have to ask, what has the value of ETFs got to do with the actual value of the underlying assets the ETFs’ values are supposedly based on? I’ll suffix this question with the fact that I am very cynical about stocks in general.
———————————————–
In response to your additional comments:
>> “As to ‘double quoting’ the holding ? Complete nonsense I’m afraid. There is only ever one owner of the shares, the price paid for ‘temporary ownership’ being the Repo rate, but the ownership is transferred from on one party to another. There is no double counting.”
Er, I didn’t ask about this but I’ve had a little read and a think. My impression is that RM isn’t suggesting the ETF is double quoted, but the value of the underlying asset is double quoted.
I can understand that logic, and it feels like it ties in with my aside statement above (I think?)
[RM – would the logic be that you lose the value from the company, and you lose the value from the ETF?]
>> Richard’s characterization of etfs ‘Nothing suggests that they add real value’ is also nonsense. Etf’s Enable investors to gain access to markets at a much lower management fees, and at much lower risk on index underperformance, than actively managed funds.
What is this? You say RM’s statement is nonsense. Then follow it with something about accessing markets. Is the implication that more easily accessed markets allows more money to be pumped into them, increasing the value of the market? If so, this only increases the value of the market, not the underlying asset (doesn’t it?). This is exactly why I am cynical about stocks.
Again, please understand I’m not attacking you, but when (I think) I can pick holes this easily, more (and better) explanation is required :).
Johan
Thanks for this
And on this “ My impression is that RM isn’t suggesting the ETF is double quoted, but the value of the underlying asset is double quoted.
I can understand that logic, and it feels like it ties in with my aside statement above (I think?)
[RM — would the logic be that you lose the value from the company, and you lose the value from the ETF?]“ – you are right: there is a compounding effect that funds (and runs) exacerbate creating illiquidity
Johan
Thanks for this
And on this “ My impression is that RM isn’t suggesting the ETF is double quoted, but the value of the underlying asset is double quoted.
I can understand that logic, and it feels like it ties in with my aside statement above (I think?)
[RM — would the logic be that you lose the value from the company, and you lose the value from the ETF?]“ – you are right: there is a compounding effect that funds (and runs) exacerbate creating illiquidity
Johan
Thanks for this
And on this “ My impression is that RM isn’t suggesting the ETF is double quoted, but the value of the underlying asset is double quoted.
I can understand that logic, and it feels like it ties in with my aside statement above (I think?)
[RM — would the logic be that you lose the value from the company, and you lose the value from the ETF?]“ – you are right: there is a compounding effect that funds (and runs) exacerbate creating illiquidity
And no real answers, at all….
Richard
A quote or warning from Zero Hedge 2014
“Still, it is doubtful that any structural considerations will stop the BOJ from steamrolling into the stock market too, and just like it did with the JGB market, completely takeover the Japanese stock market as well, which once the ECB is on the bid in the broad market tracking ETFs, will mean that equity volumes and liquidity, already abysmal, will simply grind to a complete halt as yet another market falls under the reign of central planners.”
Stock markets & derivatives (in this case ETF) could be characterised as doors one can pass in either direction.
In the case of stocks, even well known ones, liquidity is remarkably low. Taking two examples of those I follow: Vestas & Orsted. Daily volumes are around 800k (less than 1% of issued shares) and 400k (less than 0.1% of shares issued) respectively. This is about 2k to 1k shares traded per minute in any given 8 hour trading session.
In such a market trying to buy (or sell) even modest amounts of shares (3,000 or 4,000) can (& does) cause problems (Mr Parr, we will have to do this in blocks). I am speaking from practise, not theory.
This picture is repeated with many stocks.
The problem with ETFs is that many ETF “doors” face a single stock door – which has, as shown, very limited liquidity. If there is a rush to sell, price collapse will follow. As somebody who used to be a professional stock trader said to me: “Mike always go with the flow” i.e. herd mentality.
The BoJ has implemented a system which would be better if it were not needed i.e. ETFs did not exist. If somebody wants to hold stocks, they should bloody well do the research and hold them directly. At least that way, it will reduce the number of financial parasites that seem to infect our society.
Richard,
I used to be a fan of ETFs as a cheap way of making a broad investment decision. Now I worry, but for different reasons to you. I see Japan as less of a problem. These are my issues:
1) Are the ETFs that the Japanese Central Bank owns simple or synthetic? If an ETF owns the actual shares it tracks, there is some limit to the harm it can cause. It cannot own more shares than exist. If a synthetic ETF owns a series of promises to buy or sell shares, it is far more dangerous. Promises can and will be broken. Moreover,there are few reasons why synthetic ETFs cannot own more imaginary shares than there are real shares in existence.
2) Though ETFs are market agnostic, they will cause another form of volatility even when dormant, because the price of an individual share will be determined by fewer and fewer active decisions.
3) The Woodford scandal opened my eyes to the avalanche risk created by open ended investment products. Too many investors may want out at the same time. Is there a case that all investment vehicles should be closed end, as an anti-avalanche mechanism?
4) Could this be a major issue? My understanding is that almost all retail investment products are open ended. It is the open ended products that are highly marketed. Closed end products are described as for the “sophisticated” investor. Is this exactly the wrong way round? And is it another disaster waiting to happen?
The case of an interested party using ETFs to move the market is unusual, but at least it is transparent. Active investors can judge whether prices in that market are artificially inflated. Caveat emptor. The avalanche risk of a central bank sabotaging its own stock market should be small.
I share those concerns
They are real
Two separate issues are at play here, the purpose and liquidity of an ETF and the motives of those who choose to own it, in this case the BofJ.
With regard to ETFs they are a cheap and efficient way to access an underlying asset class (there are literally 1000s covering every indice and every investment theme).. the fees are a few bp and are a cheaper option and are putting downward pressure on fees in the active management community. Importantly they provide choice and diversification to investors..so the liquidity is entirely a function on the underlying asset class..So FTSE 100 very liquid and a small cap in Indice in Thailand obviously large so.
So the ETF structure is undoubtedly the investor/ savers freind.
Whether the benefits of ownership are “corrupted” in any way by the BofJ in this case is a different issue but if so it is not the principle or structure of the ETF at fault..it is akin to saying Gilts are toxic because the BofE has forced them to negative real yields. The gilt will do what it says on the tin and so will an ETF. Whether the underlying investment theme is good or bad is a separate issue altogether.
Sorry Jason, but that’s a wholly inadequate answer to the questions oosed
Many years ago my wife bought me a nice pair of bicycle clips and very nice ones at that. She had despaired of my using various rubber bands. One day I left my bike outside the office and carefully locked it to the cycle rack and removed the lights before someone else appropriated them. After work I returned to my bike and realised that I had inadvertently left my lovely new bicycle clips on the bike and they were now gone. I resorted to using rubber bands once more. Rubbers bands are almost perfect since, like credit, they are elastic and are ideal for keeping the trousers in place and there are always plenty of them around. They work wonderfully, right up to the point where you are cycling home in the dark and your trouser leg combines it self with the chain.
There’s always the trouser leg in the sock trick 🙂
Or the roll up your right leg trick (although I frequently get accused of being a Mason when I forget to roll it back down, lol)
🙂
A smiley! Brilliant 😀
And now for Christmas drinks! Merry Christmas everybody!
Please explain to me and ,I suspect, many others how we are advantaged by the complexity of trade in Exchange Traded Funds. It seems to be that none of us are advantaged except those who have the means to skim a profit from such transactions. When will be ever get back to the good old days when effort, either physical or intellectual with a direct relationship to those affected had a proportionate reward albeit some of it financial but also emotional.