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Covid crisis calls for “index fund investors to take caution”

coronavirus_financial_crisis_index_indices_investmentThe current market environment “is one that calls for index fund investors to take caution”, according to Dr. Tatjana Puhan, managing director and deputy chief investment officer of ‘anti-benchmark’ manager Tobam.

Covid-19 sparked a crisis that has revealed market imperfections for index funds, Puhan recently told Funds Europe for our April issue – and liquidity risk is one of these.

“Today’s benchmarks in the equity space base their weights on market capitalisations, and in the fixed income credit space, on the value of outstanding debt,” she said. 

“Over recent years, this led to significant exposures of the benchmarks to certain sectors and single stocks such as IT mega-caps and financials in equity markets and energy issuers in the credit market.”

Recent extreme illiquidity has been particularly pronounced in sectors that have been put under the most pressure from coronavirus volatility. Puhan observes that liquidity became tight even for the tech mega-caps that got a less-than-average beating – “even though they are thought of as being particularly liquid”.

“In extreme market sell-offs, this is not true. The mechanism is very simple: when passive investors sell, they will particularly push a large amount of these stocks into the market since they are just selling stocks all across the market mechanically and in times of high market concentration, there are few stocks with very high weights dominating the market,” she says. 

“In the worst days of the recent market sell-off, we observed up to 160 stocks in the US large-cap index not starting to trade in the morning for a significant amount of time; for instance, the mega-cap Apple stopped trading before the market close.”

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