If a violent downturn strikes the market, new ETF strategies may be vulnerable. Here's why

• ETFs holding private credit assets face potential liquidity mismatches between the rapid trading pace of ETFs and the illiquid nature of underlying private credit holdings
• Equity-linked notes in ETFs could experience stress from redemptions and underlying credit risk during major market drawdowns or banking system contagion
• Investors should ask issuers critical questions about liquidity facilities, ability to enter/exit positions, and whether redemptions would occur at prices tight to net asset value (NAV) during extreme volatility

Summary:

Financial experts are warning that newer, more complex ETF strategies may face significant vulnerabilities during severe market downturns due to liquidity concerns and lack of transparency.

Key Players:

Jamie Harrison, head of ETF capital markets at MFS Investment Management, and Christian Magoon, CEO of Amplify ETFs, both highlighted concerns about innovative ETF structures. MFS Investment Management, founded in 1924 and recognized as best new ETF issuer by ETF.com last year, is particularly focused on these risks.

Main Concerns:

*Private Credit ETFs:* Both experts flagged these as high-risk investments during volatility. The mismatch between daily ETF trading and illiquid underlying assets creates potential problems for investors seeking to exit positions.

*Equity-Linked Notes:* Magoon warned these derivative-based products face stress from redemptions and underlying credit risk during major drawdowns or banking system contagion.

Critical Issues:

• Liquidity: Harrison identified this as the primary concern during steep sell-offs, particularly for ETFs using complex derivatives and operating in less transparent markets
• Transparency: Lack of visibility into portfolio holdings could become problematic during deep sell-offs
• NAV Tracking: Questions remain about whether investors can exit at prices close to net asset value during stress periods

Investor Recommendations:

Experts advise thorough due diligence, including:

• Understanding how ETFs perform in 20% drawdowns
• Examining liquidity facilities and infrastructure
• Engaging directly with issuers
• Evaluating the firm's partnerships and subject matter expertise

The warnings come as ETF innovation accelerates, potentially outpacing investors' understanding of embedded risks during extreme market conditions.