ETF: Volatility case study

In ETF Blog, Latest by Kristia van Heerden

Us DIY investors don’t often get to see volatility in action. For the most part volatility is something reserved for the mysterious back-rooms of index houses. Fortunately, this year’s market crash is giving us all the opportunity to see volatility flex. 

 

If you owned an ETF in March, your understanding of volatility is probably close to a physical experience at this point. Looking at locally-listed ETFs during March is a great case study to understand volatility. 

 

Volatility: a recap

 

The easiest way for us ETF investors to understand volatility is to look at the price of each ETF unit. In normal market conditions, if you had to look at the price of one ETF share every day, you’d probably find sometimes it’s slightly higher than the day before, sometimes slightly lower. The move would be so small that it probably wouldn’t grab your attention.

If, for example, we looked at the price of the Satrix 40 ETF in February 2020, we’d see the following:

Date STX40 price per share
17 February 2020 R52.42
18 February 2020 R51.89
19 February 2020 R52.19

Sure, the price is a little different every day, but unless you wrote it down the day before, you probably wouldn’t notice. If you didn’t have the exact amount at hand and someone had to ask you what it would cost to buy one Satrix 40 share, you’d probably say, “Oh, it’s just over R50.” You might not be precise, but you wouldn’t be wrong. In this case, the volatility is pretty chill.

When the market crashed, however, this changed significantly. Let’s look at the price of one Satrix 40 share for three days during the crash.

Date STX40 price per share
19 March 2020 R34.30
20 March 2020 R36.51
23 March 2020 R34.55

If, on 19 March 2020, you said one Satrix 40 share is just over R34, you would be wrong the very next day. Let’s say over the weekend you told your cat (because it’s the only creature with you during lockdown) that a Satrix 40 share is just over R36, your cat would want some money back come Monday. What you have now is a spot of volatility. 

When volatility hits the fan

In the case of the Satrix 40, the volatility has been very noticeable if you hold the ETF. However, compared to what can happen in the market, this is baby volatility. Even though nobody travelled anywhere, you may have noticed the rand/dollar exchange rate going on a magic carpet ride of its own. 

The DCCUSD allows you to buy a type of American bond called a Treasury Bill. In terms of volatility, bonds are supposed to be one step up from hella boring. However, because this particular bond is so closely tied to the rand/dollar exchange rate, that is not at all what happened. 

If you held one DCCUSD unit on 16 March 2020, you would have been able to sell it for R1,789. If you held that same share on 3 April 2020, you would have gotten R2,059. Only six days later you would have missed the bus completely, only getting R1,941.40. 

In March 2020, the DCCUSD was the best-performing ETF on the JSE with a return of 18.21%. However, the volatility of this ETF was 92.28%. To contextualise that level of volatility, let’s compare that ETF to the second-best performing ETF over the same period: the 1nvest Government Bond ETF (ETFGGB) had a return of 15.83% with volatility of only 9.4%. 

On the worst day of the DCCUSD, you would have lost 47.92% of your investment. If you held the ETFGGB on its worst day, you would have lost 4.52%. 

What does this mean for me?

Let’s say I was trying to sell you one of the bond ETFs above, which sales pitch would you find more attractive?

  1. If you buy this ETF, you can make 18.21% in a month, or you could lose 47.92%.
  2. If you buy this ETF, you can make 15.83% in a month or you could lose 4.52%. 

When we think about volatility, we are thinking about how much we stand to win compared to how much we risk losing. Am I willing to lose 43% more to hold option 1 in order to win just 3% more than option 2? What you do in the privacy of your own brokerage account is your business, but I’ll pass. 

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