UPDATE 3-U.S. market sell-off ravaged ETFs

* Concern ETFs fell much further than underlying indexes

* Major managers of ETFs blame market makers

* ETFs still seen as valuable investment tool
(Rewrites first paragraph; adds State Street and BlackRock
comments, further detail on growth of ETFs)

By Aaron Pressman

BOSTON, May 7 (BestGrowthStock) – More than two-thirds of the
securities hammered in Thursday’s big selloff were
exchange-traded funds, including some considered among the
safest, shaking confidence in using ETFs for hedging risks.

The New York Stock Exchange released on Friday a list of
173 securities that were affected by the sell-off, including
111 ETFs, according to the IndexUniverse website. The Nasdaq
released its own list of 281 securities, including 193 ETFs.

Funds that were caught up in the bizarre trading were among
the largest and most popular in the fast-growing financial
segment.

The $9.2 billion iShares Russell 1000 Value Index fund
managed by a unit of BlackRock (BLK.N: ), for example, dropped
from a price of around $60 to 8 cents before recovering minutes
later.

The $200 million SPDR S&P International Dividend Fund
managed by State Street Corp (STT.N: ) dropped from around $48 to
zero at one point.

Overall, 161 funds traded for less than 25 cents a share
during the downturn, according to data compiled by
Morningstar.

Among the leading ETF managers, Vanguard Group said in a
statement that the market drop affected stocks and ETFs in the
same way and was due to the actions of market makers. The firm
recommended that investors generally place trades to buy or
sell ETFs using so-called limit orders, restricting the price
at which a transaction can be completed.

BlackRock said it was the exchanges, not ETFs, that created
the problem. And the firm questioned the exchanges’ decision to
cancel some but not all trades during the downturn.

“There should be much more transparency around that
decision should situations like this arise in the future,”
BlackRock managing director Noel Archard said.

State Street senior managing director James Ross said he
was “very disappointed” with the trading performance of ETFs
and ordinary stocks during Thursday’s crash. But he noted the
funds finished the day without any issues and back at
appropriate prices.

Adam Patti, chief executive of smaller ETF manager IndexIQ,
said the strange trading was no reason to question the value of
the products. “That shouldn’t be viewed as the norm,” Patti
said. “It is not an indication of the quality of ETFs as an
investment.”

There were over $805 billion in U.S.-traded ETFs at the end
of March, according to the Investment Company Institute, up
from $531 billion at the end of 2008.
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For a graph click on: http://link.reuters.com/cej92k
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DIVERGENCE FROM INDEXES

Investors and analysts raised concerns that the ETFs that
plunged in price fell much further than the value of their
underlying indexes during those few moments.

And even though the exchanges agreed to cancel trades that
took place in the 20 minute period between 2:40 p.m. and 3 p.m.
EDT (1840 GMT and 1900 GMT), only trades at least 60 percent
away from prices at 2:40 p.m. will be retracted, leaving some
investors with losses.

“Investors expect the value to track the underlying
securities,” Tom Graves, an ETF analyst at Standard & Poor’s,
said. “If there are going to be big divergences because of the
trading or infrastructure issues, the exchanges need to address
that.”

Exchange-traded funds own baskets of stocks, or other
securities or commodities, and resemble mutual funds except
that they are priced and traded in real-time on exchanges. In
theory, the funds are supposed to track closely the value of an
underlying index.

Morningstar analyst Paul Justice said the day’s trading was
a reminder that ETFs were best used as part of a long-term
investing strategy. “ETFs are still a very tax efficient and
low cost way to invest,” Justice said. “If you didn’t trade
yesterday, you still enjoyed all those benefits.”

Some investors were hurt in Thursday’s trading because they
previously entered stop-loss orders on ETFs, looking to hedge
their portfolios against major losses. The orders, which are
set up in advance and can remain in force indefinitely, tell a
broker automatically to sell an ETF if the fund’s price drops
below a certain level.

But on Thursday, when prices dropped dramatically for only
a few minutes, the stop-loss orders sold investors’ ETF
positions at huge losses and missed the subsequent recovery.

“Investors that stopped out intraday now realize that
liquidity has a downside,” Lawrence Glazer, managing partner at
Mayflower Advisors LLC in Boston, said. “They are not immune to
the market volatility in ETFs.”

Financial adviser John Gay at Frisco Financial Planning LLC
in Texas said he will wait and see before making any changes to
ETF investments by his clients. He placed no trades for clients
during the turmoil.

“My investment philosophy is long-term buy and hold,” Gay
said. “The sidelines were the best place to be.”

Growth Stocks

(Reporting by Aaron Pressman; Editing by Tim Dobbyn, Leslie
Gevirtz)

UPDATE 3-U.S. market sell-off ravaged ETFs