Are ETFs to Blame for Dwindling Stock Trading Volume?

August 1st at 2:13pm by John Spence

Trading volume in stocks fell noticeably in July with some analysts blaming the decline on a lack of investor interest as the market swings back and forth within a relatively narrow range.

However, there may be another culprit: exchange traded funds.

July was the slowest month in the stock market in years, the Associated Press reported. Activity tends to trail off in the summer months anyway as traders go on vacation.

“The volume in some cases is being lost to things like ETFs,” Art Cashin, director of floor operations at UBS Financial Services, told CNBC on Monday. Individual investors remain nervous about jumping into stocks after the May 2010 flash crash, he added, when asked about reports of equity volumes down 35% to 45% year over year at some of the big trading desks.

ETFs are often portrayed as head-to-head competitors against traditional mutual funds. However, one aspect of the industry’s growth that can be overlooked is that more traders are using sector ETFs rather than betting on individual company shares.

“We believe that altering allocations — even when using plain-vanilla index funds (which by the way are ultra low-cost and highly liquid) — is a more powerful strategy than trying to understand business fundamentals of a few companies better than others,” ETFreplay.com said Monday. For investment advisors, “it is the basic big-picture allocation that is the most important part.”

Year to date, U.S.-listed ETFs have seen positive flows of $69 billion, or just over 6% asset growth in 2011, according to ConvergEx Group.

“More recently, hedge funds have increased their use of ETF products to pursue a variety in investment goals,” said Nicholas Colas, chief market strategist at ConvergEx. “Some use market index products such as the SPDR S&P 500 ETF (NYSEArca: SPY) or sector funds to hedge the ‘long’ side of their books. Others use volatility products to speculate on market direction, or commodity funds to diversify into asset classes outside their traditional long/short equity strategy.”

Yet as the ETF business hits $1 trillion in total assets and climbing, some allege the financial products are making markets more volatile.

The flash crash “saw a greater percentage of bad prints in ETFs than single stocks,” Colas wrote in a report. “There’s a chicken-and-egg feeling to this worry, to be sure, and at its core this particular concern is really more about market structure than the role ETFs themselves play in capital markets.”

The opinions and forecasts expressed herein are solely those of John Spence, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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