A recent report fingered exchange traded funds (ETFs) as the financial instrument that will cause the next market meltdown, but are ETFs really the wolves in sheep’s clothing that the report makes them out to be?
The report, written by researcher Harold Bradley and Robert Litan at the Kauffman Foundation, an institute that supports research on entrepreneurship, claims that ETFs are “radically changing the markets,” which may result in a “panic-driven market meltdown,” according to The Wall Street Journal. [Kauffman Report Riddled With Untruths Regarding ETFs.]
Of course, the report does have its own shortcomings and is riddled with glaring inaccuracies.
The authors of the report argue that ETFs have over concentrated the ownership of thinly traded stocks, led to escalating number of trading failures and could trigger another major oscillation in the markets, similar to the May 6 “flash crash.”
First off, most ETFs are created to keep a portfolio that closely reflects an index and “no one stock represents a large portion of the typical ETF,” remarks Gus Sauter, chief investment officer at Vanguard Group. [ETF Criticisms: Fact or Fear?]
Secondly, Kauffman claims that ETFs trades fail 10 times the rate of individual stocks, but “ETFs settle much more efficiently than single stocks when you look at it as a proportion of total volume,” comments Leland Clemons, a director in the capital-markets group at iShares.
Lastly, the report contends that growing ETFs could run out of money if they buy underlying securities during a “short squeeze,” which would trigger widespread panic; however, investors buy and sell on the secondary market and not from the ETF. Market makers are the ones who need to buy and sell securities.
The last line of Zweig’s article really says it all: though there’s certainly a need for more education, ETFs don’t pose systemic risk. So, are we done beating a dead horse? There are bigger things going on right now.
For more information on exchange traded funds, visit our ETF 101 category.
Max Chen contributed to this article.