ETFs Are Affecting Component Stocks, Influencing Market Correlation | ETF Trends

As exchange traded funds continue to grow, the investment products may have become so large that they are affecting movements in underlying individual stocks.

When examining the relationship of ETFs to trading of stock components with lower volumes, the Goldman Sachs Group Inc. discovered that activity from ETF creations and redemptions generated significant levels of trading in constituent shares, reports Inyoung Hwang for Bloomberg.

“The outsized growth in ETFs coupled with lower market liquidity lays the stage for a cocktail of single stock impact that few investors, we believe, fully appreciate,” Robert Boroujerdi and Katherine Fogertey, analysts at Goldman Sachs, said in a note.

The Goldman Sachs analysts argue that while ETFs may provide long-term investors with a low-cost passive investment vehicle, the majority of trades are coming from active managers utilizing the highly liquid funds in tactical positions.

“Surprising to many is the reality that active managers are among the largest users of ETFs with applications spanning hedging, cash management and achieving ‘instant’ exposure to sectors or geographies in which they are underweight or lack expertise,” the analysts said in the note, according to Barron’s. “U.S. stock ETFs now account for roughly 25-30% of the consolidated tape with even larger impact during periods of market volatility, up 10-15% ten years ago. Passive portfolio turnover is 1/10th that of active managers.”

Exchange traded products, which have accumulated almost $2.2 trillion in assets in the U.S. from $230 billion in assets under management a decade ago, track an index of stocks, similar to mutual funds, except ETFs are traded on an exchange like a stock.