Exchange traded funds track the performance of their underlying components. However, as the popularity of the investment vehicle grows, some ETFs are beginning to affect the performance of individual stocks.
According to S&P Capital IQ, ETFs may pose systemic risks, especially as investors pour more money into the investment vehicle than the individual stocks that the ETFs hold, USA Today reports.
The potential problems will likely occur during periods of high volatility when investors dump ETFs. Consequently, the robust selling pressures may overwhelm the actual stocks held in popular indices.
S&P Capital IQ points out that investors may notice an ETF’s influence in company stocks where the average daily dollar volume of trading is less than the stock’s weight in the index.
For instance, Exxon Mobil (NYSE: XOM) actual shares make up 0.78% of average daily dollar volume of trading, but it makes up about 1.9% of the S&P 500 index, along with S&P 500 related ETFs. Consequently, selling pressure on S&P 500 ETFs could put excessive pressure on the company stock.
S&P Capital IQ also identifies a number of S&P 500 components that show liquidity risk relative to ETF trading action. For example, Berkshire Hathaway (NYSE: BRK.B) has an index weight of 1.36% and an average daily volume of 0.39%. Johnson & Johnson (NYSE: JNJ) has a 1.48% index weight and a 0.65% average daily volume. Microsoft (NasdaqGS: MSFT) has a 1.96% index weight and a 1.16% average daily volume. General Electric (NYSE: GE) has a 1.47% index weight and a 0.73% average daily volume.
The influence ETFs has on broad markets may not be all too surprising as studies have shown that ETFs affect index stock correlations. University of Zurich researchers have found that S&P ETFs and futures affect index stock correlations, both ETF and futures activity will affect non-index stock correlations and ETFs have a larger impact on correlations than futures. The researchers also revealed that correlations of index stocks are more sensitive to changes in index trading activity than non-index securities. [Increased Index ETF Usage Promotes Stock Correlation Across the Board]
For more information on ETFs, visit our ETF 101 category.
Max Chen contributed to this article.