As the exchange traded fund industry grows, the number of critics are growing as well. While we do hear about a number of concerns that are unique to ETFs, investors should separate the facts from fiction.
For instance, some are concerned that ETFs cause volatility in the stock market. However, people may be confusing the tail wagging the dog. ETF trading volume typically spikes during periods of heightened volatility, but active ETF trading is an effect of volatility, not a cause.
While ETF trading is more correlated to volatility than trading in individual stocks, market observers like Credit Suisse have noted that the higher volatility only corresponds to more active ETF trading, reports Bob Pisani for CNBC.
Credit Suisse explains that ETFs are typically used for “tactical allocations,” or more active short-term trading to hedge bets or short certain markets. As macroeconomic concerns trigger volatility in the equities market, more investors are turning to ETFs to capture opportunities.
ETFs are also becoming the go-to choice for broad investment exposure. Credit Suisse estimated that trading in ETFs last year made up 29% of the dollar value of daily U.S. equity trading. In the first week of January, ETF trading averaged $111 billion per day, or 33% of the dollar value of U.S. exchange trades.
Some market observers are also growing concerned over leveraged and inverse ETFs. While the geared ETFs implement more sophisticated structures, the funds are not a danger to the markets.
These geared ETFs try to reflect a leveraged or inverse prospective of a given market on a daily basis, which means that they reset returns on a daily basis. Consequently, due to the compounding effects of the daily resets, these ETFs may not perfectly reflect their target leveraged or inverse strategies over the long-term. [What The SEC Derivative Proposal Means for Leveraged & Inverse ETFs]
A few observers have been warning everyone that these geared funds are adding to market volatility. However, leveraged and inverse ETFs only make up a tiny portion of the overall market. ETFs have about $2 trillion in assets under management, but leveraged and inverse ETFs account for $30 billion in assets under management, or less than 2%. [Will The SEC Cause Backlash for Leveraged/Inverse ETFs?]
Max Chen contributed to this article.