ETFs Aren't The Reason Why Markets Are Volatile

Moreover, Davis argued that index funds are only a smart part of the overall financial market, making up about 10% of the value of global equity and bond market capitalization and even less of trading volumes.

While some critics argued that a major sell-off could trigger massive redemptions with a hoard of investors running for the exit, Davis also reminded investors that in both the 2000-02 and 2008-09 drawdowns, investors were piling into index funds, which experienced heavy inflows.

“You could make the case that these ready-made portfolios were viewed as attractive safe harbours during tumultuous times precisely because they are often low cost and well diversified. But I think that growth was part of a structural trend. More and more long-term, buy-and-hold investors are switching to index investing,” Davis said.

Lastly, ETFs’ structure or the way they trade has no direct impact on the price of the underlying investments, which means they aren’t driving market volatility. Vanguard research found that for every $1 in ETF trading volume on exchanges, less than 10 cents resulted in primary market transactions in the underlying securities. In other words, over 90% of ETF trading did not trigger buy or sells in an ETF’s underlying components.

For more information on ETFs, visit our ETF 101 category.