In an increasingly lockstep market, some critics blamed passive index-based exchange traded funds for the increased volatility experienced during the October selling, but the accusations may be misguided.
Index trackers were under the microscope after technology-specific ETFs dumped billions of dollars of large tech names like Facebook and Alphabet’s Google in late September, with some observers speculating that sales fueled the broader stock market correction, Bloomberg reports.
However, regulatory documents disclosing trades among active managers revealed that passive investors only made up a small portion of the overall sellers. According to Bloomberg data, hedge funds were net sellers of both technology companies last quarter, indicating a growing negative sentiment around the tech names before the correction.
“When you start thinking about more active money out there today, it’s still effectively at least double” ETFs, Joe Smith, deputy chief investment officer at Omaha, CLS Investments, told Bloomberg. “There’s a lot of names that have been bid up. Now that we’re going through the earnings seasons and also some of these changes that have occurred, people are finally starting to look under the hood.”
Hedge funds are now underweight technology, communications and internet retail for the first time since at least 2010, according to RBC Capital.
As the passive index-based ETFs continues to grow, the industry has drawn concerns over how indexing may affect volatility, liquidity and valuations.
“When some of these big moves happen, people thirst for a rational and logical explanation, and indexes and ETFs often fit that bill very nicely,” Lance Humphrey, a money manager in the global multi-assets team at USAA Asset Management, told Bloomberg. “Indexes and ETFs are very easy punching bags.”
For example, major indexers made the decision to shift Facebook and Alphabet into the newly created communications services sector and removed the traditional tech names from broad technology sector-related indices.
“The stocks that were sold were also very volatile, which means if there wasn’t a concurrent buy as part of the rebalance, then they would probably move a lot more than average,” Oliver Brennan, a macro strategist at TS Lombard, said in a note. “I’m not trying to suggest the trigger and the sole cause for the selloff was the rebalance, but it happened at the exact worst time.”
TS Lombard calculated that sector ETFs sold around $10 billion in Facebook, Alphabet and other former tech-related stocks.
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