The rising popularity of index-based ETFs may be making it harder for stock pickers and active managers to find value or opportunities in the equity market, potentially pushing more investors to forgo inaccurate picks and rely on the passive products instead.
According to a new research study conducted by Constantinos Antoniou of the University of Warwick, UCLA Anderson’s Avanidhar Subrahmanyam and Onur Kemal Tosun, also of Warwick, market signals are becoming distorted due to the rising prominence of ETFs.
“Specifically, we hypothesize that since ETF ownership makes stock prices more volatile and less informative, it adversely affects the ability of managers to learn about the prospects of their firms from stock prices,” the researchers said.
Most ETFs passively track a benchmark index comprised of tens, hundreds or even thousands of individual securities, regardless of a company’s individual prospects. The researchers argued that ETFs’ passive approach diminishes the “pricing efficiency” of individual stocks in the underlying indices. In other words, company share prices are either higher or lower than they would be if ETFs picked stocks based on the companies’ fundamentals.