Why ETF threat criticisms are 'over the top'

One expert rebuts common arguments against the rise of passive investment products

Why ETF threat criticisms are 'over the top'

As passive investment products steadily gain popularity among consumers and institutions, numerous analysts have warned of possible adverse impacts on the markets. But a senior ETF analyst with Bloomberg Intelligence argues that many of those warnings are exaggerated.

“The headlines are over the top,” Balchunas said in a recent interview with Vanguard Canada. He pointed out that the size of indexing relative to the fund industry is often mistaken for its size relative to the stock market.

“Only half of the $27 trillion [about CAD 35 trillion] U.S. stock market is owned by funds,” he explained. “Of the half that's owned by funds, passive is roughly 35% of that half and, therefore, 16% to 17% of the whole equity pie. ETFs then own a little less than half of that, or 7.4% of the stock market.”

He also noted that much of the criticism levelled against passive investing originates from active managers, who have a vested interest in tearing down their index-based competitors.

As for fears that indexing could become large enough to interfere with stock prices and market efficiency, he said he believed having just a quarter of the stock market being actively traded and setting prices would be fine.

 “If prices were moving in lockstep because so many assets were in index-based products, then you would see price dispersion compress,” he said. “But we're just not seeing that. Not on a macro level and not on an individual-stock level.”

He also dismissed the notion that ETFs are helping create a stock-market bubble, arguing that people are just flocking to ETFs as the best vehicle for them to invest because of their typically lower costs and capital-gains distributions, as well as their intraday liquidity. The passive space isn’t monolithic, he added; aside from market-cap-weighted funds, investors can buy smart-beta or fixed-income ETF strategies.

“Some people contend that passive flows are driving up the stock prices of big companies,” he continued. “But the large active funds tend to hold the same stocks: Facebook, Amazon.com, Netflix, Google parent Alphabet. If those famous ‘FANG’ stocks fell 40% in a day, should ETFs get the blame?”