Don't blame ETFs for stocks' recent declines

The latest numbers from ETF research firm ETFGI show that globally, ETF assets have already breached the US$5 trillion mark, demonstrating the growing influence of the space among investors. Some detractors have suggested that the increasing concentration of assets in ETFs would exacerbate market moves and cause indiscriminate selling during downturns.

So that begs the question: should ETFs be blamed for the recent selloffs that rocked the US stock market? A recent MarketWatch report laid out evidence to the contrary.

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“The numbers simply don’t support the idea that the rise in ETF ownership is creating a world where everything is correlated,” Michael Venuto, co-founder of Toroso Investments, said in the report. “Remember that ETFs were a fraction of their current size in 2008 [during the financial crisis], but you had the same kind of broad selloff we saw this week.”

The past week did feature heavy selling in ETFs and other stock funds. Investors pulled US$30.6 billion out of equity funds in the week through Wednesday, according to global fund tracker EPFR. Stock-fund withdrawals were heavily concentrated in ETFs, with stock-based ETFs shedding US$20.45 billion over last week.

But data from Toroso Investments indicate that ETFs currently hold 6.97% of the US stock market. That’s a minute fraction of the influence mutual funds, international investors, retirement funds, and households have.

And while ETFs represent a particularly busy pocket of the market, Bloomberg ETF analyst Eric Balchunas has noted that only 10% to 20% of ETF trading on heavy-selling days actually involve the underlying securities, as opposed to simply exchange shares of a fund. He even speculated that ETFs could limit declines because of the added liquidity they cause in the market.

Detractors may point to the past week’s increase in stock correlations as a sign of ETFs corrupting the market and causing names to move in tandem regardless of their fundamentals. But MarketWatch noted that correlations had been practically nonexistent before that, even with the massive growth of ETFs. And the selloffs across sectors could be attributed to recently released US jobs figures, which stoked fears of inflation and more aggressive Fed rate hikes.

Principal Global Equities Chief Investment Officer Mustafa Sagun said the recent decline could be blamed not on popular traditional-beta ETFs, but on volatility-based tactics. “Such volatility strategies are not price-sensitive, meaning they don’t buy and sell the market based on fundamentals,” he said. “Instead, when volatility goes up, they have to lower their risk, which means they have to sell stocks, and that selling begets more selling. I don’t see ETFs as contributing to this.”