Last Updated: 2 June 2023
It would sound like hyperbole to say, “The media is after ETFs,” if CNBC weren’t literally running footage from Frankenstein. Enough’s enough.
I don’t know if you caught it, but my friend and colleague Matt Hougan was defending ETFs on CNBC two weeks ago. While I could comment on Matt’s slightly damp appearance (he ran across town, literally, for the spot), what’s most shocking is the smear campaign perpetrated in the piece.
“A monster in the making” is how Herb Greenberg described ETFs, right in the opening minute. What follows is a mishmash of accusations crammed together, one after another: ETFs caused the “flash crash”; ETFs are responsible for rising asset correlations; ETFs are an “illusion.” All this peppered with footage from Frankenstein featuring torches and pitchforks. And all of this, theoretically, because, “ETFs are feeding from the same trough.”
Last week, the smear campaign got into high gear again. This time the horrible specter of short-sellers somehow magically breaking the ETF creation-redemption mechanism was raised, clearly by people who understand neither how short selling is reported, nor how ETF creations and redemptions work.
Here’s a brief survey of some of the great ETF scare-tactic headlines of the last few months. See if you can guess which ones are mainstream and which ones are from bloggers:
Ten Shocking ETF Charts from the “Flash Crash”
Risks Lurk for ETF Investors
ETFs Causing Volatility? Here’s The Real Problem
Problems With Energy Sector ETFs
Why ETFs are “starting to scare” one financial advisor
When Sector ETFs Are a Bad Bet
Can a[n] ETF COLLAPSE?? Very Scary!! Make sure you have physical!
Scary ETF Stories
Market warned about permitting risky ETFs
The thing that’s startling to me is that despite all this hype, nobody’s making any apt comparisons. If ETFs are single-handedly causing all this high-correlation structural risk and threatening life as we know it on Planet Earth, then surely they must be a dominant pool of assets, right?
Compared with the true institutional market, or even retail mutual funds, ETFs are just a drop in the bucket. ETFs crossed $900 billion under management for the first time just yesterday, according to our ETF Daily Data. To put that in perspective, traditional mutual funds crossed the trillion-dollar barrier in 1990, over 20 years ago.
Put into even greater perspective, traditional mutual funds grew from $9.6 trillion under management in 2008 to $11.2 trillion at the end of last year, a one-year growth spurt of $1.5 trillion. ETFs grew “just” $240 billion in that same period. All these stats, by the way, come from the Investment Company Institute’s 2010 Fact Book.
But even that’s just a drop in the bucket compared to the serious money—retirement assets. Retirement assets in 2009—which, to be clear, likely feature almost no ETFs—topped $16 trillion, down from the all-time high of $18 trillion in 2007, but still a monumental number. Of that $16 trillion, about half is in participant-directed accounts, like 401(k)s and IRAs, and about half is in old-school defined benefit plans.
Now, we don’t know exactly what the split in the DB world is, but I can tell you from experience that half of that is surely in traditional equities. On the self-directed side, the ICI suggests about half is also in equities. That puts something like $8 trillion of sticky retirement assets all chasing the same small pool of public companies.
And people are worried that ETFs are driving rising correlations? Preposterous.
Let’s look at it from another angle. According to Standard & Poor’s, there are roughly $915 billion directly invested in S&P 500 index products. That’s almost $1 trillion pegged to a basket of stocks worth $10 trillion, total. In contrast, the two big S&P 500 funds—SPY and IVV—have about $100 billion between the two of them.
A drop in the bucket. Here, allow me to visualize for you how insignificant ETF assets really are in the grand scheme of S&P 500 ownership:
And somehow ETFs are suddenly to blame for the rising correlation of S&P 500 stocks?
Now, the only caveat that I’ll make here is that yes, SPY is the most liquid security in the world. But activity in SPY is not, by any stretch of the imagination, what’s driving the actual price of, say, Microsoft. Despite SPY’s prominence on the NYSE, it’s still not much to write home about compared to where the big money changes hands—the futures markets.
Let’s just look at yesterday’s volume and notional traded dollars.
Yes, $21 billion in traded volume is a big number, but driving the underlying? Hardly.
But what about the evil specter of leveraged and inverse funds, and the idea that their daily activity is raining chaos upon what would otherwise be a tranquil market? Surely the pitchforks are deserved for the evil speculators?
Well, currently there are $10 billion in leveraged and inverse large-cap U.S. equity ETFs. Let’s assume (for the sake of simplicity) that ALL of that is triple leverage (it’s not), that all of it is the same direction (it’s not) and that all of it is benchmarked against the S&P 500 (it’s not). That’s an implied imaginary exposure of $30 billion in long S&P 500 exposure that needs to be held in swaps. Those swap counterparties are presumably using the futures markets to get their exposure. Now let’s imagine that the “true up” every single day is 10 percent of that total value. That implies a kind of worst-case scenario where swap counterparties have to put on or take off $3 billion of S&P exposure every day.
Golly, do you think the $106 billion daily futures market could possibly absorb such a massive participant in the market?
The reality, of course, is much simpler than this. On any given day, the long and short end of the leveraged/inverse fund market isn’t 100 percent in either direction, it’s merely off kilter. (Last night, it was about 70 percent short/30 percent long for large-cap equities. The remaining exposure is mostly at 2X, not 3X leverage, and swap counterparties have more than just the December e-mini S&P contract to play with.)
In other words, if you’re suggesting that leveraged funds are driving the futures market, you’re off your meds.
ETFs may be making a lot of noise, but compared to the true big boys—the retirement assets, the hedge funds and the institutions—they’re just a drop in the bucket.