Ok, here’s the thing. You can’t listen to cynical people when it comes to ETFs.
Fortunately, we’re not cynical people.
No matter what anyone tells you, the rampant proliferation of ETFs is an unequivocally positive development because they allow long-term, fundamentals-minded investors to allocate as they see fit at very low cost thus freeing them from the tyranny of nefarious money managers who charge exorbitant fees because they are greedy bastards who can’t be trusted to look out for retail investors’ money.
Those are the facts. And sure, there are tons of mutual funds that are low-cost indexing vehicles and thereby offer the exact same benefits in terms of allowing long-term, fundamentals-minded investors to allocate at virtually no cost and yes, you might reasonably ask why a “long-term” investor needs instantaneous liquidity if the mantra is “buy and hold”, but if you’re asking that question or if you’re predisposed to saying something like “well what was wrong with a Vanguard mutual fund?” you’re a cynical person who can’t be trusted, ok? Ok.
And because ETFs are definitely vehicles that attract long-term, fundamentals-minded investors, there’s no way that people would have sold SPY en masse last week, effectively negating the entirety of the massive January inflow which was itself certainly not a manifestation of people using ETFs to speculate on short-term gains, right? Right.
Or actually no, that’s entirely wrong. Because as it turns out, SPY saw a record $23.6 billion in outflows last week. As Bloomberg’s Luke Kawa writes, “the five-session stampede for the exits erased the previous nine weeks of inflows into the fund.”
“Retail investors had poured more than $100bn into equity ETFs during January [and] of that $100bn, $40bn was invested into US equity ETFs,” JPMorgan wrote on Friday. “So more than half of the $40bn that had entered US equity ETFs in January has been withdrawn already. So again, the picture we are getting in the US equity ETF space is one of advanced rather than early stage de-risking.”
Well damn. That moved from “early-stage” to “advanced” de-risking pretty goddamn quickly, didn’t it? I mean where was the “early stage”? Because just two weeks ago people were plowing money into ETFs. So it kinda looks like they skipped straight from panic buying ETFs to ride the “blow-off top” to “advanced” de-risking all in the space of like 10 trading days.
Meanwhile, Goldman is out with a new piece that documents the extent to which ETFs have dominated the tape in February. Specifically, ETF trading volumes represented around 34% of the total ConsolidatedTape month to date:
SPY outflows in February have accounted for nearly 80% of total US Equity ETF net flows MTD. Next on the list: QQQ and JNK (go figure).
Oh, and another notable thing about the action in the ETF space this month. As Goldman goes on to write, “investors traded nearly as much through ETF options ($1.3trn notional) as they did in the ETFs ($1.4trn).”
There are a lot of ways you can interpret that, not all of them bad, but give me a break. These things are functioning almost solely as vehicles for people to access liquidity or as a way for people to hedge.
Again, that’s not necessarily a “bad” thing (and there are arguments for why it’s actually “good”) but I’m still not sure it lines up well with how a lot of folks like to describe the ETF space. People are “leaning on SPY (as they have S&P500 futures) in a fast moving market,” Goldman says, summing up. So it’s just everyone slinging a flaming hot ETF potato around.
The bottom line here is simple: these passive flows have a tendency to be one-way on the way up and one-way on the way down just as countless people (including Howard Marks) have suggested they would be. On that note, we’ll just leave you with one last quote from Goldman:
ETF outflows have turned many passive funds from forced buyers to forced sellers.