God knows I have bent over backwards when it comes to finding the silver lining in the “ETFs dominate the tape during drawdowns” story. I’ve also tried pretty hard to expound upon that silver lining once I’ve located it.
So you can spare me the comparisons to the ETF doomsayers. I ain’t one of ’em.
That said, I am still not wholly convinced that the following chart represents something that is, on balance, a positive development:
As you can see from that rather dramatic spike over there on the right-hand side, ETF trading surged this month amid the selloff in U.S. equities.
“This month alone, investors traded $1.4 trillion of ETFs (32% of Consolidated Tape) and $1.7 trillion notional of ETF options”, Goldman writes, in a note dated Monday evening. The bank goes on to say that the 32% figure “is high relative to the past six months and after controlling for the level of market volatility.”
On October 11, ETFs were 41% of the tape – 7% higher than the VIX spike would have warranted:
Unsurprisingly, 25% of ETF volumes this month are concentrated in SPY. That, Goldman notes, is more than 160bps above the 6-month average.
“This points to investors leaning on S&P500 ETFs (as they have S&P500 futures) to seek liquidity in a fast moving market”, the bank writes, stating the obvious.
As ever, folks will point to that as a positive development to the extent it means ETFs are serving as a handy liquidity conduit during drawdowns. But for the umpteenth time, I’m still not sure that makes sense from an intuitive perspective.
Yes, the “passive” characterization is meant to describe the nature of the vehicles, but implicit in the notion of an index-tracking product is the idea that people who buy it are passive investors. To deny that is to be deliberately obtuse.
In the past, I’ve been accused of conflating one “passive” with another “passive” when it comes to ETFs, but let me ask you this: Isn’t the whole idea of indexing to facilitate long-term investing with a mind towards passively tracking broad-based measures of U.S. corporates (i.e., benchmark indices)? Isn’t that the point? Is it not at least a little bit disingenuous to assert that the real purpose of index ETFs is to serve as liquidity conduits for people to tap in the event something goes wrong? Isn’t there at least some sense in which index ETFs are now to stocks what CDX and iTraxx are to single-name CDS?
If your answer to any of those questions is “no”, well then politely explain why, exactly, it is that I’m wrong. And when you do that, try to avoid relying on eye-rolls and scoffs and instead attempt to address precisely why it is that what I’m saying there is misguided, because frankly, I don’t think you can do it.
Finally, consider that in the same note, Goldman observes the same thing they observed after the February rout, which is that investors are trading the holy hell out of ETF options. To wit:
Investors traded more notional value through ETF options than the entire ETF market. This point is noteworthy in our view when you consider the limited number of ETFs that actually have “deep” options markets. Less than 30% of the 2,136 US Listed ETFs in the market have listed options. And, less than 10% of them have more than 5,000 contracts total outstanding. However, amidst growing uncertainty, investors traded more notional through ETF options ($1.7 trn notional) as they did in the ETFs ($1.4trn). Consider SPY, the deepest option market in ETFs, where investors traded $1.1trn month to date, 3.2X the amount that traded in the SPY ETF.
If what you want to argue is that ETFs are helping to improve liquidity during drawdowns and, via options, serving a valuable purpose as index hedges, well then that’s fine. Assuming you just go ahead and ignore the fact that they (almost) all broke on August 24, 2015, it’s also completely plausible.
But spare me the “ETFs are wonderful because they are primarily used by retail, buy-and-hold investors who want cheap exposure to a broad-based basket of blue chips” pitch, because that’s not how they’re being used.
That’s it, I’m done.