Oh, for God’s sake.
Earlier this month, following the October 10/11 drawdown, Goldman decided to take a look at whether investors were turning to ETFs and ETF options for liquidity and index hedging, respectively, during the rout and the answer was a resounding “yes”.
ETF trading surged this month amid the selloff in U.S. equities. On October 11, ETFs were 41% of the tape – 7% higher than the VIX spike would have predicted.
As I’m wont to do, I suggested that’s not necessarily a positive development or, at the very least, it suggests ETFs are not being used as intended. Here, specifically, is what I said:
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?
Fast forward to Friday and Goldman is out with a new piece documenting the use of ETFs during the Wednesday selloff.
In case you have a short memory (or in case, like me, years of drowning the synapses in Balvenie makes it hard to remember what happened two hours ago, let alone what happened two days ago), the Nasdaq suffered its worst one-day decline since 2011 on Wednesday.
As Goldman writes on Friday morning, ETFs were 32% of the tape on Wednesday, with “most of the volume concentrated in large market cap weighted Index ETFs; 30% from SPDR S&P500 ETF (SPY), 11% from PowerShares QQQ and 4% from iShares Russell 2000 (IWM).”
The good news (and don’t skip over this, because I don’t want you to accuse me of being an ETF doomsayer) is that Goldman doesn’t see much in the way of evidence to support the contention that this is affecting prices.
“We are seeing little differentiation in performance at the market level between stocks that are most held by ETFs versus least held”, the bank says, adding that when you throw in the fact that “ETF flows have been mostly benign overall”, there’s little evidence for the argument that “passive positioning [has been] a driver or compounder of weakness in the market as of late.”
Duly noted, but consider this, from the same note:
On 24-Oct, $162bn in flows traded through the ETF markets, and the ETF options market traded another $211bn in notional exposure. Over half of this combined flow came from the largest ETF in the market, the SPDR S&P500 (SPY). Importantly for SPY, over 3X the notional traded in options as ETFs. Nearly twice the number of puts traded on ETFs than calls – with hedging seen in many ETFs including S&P500, Nasdaq, Small Caps, Semiconductors, and Industrials. For many ETFs on 24-Oct, investors traded a significantly higher number of puts than calls. In SPY, investors traded over 2X the number of put contracts than calls. Hedging demand was quite pronounced in the VanEck Vectors Semiconductor ETF (SMH) where almost 10X as many puts traded as calls.
Ok, so do me a favor, will you? Let’s just step back out of the weeds for a minute and think about this from a purely common sense perspective.
Is this what we want? Is that really what these are for? Maybe it is. Maybe I’m the crazy one. It seems like somebody calls me crazy at least once everyday, and it’s become a point of pride for me, so do feel free to join in (the line stretches around the block though, so you’ll have to take a number).
But in case you somehow haven’t surmised this, I’m no Johnny-come-lately to this debate. I mean, I’m not Methuselah over here either, so I don’t want to pretend like I’ve had front row seats for every epochal market structure shift in history, but I have most assuredly been around for the entirety of the active-to-passive “revolution” and I cannot remember a single time when someone said: “What’s great about passive ETFs is that when the market crashes, people can run screaming to the options market on the way to trading hundreds of billions in notional while sweating bullets and chugging Red Bull as the Nasdaq careens lower by 4%.”
Plus, what happens to all of those open positions if we get a more acute version of August 24, 2015 when ETFs literally broke? I suppose we’d all get together and collectively figure out a dispute resolution mechanism, but my God, it would be a nightmare.