ETFs and market efficiency – some evidence

A few weeks ago, I speculated that the rise of ETFs negatively impacted market efficiency. At that time I had not heard of any research that provided evidences to confirm or dismiss my fears. Not anymore.

A few articles (see here, here, here and here) have reported that a recent Goldman Sachs equity research piece (titled ETFs: The Rise of the Machines) found that ETFs had more influence than previously believed on share prices. I haven’t had access to this GS report, but here’s an extract from one of the articles:

Are exchange-traded funds an unseen force, like gravity, that help determine stock-price moves? New research suggests that the rise of ETFs may be complicating stock pickers’ chances of selecting winners or losers. That could make it even harder for stock-fund managers to outperform their benchmarks as assets in ETFs grow.

The $1.2 trillion in U.S. stock ETFs is having a much larger impact on the market than the fund industry claims, according to a recent report from Goldman Sachs. At issue: Heavy trading of index-tracking ETFs appears to be herding individual stocks up or down together, particularly in niche industries such as real estate and mining.

Goldman’s equity research team contends that increases in ETF trading appear to be tightening correlations, or the tendency for individual stocks and sectors to move up or down in lock step, regardless of a company’s fundamentals.

This was precisely my point in my previous post. But the extent of this ‘ETF distortion’ is hard to measure:

Comprehensive data aren’t available, but a study last year by the Investment Company Institute estimated that only 9% of ETF trades trigger buying or selling in individual stocks. Goldman, however, assumes the number is much higher, closer to 50% in some sectors.

As ETFs keep growing as an asset class, it is likely that those effects are going to be exacerbated. Perhaps we need even more activist investors to bring some balance back to the Force.

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2 responses to “ETFs and market efficiency – some evidence”

  1. emerich says :

    “Complicating” Stock pickers chances? “Negatively impacted market efficiency”? That implies easier pickings for stock pickers.

    • Julien Noizet says :

      I’m not sure to follow.
      If stock pickers pick stock based on fundamental analysis but the share price does not follow the fundamentals, it doesn’t seem to facilitate their job.

      The only ones who benefit are those following trade flows.

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