How Much Do Etfs Influence Stocks

ETFs in Media Cross-hairs

Despite the lack of statistical evidence, ETFs have been blamed for exacerbating market volatility, high equity correlations, and maliciously influencing single stocks. To start off 2012, both volatility and correlation have fallen significantly and now ETFs are being blamed for low volumes.

In an earlier report addressing the topic of higher correlations (see ETFs and Correlation: The Chicken or the Egg?), we noted that ETF assets (just over $1 trillion) were a mere fraction of the total stock market. Furthermore, only about 40% of ETF assets actually track U.S. equities. The remainder tracks foreign equities, bonds, or commodities.

Exhibit 1: U.S. Equity and Value Traded Breakdowns

Suggests more naturals inside the spread

The relative lack of arbitrage opportunities suggests that there are more natural buyers and sellers trading inside the spread that don’t ever need to trade the underlying basket of stocks. In addition to strategic buyers/sellers, statistical arbitrage is tremendously popular as traders exploit statistical relationships between ETFs (and futures, stocks, etc). In fact, this is likely the reason that ETF spreads are as tight as they are ( as we covered in a previous report, Covering the Spread) even for international ETFs whose underlying are not trading during all U.S. hours.

End of Day Impact Overstated

There is also a strong belief that ETFs affect stocks even more at the end of the trading day. However, this seems counter to what we observe in the microstructure of the market. Compared to regular stocks, ETFs actually tend to trade more at the open and less at the end of the trading day. There’s a couple factors that contribute to this:

Exhibit 6: Volume curves for Stocks and ETFs

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