This Dire Stock Market Warning Is ‘Fake News,’ Analysts Say

Worries of an ETF bubble persist even as exchange traded funds soar in popularity. But two ETF professionals say they have proof the biggest worries about ETFs are “fake news.”

Do ETFs threaten the market’s structure by making it too easy to pile into — or bail out of — the same stocks or bonds at lightning speed?

That’s the public claim of Michael Burry. Burry is famous for appearing in “The Big Short,” portraying his bet against mortgages ahead of the 2008 crisis. Burry, who ran Scion Asset Management, has called ETFs and passive investing a “bubble.” He says ETFs put too much fast money into too few concentrated positions.

That assertion is “fake news,” Matt Bartolini, head of ETF provider SPDR Americas Research, told a gathering of financial advisors at the Schwab Impact conference in San Diego. He and Michael Arone, managing director at State Street Global Advisors, presented data to debunk worries about an ETF bubble.

“Slowing growth and policy uncertainty has ignited these micro bursts of volatility. And as a result of that, we tend to have the sort of lazy narratives that come out searching for a culprit,” Bartolini said. “And, “given the rise of passive investments, ETFs are typically to blame.”

Passive Investing Isn’t Taking Over The World

The rise of passive investing is undeniable. Net assets in index mutual funds jumped 433% to $3.3 trillion between 2008 and 2018, says The Investment Company Institute. Meanwhile, $3.4 trillion is now invested in ETFs, up 534% from 2008. Most ETFs are passive and track an index. Passive strategies soak up nearly half of U.S. listed fund assets.

And yet, Arone points out passive strategies make up only about 26% of global funds. And that shows how the global market is still predominantly actively managed. “When we widen the scope, the story starts to shift,” he said. Furthermore, U.S. managed assets of indexed mutual funds and ETFs only make up 9% of the market value of global stocks, Bartolini says.

ETF Bubbles Won’t Pop In A Market Meltdown

There’s concern by some that the unique structure of ETFs will melt down in a period of rapidly falling prices. Some claim ETFs have not been adequately tested in a U.S. stock market decline. The fear is trading might seize up.

But Bartolini says the ETF structure has been around since 1993. That’s when the SPDR S&P 500 Trust (SPY) was created. But that means SPY stock endured the brutal downturns of 2000 and 2008, without investors having trouble getting their money.

Additionally, there have been brutal sell-offs in small-cap stocks, emerging markets stocks and junk bonds. None of these events triggered any difficulty in the trading of ETFs, Bartolini says.

ETFs Don’t Make Sell-Offs Worse

Many investors own the same positions in ETFs. Couple that with the fact ETFs are easy to sell. So, the worry is panic can be magnified with ETFs as investors dump their holdings.

But Bartolini found that trading in ETFs didn’t yield equal trading volumes in the underlying stocks in previous sell-offs. Of every $8 in ETF trading volume, that only translates into $1 of buying or selling of the underlying shares. If you buy a share of SPY stock, a holder of SPY stock sells. There’s no need to buy the underlying stocks in the ETF like Microsoft (MSFT) and Apple (AAPL) in most cases.

Bartolini looked at trading on Feb. 5, 2018, when the S&P 500 fell a massive 4% in one day. That day, ETF trading only accounted for 2% of the underlying stocks’ volume. And that small effect was consistent across giant, large, midsize and small stocks, he says. The effect was the same, too, by sector.

Most Active Managers Don’t Beat ETFs In Sell-Offs

Critics of passive ETFs claim these funds sell off in declines like lemmings. Some say you need professional managers to outsmart corrections or bear markets.

The evidence points to the contrary, Bartolini says. Most actively managed funds underperformed the benchmarks during both the bear markets of 2000 and 2008. “Active management didn’t rise to the occasion like most people thought,” he said.

It was a similar story in the nearly 20% decline in the fourth quarter of 2018. Less than half the active managers beat their benchmarks during that period of market stress. And the ones that did, on average, did so by tiny amounts and still posted losses.

“Active management didn’t provide downside protection (investors) were seeking in the troubled times of the fourth quarter,” Bartolini said.

ETF Bubble? Largest ETFs

Symbol Name Expense ratio Assets ($ billions)
SPY SPDR S&P 500 ETF Trust 0.09% $280.06
IVV iShares Core S&P 500 ETF 0.04% $193.57
VTI Vanguard Total Stock Market ETF 0.03% $129.62
VOO Vanguard S&P 500 ETF 0.03% $122.77
QQQ Invesco QQQ Trust 0.20% $80.26
VEA Vanguard FTSE Developed Markets ETF 0.05% $75.64
IEFA iShares Core MSCI EAFE ETF 0.07% $68.61
AGG iShares Core U.S. Aggregate Bond ETF 0.05% $65.92
VWO Vanguard FTSE Emerging Markets ETF 0.12% $64.40
EFA iShares MSCI EAFE ETF 0.31% $61.71

Original article By Matt Krantz: