Exchange-traded funds (ETFs) are great. They’re packaged investment products that trade all day like stocks.
You can buy, sell and short ETFs that track:
- all the major stock market indexes
- any and every industry group
- different investing styles
- commodities like oil, gas, gold and silver
- entire countries
Just about any asset class or portfolio product Wall Street thinks you want to trade or leverage your bets with – even inverse ETFs that go up when their underlying market indexes go down – they are all here.
ETFs are hot right now. So is passive investing.
They’re so hot together that they’re going to ignite the next market crash.
It’s not a matter of if, it’s a matter of when. And it has ETF sponsors and regulators worried to death.
How Far ETFs Have Come
The first ETF in the U.S. was the SPDR S&P 500 ETF (NYSEArca:SPY). It was launched in 1993 by State Street Global Advisors under the product label Standard & Poor’s Depository Receipts (SPDRs).
Today, eighty ETF sponsors manage ETF fund families with almost $2.5 trillion in assets under management (AUM). But just three companies sponsor the vast majority of these funds.
BlackRock’s ETF iShares products account for 39% of the market with AUM of over $1 trillion, the Vanguard Group has 23% of the market with $615 billion in AUM, and State Street Global Advisors has a 19% share of the market with $510 billion in assets under management. State Street has their SPDR products, of which $235 billion is in one ETF, the original SPY.
Together the “Big Three” control 82% of the ETF industry.
And now, everyone’s trading ETFs, causing the market to grow explosively from 2002 through 2014.
Since 2009, trading volume in listed ETFs averaged 28% of the total consolidated dollar value of shares traded in the U.S. According to Keefe Bruyette & Woods’ ETF Spotlight Industry Update from February 3, the dollar volume in 2016 was 29% of all shares… worth $91 billion per day.
Of the 25 largest ETFs (by AUM), 58% of trading volume is accounted for by institutions, with retail investors trading the remaining 48%.
To give you an idea of the scale, here are the top ten most traded stocks by dollar volume in all of 2016 in reverse order:
10) Bank of America Corp. (NYSE:BAC) traded $423 billion in shares
9) Microsoft Corp. (NasdaqGS:MSFT) traded $429 billion in shares
8) VanEck Vectors Gold Miners ETF (NYSEArca:GDX) traded $470 billion in shares
7) iShares MSCI Emerging Markets ETF (NYSEArca:EEM) traded $603 billion in shares
6) Amazon.com Inc. (NasdaqGS:AMZN) traded $710 billion in shares
5) Facebook Inc. (NasdaqGS:FB) traded $739 billion in shares
4) PowerShares QQQ Trust ETF (NasdaqGM:QQQ) traded $784 billion in shares
3) PowerShares Russell 2000 ETF (NYSEArca:IWM) traded $931 billion in shares
2) Apple Inc. (NasdaqGS:AAPL) traded $1.008 trillion in shares
1) SPDR S&P 500 ETF Trust (NYSEArca:SPY) traded $5.480 trillion
Do you see those five ETF’s in there? Did you notice that SPY traded 5 times more than Apple?
ETFs are getting even hotter because they’re what the fast-growing, passive-investing crowd are incorporating in the construction of their portfolios.
Who is the Passive Investor?
Passive investing is, generally speaking, the opposite of actively managing a portfolio.
Active management can incorporate timing investments, taking profits, rebalancing, holding various amounts of cash, and sometimes shorting stocks or asset classes. In contrast, passive investing is all about not trying to beat the markets, but following them closely, since they tend to go up over time.
What happened in 2008, and how markets and managers performed since 2009, tells the story of the modern rise of passive investing.
If you remember, stocks fell about 50% in the credit crisis of 2008. Everyone got clobbered. Mutual fund investors, actively managed portfolios, passive investors, and just about everyone else lost big time. Only a tiny handful of swashbuckling hedge fund managers shorted subprime mortgages, banks, and the market and hit the jackpot.
A lot of investors lost faith in their managers, their mutual funds, and the market. They got out on the way down or at the bottom in early 2009.
No one knew that March 2009 would be the start of the market’s comeback to incredible new highs.
At their recent all-time highs, the Dow Jones Industrial Average is up 229% since March 2009, the S&P 500 is up 255%, and the NASDAQ is up an astounding 360%.
A passive investor who theoretically got into the market at its lows, or held onto their stocks since hitting their lows in 2009, would have reaped these big rewards. No active manager anywhere in the world has come close to the passive gains investors could have reeled in since 2009.
With the market’s recent history and the likes of Warren Buffett and Vanguard advising investors they can’t beat the market or that active managers’ fees are a huge additional headwind on performance, it’s no wonder passive investing has become all the rage.
Not only are investors going passive on their own by constructing portfolios with index and benchmark ETFs and mutual funds, brokerages are pushing so-called “robo-advisory” services on investors. These investors, who want somewhat actively managed (insofar as rebalancing lopsided portfolios from gains or losses) investment accounts, are getting algorithms that gently rebalance passive holdings to attempt to maintain the account holder’s investing objectives.
It all makes perfect sense.
The marriage of exponentially growing ETFs and the fast-growing passive investing trend are enticing more and more investors who’ve been out of the market for years back onto the playing field, as they tiptoe back in as news channels regularly report higher all-time highs.
But what makes sense on the surface, is in reality an already overgrown killing field drawing in the unsuspecting and uninformed.
I’m going to tell you in excruciating detail where the machine guns are hiding and how passive investors are about to get mowed down by their beloved, seemingly blank ETFs.