Editor’s Note: The “It’s All Good Until It Isn’t” series features in-depth analysis of market-moving instruments, products, and trends. You’ll see, firsthand, as Shah highlights their positive and negative attributes, their impact on market and investment returns, and what systemic risks they pose.
In this series, Shah exposes the dark side of the $5 trillion ETF market. In the last article in the series, you’ll receive ongoing risk assessment measures in the ETF space and hundreds of actionable trades to make as ETFs take the market higher and eventually crush it.
So stay tuned and enjoy!
What’s not to like about ETFs?
At least until you dig a lot deeper into what everyone loves about them, how supposedly liquid they are, and what risks the “sponsors” and “authorized participants” who create, redeem, and trade them and all their underlying parts, really pose to the $5 trillion industry.
What Most Investors and Regulators Don’t See
What investors and regulators don’t see, because they’re not looking under the hood of what’s driving the runaway ETF marketplace, is how important ETFs have become to almost all types of investors.
Most investors and regulators looking at the ETF industry see ETF products as passive investment vehicles.
And, sure enough, the passive investing movement has been a home run since it took off after the 2008 stock market implosion.
As markets moved higher and higher, passive investors feel like geniuses.
But there are huge problems with the growing amount of assets being parked in indexed ETFs.
One valid criticism of ETFs as passive vehicles is exponentially increasing volumes in passive investment products means more and more investors are losing out on informational efficiency in individual securities’ prices as asset prices become untethered from fundamental values.
Eventually, markets will no longer serve their crucial role of efficiently allocating capital.
The passive investing movement is another “it’s all good until it isn’t” story.
But ETFs aren’t just passive investment tools.
They’re trading tools.
The Evolution of ETFs
The evolution of ETFs into ever more specialized index-linked products has increasingly turned what were once passive products into the building blocks of very active portfolios.
Investors and regulators haven’t grasped that yet.
The huge daily volume of trading in ETF products isn’t just investors parking money, it’s increasingly about traders and active managers managing strategies using ETFs.
What’s increasingly worrisome is how active trading in ETFs could get…to the downside.
Most of the “known” worries surrounding passive investors parking trillions of dollars in ETFs is what would happen in a downdraft if they become “active” and start selling.
But no one’s focusing on active managers using ETFs or on institutions and hedge funds using ETFs. Most of them are incorporating “herd” following strategies. No one’s worrying about how these players could start a downdraft, in any number of ways (including on purpose) to trigger a herd-selling stampede.
What could happen then would expose something that investors don’t understand and something regulators have no idea how to control.
I’ll tell you exactly what’s out there on Tuesday. So stay tuned.