Warnings about the\nrisk that the widespread use of ETFs entails for the proper functioning of\nfinancial markets are widespread. The criticism, no matter whether genuine or\nmotivated by interests, is fundamentally based on two complementary narratives:\nthe „dumb money“ distortion and the „house of cards“ risk.<\/p>\n\n\n\n
The first points to\nthe misallocation of capital caused by investors blindly pouring capital into\nindex-tracking strategies. If investors stop discriminating between good and\nbad businesses, innovation and entrepreneurship would be disincentivized,\ndampening the creative destruction that underpins the capitalist system; a sort\nof socialism by the back door.<\/p>\n\n\n\n
The second narrative\nrefers to the risks for market stability posed by the exponential growth of\nETFs. The main problem is that these instruments are often not backed by direct\nownership in the securities that make up the underlying index, but they are\nreplicated with derivative contracts. This allows the volume invested in these\nassets to be much higher than that of their reference indexes. The fear is that\nin a time of market panic there may be massive requests for reimbursement,\nwithout there being enough underlying positions in the market to sell and\nreturn the money back to investors. <\/p>\n\n\n\n
And now, the two\nnarratives merge into one: given that the emergence of ETFs has made it easier\nfor retail investors to access less liquid asset classes, such as high yield or\nemerging market bonds, which were previously outside their scope. And because\nretail investors have a tendency to buy euphoria and sell in panic, market\nfluctuations are exacerbated, causing markets to be inherently more unstable.<\/p>\n\n\n\n
These arguments,\nalthough they have a logical appearance, are just a remix of old misconceptions\nabout how markets work, intentionally disseminated by those who have more to\nlose by the success of ETFs. For example, swap-based ETFs are not different\nfrom any other derivative contract, such as futures or options, which have been\nan integral part of financial markets for decades. In addition, if investors\ntend not to control their impulses, this would affect both ETFs and mutual\nfunds alike.<\/p>\n\n\n\n
In fact, with the\nempirical evidence accumulated so far, the arguments about misallocation of\ncapital and market stability are mutually contradictory. If passive investors\nbuy and sell indiscriminately, active investors will be able to exploit the\nmany arbitrage opportunities that will be presented to them. This should help\nboth to stabilize the market and to improve active managers‘ returns. Given\nthat, as is known, most fund managers perform in line with the market, either\nthe distortions caused by ETFs are minimal, or retail investors are not as dumb\nas they are supposed to be.<\/p>\n\n\n\n
Ironically, the\narguments can be turned around, resulting in a much more plausible explanation:\nit is active managers and speculators who, in their pursuit to generate alpha,\nconstantly try to anticipate the next turn of the market; overreacting to the\nflow of news and, therefore, destabilizing the market.<\/p>\n\n\n\n
In contrast, retail investors are afflicted by one of the most ingrained behavioral biases: the inability to sell positions at a loss. Normally, these are individual securities in poorly diversified portfolios, which often turns out to be a poor investment decision. However, when this strategy is applied to diversified ETFs, not only does it drastically improve expected returns, but it indirectly contributes to improving financial stability; a sort of „invisible hand“ providing support to financial markets.<\/p>\n\n\n\n
Fernando de Frutos, MWM Chief Investment Officer<\/strong><\/p>\n","protected":false},"excerpt":{"rendered":" Warnings about the risk that the widespread use of ETFs entails for the proper functioning of financial markets are widespread. The criticism, no matter whether genuine or motivated by interests, is fundamentally based on two complementary narratives: the „dumb money“ distortion and the „house of cards“ risk. The first points to the misallocation of capital … Continued<\/a><\/p>\n","protected":false},"author":2,"featured_media":3029,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"_monsterinsights_skip_tracking":false,"_monsterinsights_sitenote_active":false,"_monsterinsights_sitenote_note":"","_monsterinsights_sitenote_category":0,"footnotes":""},"categories":[126],"tags":[],"class_list":["post-3032","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-unkategorisiert"],"acf":[],"post_mailing_queue_ids":[],"_links":{"self":[{"href":"https:\/\/www.borealcm.com\/de\/wp-json\/wp\/v2\/posts\/3032","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.borealcm.com\/de\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.borealcm.com\/de\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.borealcm.com\/de\/wp-json\/wp\/v2\/users\/2"}],"replies":[{"embeddable":true,"href":"https:\/\/www.borealcm.com\/de\/wp-json\/wp\/v2\/comments?post=3032"}],"version-history":[{"count":0,"href":"https:\/\/www.borealcm.com\/de\/wp-json\/wp\/v2\/posts\/3032\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/www.borealcm.com\/de\/wp-json\/wp\/v2\/media\/3029"}],"wp:attachment":[{"href":"https:\/\/www.borealcm.com\/de\/wp-json\/wp\/v2\/media?parent=3032"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.borealcm.com\/de\/wp-json\/wp\/v2\/categories?post=3032"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.borealcm.com\/de\/wp-json\/wp\/v2\/tags?post=3032"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}