Big Market Players Are Loving ETFs Even as They Fear the Fallout

Large institutions have jacked up their usage of exchange-traded funds since the Covid crash -- even as they fear these investing tools are fueling market volatility.

About a third of institutional traders surveyed by Keefe, Bruyette & Woods said they’re embracing ETFs more in the wake of the March 2020 stock collapse, which sparked a deleveraging wave like no other across the financial system.

Of 40 respondents, 85% said the liquidity of products is their key selling point. Nearly nine in 10 plan to use them to the same degree or more this year.

But despite the full-throated endorsement from the likes of hedge funds and private-equity firms, concerns that ETFs are distorting markets prove remarkably enduring.

Virtually all professional traders said these typically passive products have “a meaningful impact” on share prices and trading volumes -- with 83% saying they’re creating volatility.

“Institutional investors are increasingly more focused on the impact of ETFs on the underlying equities,” according to the survey published this week.

The likes of Michael Green, chief strategist at Simplify Asset Management, have long warned that passive investing is creating an unsustainable bubble in asset prices. And while it’s notoriously difficult to precisely pinpoint the impact of passive flows on stock prices, academics have found links. For example, a 2014 paper from the National Bureau of Economic Research concluded stocks held by a substantial number of ETFs were more volatile than equities that weren’t.