ETF Volume Surges Most Since 2008 Amid Unprecedented Volatility

Investors increased their use of U.S. exchange-traded funds by the most since January 2008 last month, as concern the economy is slowing prompted a shift toward bets on the direction of the entire market and industries instead of individual companies.

Average daily trading volume for ETFs jumped 83 percent from July to 2.24 billion shares, according to data compiled by Bloomberg. The SPDR S&P 500 ETF Trust, which tracks the benchmark measure of U.S. equities, saw a 105 percent jump to 394 million per day.

U.S. stocks produced the biggest gains and losses of the year in August, including a stretch of four days when the Standard & Poor’s 500 Index alternated between rallies and declines of 4.4 percent or more. Unprecedented swings caused correlations to tighten, spurring investors to make broader bets, said James Dailey of Team Financial Asset Management LLC.

“People didn’t care what stocks they owned,” Dailey said in a telephone interview from Harrisburg, Pennsylvania. The company manages $215 million. “They weren’t picking stocks but saying, ‘I want out of stocks, I’m shorting stocks or hedging,’ and they were doing it through ETFs.”

Stocks in the S&P 500 moved in lockstep with each other by the most since at least 1990, according to MF Global Holdings Ltd. The average correlation coefficient between the 500 companies and the index was 0.8268 on Aug. 18, using 60 days of data, according to MF Global. The increase shows investors were ignoring the merits of individual stocks and instead reacting to news about the economy, said Craig Peskin, co-head of technical analysis at the New York-based securities firm.

Gold Rallies

Investors pared back on risky assets last month amid concern the U.S. economy is faltering and Europe’s sovereign-debt crisis will spread. The S&P 500 posted its biggest monthly loss since May 2010, while gold futures had their largest monthly advance since November 2009 and prices jumped to a record $1,917.90 an ounce. The SPDR Gold Trust briefly surpassed the SPDR S&P 500 ETF Trust as the biggest fund by market value.

The ProShares UltraShort Gold fund and the PowerShares DB Gold Double Short ETN posted the largest increases in daily trading among the 100 securities with the highest volume, according to data compiled by Bloomberg. The number of shares that changed hands jumped more than sixfold, the data show.

Investors turned to ETFs for liquidity and a more efficient way to make bearish wagers, Dailey said. “That’s why you saw the explosion in inverse and leveraged ETFs,” he said.

Swaps, Derivatives

Leveraged ETFs use swaps or derivatives to amplify returns, while inverse funds are designed to move in the opposite direction of their benchmark index. Leveraged ETFs held over longer periods sometimes deviate from the performance of the underlying assets, raising concerns the funds may not be suitable for some investors and pushing the U.S. Securities and Exchange Commission to halt the approval of new funds making significant use of derivatives.

Traders piled into leveraged inverse funds to bet the record prices in gold will drop. The ProShares UltraShort Gold Fund and the PowerShares DB Gold Double Short ETN are both designed to double the daily inverse of the metal. Shares outstanding increased 150 percent and 110 percent, respectively.

ETFs are “corroborating evidence of what happened in both sides of the gold trade in August,” Michael Cuggino, who helps manage about $15 billion at Permanent Portfolio Funds in San Francisco, said in a telephone interview. “When volatility goes up, leveraged products are a way to get that better return for people who are active traders.”

VIX Bets

Amid unprecedented price swings, investors boosted their bets on stock-market volatility. The Chicago Board Options Exchange Volatility Index climbed 25 percent last month, while daily volume for the VelocityShares Daily Inverse VIX Short Term ETN, which rises when futures on the measure fall and vice versa, had the third-biggest increase out of the 100 ETFs, jumping 276 percent.

Financial stocks had the second-biggest loss out of 10 groups in the S&P 500 during August. Volume for the Direxion Daily Financial Bull ETF 3X Shares fund, which gains three times as much as the industry during a rally, climbed 185 percent as shares outstanding surged 70 percent.

“It was a product of the panic that you get when the herd moves in such an aggressive fashion one direction or the other,” Dailey said. “Any time you have that kind of behavior, it’s always a question of ‘What are the opportunities?’”

Before it's here, it's on the Bloomberg Terminal. LEARN MORE