Tail Can Wag Dog When ETFs Influence Single Stocks, Goldman Says

Exchange-traded funds have gotten so big that they often influence trading in individual stocks, Goldman Sachs Group Inc. said.

Researchers at the New York-based firm examined industry ETFs and their relationship to trading in members with lower volume. They found the process of buying and selling shares to create and redeem the funds accounted for significant levels of trading in constituent shares.

“The outsized growth in ETFs coupled with lower market liquidity lays the stage for a cocktail of single stock impact that few investors, we believe, fully appreciate,” Robert Boroujerdi and Katherine Fogertey, New York-based analysts at Goldman Sachs, wrote in a note dated Friday.

ETFs, which are bundles of securities that trade like stocks on an exchange and usually track an index, have exploded in popularity over the last decade. Assets under management have climbed to $2 trillion in the U.S. from $230 billion a decade ago, Goldman Sachs’s data show.

Tracing the securities’ relationship with equity volatility and correlation has been a challenge for Wall Street partly because they rose to prominence in the years when the financial crisis and its aftermath were roiling markets. Goldman Sachs’s research examined stocks that were included in big industry indexes and tried to measure the amount of trading that was likely to have been driven by the ETF alone.

For Chevron Corp. and Exxon Mobil Corp., demand for those securities contributed to 15 percent and 13 percent of average daily volume respectively in the last three months, according to the note.

Share Moves

The proportion was higher for other companies. ETFs, rather than company fundamentals, drove a fifth of the value of shares that changed hands in Vornado Realty Trust and 83 percent for a smaller firm such as Hecla Mining Co.

Boroujerdi and Fogertey also highlighted the correlation between ETF use and market volatility, saying that “investors reach for ETFs when fear is high.”

When the monthly average for the Chicago Board Options Exchange Volatility Index rose above 35, ETFs accounted for 35 percent of the total traded value, compared with just 15 percent when the so-called fear gauge was below 12, data compiled by Goldman Sachs since 2004 show.

The researchers also noted that ETFs can be imperfect as hedging tools. They cited high correlations between industries, the makeup of companies in particular funds and imprecise names leading to unintended exposure to stocks.

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