The Herd: Are ETFs Changing the Structure of the Markets?

by Craig Basinger, CFA & Shane Obata


There is no question Exchange Traded Funds (ETFs) have exploded in popularity. They offer many benefits to investors and their merits are well known. There is also rising evidence ETFs are changing the structure of the markets and how investors behave. Just to show how the popularity of ETFs or passive indexing has risen, the three pie charts show how passive funds/ETFs have been gaining market share over the years. In 1993, passive indexing strategies made up 2.4% of total assets. Now, they have reached 36%. There are studies that indicate over 28% of volume on the U.S. exchanges is ETF-driven.

As the daily net flows for an ETF drive the market makers to execute basket trades for the ETF, there is evidence this is suppressing disparity in performance from one company to the next. It is more blanket buying or selling, indiscriminate and based solely on the targeted index composition. If most of the flows are in the ETFs that track the main indices, then flows trigger broad based buying or selling. We have certainly seen a drop in index disparity (2nd chart), meaning the variance between index member price performance has been historically low for years. Many believe this is attributable to the rise of ETFs and more money invested in index products.


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Charts are sourced to Bloomberg unless otherwise noted.

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