Thu, 20 Oct 2011
Fears about the strength of the global recovery--not the proliferation of exchange-traded produces--are driving the wild swings in the stock market, says iShares' Leland Clemons.
Scott Burns: Setting the record straight on ETF market impact.
Hi there, I'm Scott Burns, Morningstar's director of ETF research. Joining me today is Leland Clemons, managing director with iShares running their U.S. capital markets desk.
Leland, thanks for being here.
Leland Clemons: Thanks for having me, Scott.
Burns: So, you are in a very unique position. You kind of run and orchestrate how iShares deals with the authorized participants and helping folks, especially larger institutions, make bulk transactions. There has been a lot of noise in the news lately about people saying, "ETFs are causing all the volatility that we see in the market."
How do you respond to that?
Clemons: So, we've actually done quite a bit of analysis on this, and I think are soon to have a white paper out on our website. Predominantly, what we've seen is the volatility in the markets is largely driven by macro factors right now. That ETFs exist, which allow investors to express opinions through their asset allocation or tactical moves on those factors, is not necessarily causality.
The two things, I think, are correlated, but we haven't seen any evidence--and we've looked back in periods where there were equivalently high correlations or periods of macro trading environment, and ETFs don't seem to be the unique thing that all of a sudden is now causing higher volatility or higher correlation amongst assets.
Burns: I think for our viewers understanding from an academic standpoint, how high that hurdle is to get from correlation to causation--what kind of things did you look for to really kind of stretch that out and pull that apart?
Clemons: So in some of the largest ETFs--whether it's the S&P 500 ETFs, IVV, but you could add SPY the largest fund out there in the asset class--or small cap, IWM and others, when you cumulate the assets in those ETFs up, you tend to be around 1%, 1.5% of total market cap in the underlying securities. I don't think anyone would suggest that that is a size that's going to be driving prices or affecting volatility in the way that, I think, some of the hyperbole that exists in the media right now would suggest.
Burns: Well, that gets you to the assets, but to play devil's advocate here, in terms of trading volume, though, it's a lot higher than 1% when you add that all up. Do you have stats on that?
Clemons: Certainly, if you looked at the secondary market volume as driving price movements in the underlying, you might say, wow the ETF volume is pretty significant relative to the volumes of some of the underlying securities.
However, unlike mutual funds, because ETFs have a secondary market, when investors are buying and selling the ETF, it's not necessarily resulting in a trade in the underlying securities. So, to suggest that the secondary market volume of an ETF is driving the prices with equivalent trades in the underlying securities, is just inaccurate.
So, for example, in our Russell 2000 Fund, IWM, which trades 50 million to 60 million shares a day, we just don't see the kind of primary market creation/redemption activity that would suggest that kind of activity; maybe we see $100 million, $200 million a day in total creation and redemption activity, cumulative...
Burns: ...To put that in perspective, the total market cap of the Russell 2000 is around…
Clemons: ... I think just over $1 trillion.
Burns: $1 trillion. So we're looking at $100 million of new shares creates or redeemed on a $1 trillion asset.
Clemons: And I'm telling you gross number, so creates and redeems compiled together, and generally, those two things are offsetting. So the net number you may see in true changes in shares outstanding on one given day is probably half of the total that we see, creations and redemptions. But the numbers just don't add up to a lot of hyperbole suggesting that ETFs are driving the markets around.
Burns: So I'm going to ask you to editorialize a little a bit. The numbers aren’t there. There is all this anecdotal kind of criticism out there, but why do you think, whether it's regulators or critics, following Ockham's razor that the simplest solution is the best, that maybe markets are volatile because people are just really freaked out. Why do you think there is this need to find some Boogie Man?
Clemons: Everybody wants to find a reason, right, a reason or a culprit. And the fact that ETFs have grown in popularity across all investor types over the past five years, that the volumes and assets have grown tremendously, that the number of products is coming to market, seems like a good scapegoat to point at ... and certainly easier than trying to figure out the causes of a macroeconomic slowdown. But again, the numbers just don't seem to hold up when we look at that. It makes for good coverage in newspapers and on television, but it just doesn't add up.
Burns: Well, Leland, thanks for sharing your views and some preliminary views on the whitepaper that's coming out. We'll look forward to see that. And I'm pretty sure that our viewers will be able to see that posted on Morningstar.com as well once it's out there. So thanks for joining me.
Clemons: You bet. Thanks.