ETF share of US market revenue rises to record 31%

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Exchange-traded funds accounted for a record 30.7% of US stock market turnover last year, a jump of more than a fifth from their 25.3% share in 2021, raising questions about their seemingly unstoppable rise.

The data, revealed in the latest report by the Investment Company Institute, a US trade body, reignites concerns about their influence on the broader market and underscores their growing use as short-term trading tools for participants looking to change quickly. market exposure, analysts say.

Shelly Antoniewicz, senior director of industry and financial analysis at ICI, attributed ETFs’ higher revenue share last year to “high market volatility.”

“During times of market turbulence, secondary market trading in ETFs [of ETF shares] volumes increase, both in absolute terms and as a share of total trading, as investors, especially institutional ones, turn to ETFss to transfer and hedge risk quickly and efficiently,” he said.

While agreeing that high market volatility will have driven ETF volumes, Rabih Moussawi, an associate professor of finance at the Villanova School of Business, said the jump in ETF trading could also be due to the introduction of expiries of options on the S&P 500 index last year.

This has led to a “shooting” in zero-day-to-expiration options volumes and the likelihood of an “increase” in ETF trading by options market makers, who typically use ETFs to hedge their options positions.

“Given that ETFs have been shown to increase the volatility of underlying stocks, this could suggest an escalating effect of ETFs on market volatility due to 0DTE options trading,” Moussawi added.

Valentin Haddad, co-author of a 2022 academic paper advocating the rise of passive investing distorted price signals and driving up US stock market volatility, he also thought the increased use of ETFs was evidence of a move away from their use simply as long-term portfolio building blocks. Instead, he believed investors were increasingly trading macroeconomic news in the current environment, something that “ETFs are uniquely suited for.”

“If anything, it only confirms that the view that ETFs are merely a tool for passive trading is not accurate; market participants use them very dynamically,” she added.

In dollar terms, US ETF trading volumes increased 22.5% year over year to a record $44.1 trillion, ICI data shows.

The jump in ETF revenue share comes after several years where this measure has stabilized at 25-27%. This steady percentage has held up despite dramatic market growth, with assets of U.S.-listed ETFs increasing from $992 billion in 2010 to $7.2 billion at the end of 2021, according to ICI, before slipping. to $6.5 billion at the end of last year when the markets tumbled.

Investors poured $609 billion net into U.S.-listed ETFs last year, even as the market crashed and a record $1.1 trillion was withdrawn from U.S.-domiciled mutual funds.

ICI data shows that ETF trading volume peaked at 39% of stock market turnover on June 13 last year, a day before the much-anticipated Federal Reserve meeting to set rates.

However, ETFs seem to grow in importance even in times of relatively low volatility. Their market share has never fallen below 21% on any trading day in 2022, another record and much higher than the 14% recorded in 2021.

ETFs also continued to account for about 30% of trading volumes during the first few months of 2023, rather than returning to lower levels, Antoniewicz said, though he argued that was because volatility remained high.

One of the arguments used by ETF advocates is that while trading of ETF shares has increased in the so-called secondary market, trading of their underlying securities in the primary market, which involves the creation and redemption of ETF shares, remains minimal.

Secondary market activity accounted for 86% of ETF trades last year, with the primary market accounting for the remaining 14%.

Primary market trades in US equity ETFs totaled $5.2 billion last year, 5.2% of the $99.8 billion traded in stocks for the year, up from 4.6% in the year. 2021.

ICI argued that this low percentage means that trading in domestic equity ETFs had “minimal impact” on the underlying stocks.

Concerns about the growing share of trading represented by ETFs center on the fact that the vast majority are passive funds that track the index: At the end of the first quarter of this year, 94% of US ETFs were passively managed.

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But Antoniewicz downplayed any concerns on the grounds that passive investing is not homogenous. He said there was “a huge range of different stocks, asset classes and tactical investment positions,” adding that the choice of index was an “active decision.”

Bryan Armor, director of passive strategies research, North America at Morningstar, was also relaxed about the growing importance of ETFs.

“ETF trading activity has increased as investors reorganize their portfolios amid the rout of stocks and bonds,” he said.

“They’re a price discovery tool and allow investors to quickly change beta exposures, so it makes sense that investors increasingly used ETFs as the bull market concluded more than a decade ago.”

Armor expected this trend to continue as ETFs capture further market share from mutual funds.

“ETFs and their underlying stocks are scrutinized in tandem by market makers and traders. One can’t survive without the other, so I think it’s nearly impossible for ETFs to take an undue share of volume.”