August gave stock investors a wild ride. Daily 100-point-plus swings in both directions were common. That's stirred up discussion that exchange-traded funds (ETFs), which are similar to stocks because they trade on exchanges, could be helping fuel volatility in the stock market.
In August, ETF volume reached the highest level since 2009, according to market research firm Birinyi Associates. And now, reports the Wall Street Journal, the Securities and Exchange Commission is investigating whether leveraged and inverse ETFs, which try to amplify the market's returns by as much as two or three times the market's actual performance, played a role in the stock market's increased volatility last month.
Is there cause for concern? Probably not, according to many experts.
ETF trading volume increased dramatically in August. According to Birinyi Associates, 70 billion shares were traded last month, which is an 86 percent increase from July, and a 110 percent increase from a year ago. Although that's significantly higher, it's not enough volume to move the entire stock market. Total trading volume in the stock market increased, but ETFs only made up a small part of it. "I don't think [ETFs] were a real deciding factor, or [ETFs] were driving the volatility," says Kevin Pleines, an analyst at Birinyi Associates. "I think the volatility was there anyway. Overall volume was huge, too."
For many popular ETFs, including SPDR S&P 500 (symbol: SPY), iPath S&P 500 VIX Short-Term Futures ETN (VXX), a product that tracks volatility in the market, and Direxion Daily Financial Bull 3X Shares (FAS), a leveraged fund that tracks financial services companies, shares experienced huge spikes in trading in August: 104 percent, 119 percent, and 200 percent, respectively. Overall trading volume in leveraged ETFs, according to Birinyi, rose 114 percent in August, and that accounted for 19 percent of all ETF shares traded last month.
The kicker, says Paul Justice, director of ETF research at Morningstar, is that the overall market share for leveraged ETFs is tiny, and trading within that category has very little effect in the overall stock market. Leveraged and inverse ETFs make up only 5 percent of total ETF assets, according to Morningstar.
Currently, inverse stock ETFs (those that bet against the market) and leveraged bullish stock ETFs (those betting for the market) hold about the same amount of assets so the two offset each other, and the net impact on the market is minimal. The net effect of all the trading in those funds is only $13.5 million, according to Morningstar. "That's a drop in the bucket," Justice says. ETFs currently hold about $1.1 trillion in assets.
While there isn't much of a case to be made now, Pleines says the growing popularity of ETFs could eventually have a bigger impact on stock market volatility. "I don't think it's playing a huge role in these swings yet, but it does have the potential because it's such a growing asset group," Pleines says.