The $7 Trillion ETF Boom Gets Blamed Again for Dumb Stock Moves

It’s the latest critique of the passive-investing boom: Fresh academic research claims that the relentless flood of index-chasing cash on Wall Street is distorting stock prices and causing extreme market moves.

With assets in such exchange-traded funds now above $7.1 trillion in the US alone, a team from Goethe University in Frankfurt has published a paper arguing the frenzy is disrupting the natural investing order by spurring equity gyrations and blunting the role of company earnings on market prices, among other charges.

In so doing, the study adds fuel to familiar gripes about an allocation approach that’s been dubbed “worse than Marxism” and named a chief suspect in bubble-like valuations in US mega-cap stocks.

Industry champions strongly reject such claims, and the Goethe team acknowledges that the current literature is inconclusive. So they determined to find out how passive ETF ownership affects things like liquidity and the likelihood of extreme price moves.

Using a sample that included 872 passive ETFs, all common US stocks, and ownership and return data spanning more than 20 years through to the end of 2021, the researchers concluded that higher passive ownership increases a stock’s bid-ask spread, its volatility and its sensitivity to broader market liquidity.