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FLASHBACK FRIDAY: Unraveling the Ramifications of the ETF Bubble

Flashback Friday sponsored by Instinet

Traders Magazine Online News, January 18, 2019

John D'Antona Jr.

Bubble? What bubble?

Just three years it appeared that exchange-traded funds (ETFs) prices were climbing through the stratosphere as lack of alpha in plain vanilla equities coupled with scarcity of ETF product made the sector hot. To many, a bubble was a forgone conclusion and some in the industry were defensively positioning themselves from impending doom.

Back in 2015, guest contributor Tim Quast likened the ETF market to the mortgage-backed securities market circa 2004-5 where a finite amount of home loans were parsed, sliced and diced into more and more complex derivative instrument. And as Quast noted in his original piece, everyone remembers the ensuing financial meltdown that occurred. Quast made the same assertion about ETFs – “too many ETFs are dependent on the same stocks. When underlying share-prices experience prolonged flattening, derivatives predicated on them may be rendered worthless.”

So, what happened?  

First, no bubble occurred. Yet.

Whew.

Matthew Bartolini

And as can be evidenced to even the casual observer, ETF issuers such as BlackRock, Vanguard, Invesco and other continued to issue ETFs backed by myriad new underlying company stocks – such as “green” companies, new tech firms and others. And investors flocked to the new supply. According to data from ETFGI, an ETF market consultancy, ETF inflows hit a high of $653.6 billion in 2017. Issuance last year dropped a bit to $516.1bn into exchange traded funds and products last year down about 21%. Still, ETFGI data show that 2018 inflow still represents the second-best year on record for the ETF industry.

Matthew Bartolini, Head of SPDR Americas Research at State Street Global Advisors recently spoke with Traders Magazine and said that despite disappointing returns for equity investors, ETFs still managed to attracted over $300 billion of inflows for the second consecutive year in 2018, according to his own data.

“ETFs second consecutive year with over $300 billion in flows was a first for the industry. Nonetheless, three out of the five major asset class focuses we track had a decrease in assets: Equities, Commodity and Specialty,” Bartolini said. “Considering that equity focused ETFs made up 80% of all ETF assets to start the year, if their assets decline, so do the industry’s.”

He continued to note that while fixed income ETFs broke their consecutive monthly inflow streak (38 in a row) during the year and didn’t surpass $100 billion in total flows, 2018 was still a good year. As a result of the risk-off market sentiment, bond ETFs amassed a staggering $16 billion in the month of December – the second highest monthly flow total of all time. With November registering the sixth highest flow total ever, bond ETFs closed out 2018 with the largest back-to-back month hauls ever. As investors continue turning to ETFs for asset allocation, Bartolini expects fixed income assets to continue this ascent, irrespective of market sentiment.

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