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Academics question dark side of ETFs

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A new study by academics from three business schools – Arison School of Business, Stanford University, Graduate School of Business and the University of California, Los Angeles – asks if there is a dark side to exchange traded funds (ETFs)

The three authors, Doron Israeli, Charles MC Lee and Suhas A Sridhara, have published an update to Is There a Dark Side to Exchange Traded Funds (ETFs)? An Information Perspective, commenting: “In a noisy rational expectations framework with costly information, some agents expend resources to become informed, and earn a return for their efforts by trading with the uninformed.”
 
They examine the proposition that an increase in ETF ownership is accompanied by a decline in pricing efficiency for the underlying component securities.
 
“Our tests show an increase in ETF ownership is associated with: (1) higher trading costs (measured as bid-ask spreads and price impact of trades); (2) an increase in “stock return synchronicity” (measured as the co-movement of firm-level stock returns with general market and related industry stock returns); (3) a decline in “future earnings response coefficients” (measured as the predictive power of current returns for future earnings), and (4) a decline in the number of analysts covering the firm.”
 
The paper concludes: “Our findings support the view that increased ETF ownership can lead to higher trading costs and lower benefits from information acquisition, a combination which results in less informative security prices for the component firms.”
 

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