Risky mutual funds don’t make the stock market volatile
Exchange-traded mutual funds that use risky strategies in pursuit of outsized returns are not making the stock market more volatile, according to a study by Morningstar Inc.
The report argues that so-called leveraged ETFs, which attempt to magnify underlying moves in stock prices, have had little effect on the market’s heightened volatility in the last few years. Instead, the study says, fundamental factors such as corporate earnings play a far bigger role.
The fund-tracking firm is walking a fine line of sorts in its report.
Morningstar stresses that it is not a “blind industry cheerleader,” and doesn’t want to be seen as reflexively defending a controversial part of the mutual fund world that critics say is much too risky for small investors.
The firm points out that it advises against investing in leveraged offerings. “While traders and hedgers might find a use for leveraged and inverse ETFs, we recommend that investors avoid them,” the report says.
Still, Morningstar says, “we do not believe that they are causing an increase in market volatility.”
ETFs are mutual funds that trade like stocks and can be bought and sold throughout the day. A leveraged ETF is like a regular fund on steroids. It gives two to three times the return of an underlying stock index. For example, if financial shares rise 2% on a given day, a fund could jump as much as 6%. Some leveraged funds move in the opposite, or inverse, direction of an index. If an index rose 2%, an inverse fund could fall up to 6%.
It would seem logical that the funds would exacerbate market fluctuations – the number of leveraged and inverse ETFs has risen steadily to 249 – but Morningstar found no evidence of it.
The study cites a few reasons, including the small size of the leveraged ETF sector compared with the rest of the stock market. Also, the sector’s asset size has remained relatively stable in recent years, rather than bouncing up and down with the market.
Leveraged and inverse funds have a total of just $32 billion in assets, which equates to just 3.2% of all U.S. ETF assets, according to Morningstar. That’s less than half the $83 billion in the largest ETF focusing on the S&P 500. And it’s a fraction of the $10 trillion in all mutual funds.
Leveraged ETFs account for a far higher amount of trading volume – 14% of all ETFs – but most of that is between one small investor and another, and doesn’t play a big role in moving stock prices around, the study said.
And rather than swinging up and down with the stock market, the sector’s asset size has remained fairly consistent since the end of the last bear market in March 2009, ranging from $30 billion to $36 billion, according to Morningstar.
“This stability flies in the face of the volatility argument,” the report said.
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