Passive ETFs Turn Out to Be Pretty Active

Supposedly passive exchange-traded funds have gained popularity, with trading volume hitting a high of $1.1 trillion in April, per Tradeweb. These vehicles customarily track indexes, notably the S&P 500, but they are increasingly employed for active trading.

Most prominently, ETFs are being used to short the Russian market. The iShares MSCI Russia ETF, for instance, has lost almost all its value, and trading was suspended as a result. Before that, however, short-selling for the fund was enormous.

A study last year by professors at Cornell University and the University of Technology Sydney found that a third of ETFs by number were employed in active trading.

Aside from shorting, another active use is to hedge active trading. Still another: leveraged funds, which use borrowing to magnify gains—with the obvious downside that they also magnify downswings.

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Then there’s the category of funds that the study says “constitute active bets on some segment of the market or factor.” In other words, they are linked to market changes that alter the portfolio. An example is the iShares MSCI USA Momentum Factor ETF, which tracks a selection of large-cap stocks that show price momentum. Needless to say, in this climate, is it down almost 25% this year.

Also included in this category are “thematic” ETFs—which, instead of following a broad index, are tailor-made to follow such sectors as electric vehicles, artificial intelligence, biotechnology and cybersecurity. The rap on these is that they have very little to do with passive management, as fund managers choose what to put in them.

“Precisely because many ETFs are active investment vehicles, their impact on the market more generally is an important area for future research,” the academics wrote.

“Issues such as whether ETFs enhance market stability, or how ETFs impact liquidity, or whether particular types of ETFs (such as leveraged products or exchange-traded notes) can be harmful seem fruitful areas for inquiry.”