March 07, 2022
What’s given can be taken away. It’s certainly true in stock market investing. Take money inflows and outflows from active and passive exchange-traded funds (ETFs), as well as funds that track market indexes, for instance.
Last year, net inflows into global ETFs nearly topped $1 trillion for the first time, most of which went into ETFs tracking U.S. stocks. The three biggest index ETF sponsors – Vanguard, Black Rock, and State Street – now control more than 75% of U.S. ETF assets (which held a collective $7.2 trillion last year).
But surging inflation, the possibility of higher interest rates, and the situation in Ukraine have combined to put downward pressure on stocks. As of this writing, the SPDR S&P 500 ETF Trust (SPY) has dropped 9.6% in value so far in 2022. And the Invesco QQQ Trust (QQQ), which is essentially an ETF proxy for the NASDAQ 100 (the top 100 stocks in the NASDAQ Composite Index), is down more than 13% this year.
When this occurs, investors flee. So far ETF investors have taken $8.5 billion out of SPY and $3.4 billion out of QQQ. This creates more downward pressure.
It gets worse with narrowly focused ETFs, like those tracking certain sectors or industries. Floods of cash come in when times are good, pushing prices up. But when things turn for the worse, a lot of that capital exits just as easily, sending values downward quickly.
This phenomenon leads investors to buy high and sell low. And as an ETF’s focus narrows, the problem worsens. But it happens in index ETFs too:
So, a single ETF isn’t always a diversified investment on its own. And when investors buy high, sell low, and aren’t diversified, performance can be ugly.