September 20, 2016
The use of ETFs in portfolios has been on the rise for years now. According to ICI’s 2016 Factbook, there is over $2.1 trillion invested in 1,594 ETFs.
One reason investors choose ETFs is that they trade like stocks, as opposed to mutual funds which are bought and sold after the close. But as ETFs grow in number and size, it becomes more important for investors to pay attention to ETFs that they own, as well as the ETFs in that same space.
If an investor only owns individual stocks, they might not think to pay attention to ETFs at all, but that can be a mistake. An academic study from November 2013, titled Do ETFs Increase Stock Volatility?,“estimated that an increase of one standard deviation in ETF ownership is associated with an increase of 16% in daily stock volatility.” So it’s worth the extra time and effort to know who else is invested with you, whether it be an ETF, a mutual fund or a large institution.
How can an ETF affect your stock? Let’s start with rebalancing. ETFs that track an index usually rebalance their holdings quarterly. GDXJ, VanEck Vectors Junior Gold Miners ETF, is a basket of junior gold miners. This ETF rebalances quarterly, as it did at last Friday’s close. Earlier in the week it had been announced as to what the rebalancing might look like in terms of which stocks in the basket would be sold and which would be added, as well as potential changes in each basket component’s position size. When these announcements are made, they are not to be taken as fact, because almost all ETFs have a fair amount of leeway written into their prospectus.
If you happened to own one or more of the junior miners held by GDXJ, you might have been surprised at the close on Friday to see the huge volume traded as well as the price action. A couple of daily charts (courtesy of StockCharts.com), showing 1-month of trading, make the GDXJ rebalancing effects easy to see:
As ETFs grow in popularity, and therefore size, they become the tail that wags the dog for a lot of their component holdings. Sometimes these large swings are caused by rebalancing stick, but many times they reverse as the fundamentals of a particular stock come back to dominate the action.
As an example of just how fast an ETF can grow, take a look at the shares outstanding (courtesy of INO) for GDXJ, which happened to hit a new 52-week high on Friday:
GDXJ shares outstanding:
And as this chart from Sentiment Trader shows, the fund flows into GDXJ on Friday hit a record. According to Sentiment Trader, their fund flow “represents the past week of flows into and out of the ETF. It is NAV-adjusted, so it is a better representation of actual money moving into or out of the fund instead of just reflecting movement in the fund price itself.”
As you can see, ETF rebalancing can affect your individual stock holding as well as the growth of the ETF itself. A third twist comes into play if there happens to be a 2x or 3x levered ETF that tracks a similar basket as the ETF in question. In the case of GDXJ, there is JUNG, Direxion Daily Junior Gold Miners Bull 3X ETF, which is an ETF tracking the 300% daily move in the MVIS Global Junior Gold Miners Index, the exact same basket that GDXJ is tracking. As money flows into JNUG, and its inverse sister JDST (300% inverse to GDXJ), these levered ETFs must either buy or sell the underlying, in this case GDXJ, or options on the underlying. Either way, the counterparties will then look to hedge their risk by either offsetting trades of the tracker, GDXJ, or some proprietary basket they use comprised of some of the same stocks held by GDXJ. Regardless of the ‘how’ the end result can mean that your individual stock holding gets pushed around in price for reasons that are unrelated to that specific company’s fundamentals.
One final thing to always be aware of is that just as your single stock can be moved by an ETF’s moves, your ETF can be moved by the overall market. The perfect example is the ETF flash crash of 8/24/15 when several ETFs had enormous moves, which sadly triggered sell stops for some people. Take a look at my favorite from that day, RSP which is the Guggenheim S&P 500® Equal Weight ETF. Here is a 1 month daily chart which shows the 43% move this ETF had that day, only to climb right back to where it had been. Painful for those GTC (good till cancelled) sell stops that sat under the market.
The bottom line here is that when you own something in the market, really anything in the market, you have to pay attention to all the moving parts in and around that asset. It’s when you are looking left that you get hit from the right. As Stephen Hawking said, “I have noticed that even those who assert that everything is predestined and that we can change nothing about it still look both ways before they cross the street.”
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