Morningstar Advisor - February/March 2012 - (Page 60)
Gray Matters
How Index Trading Increases Market Vulnerability
By James X. Xiong and Rodney N. Sullivan
The rise of passive investment strategies may play a role in the market’s increasing fragility.
A more detailed version of this paper will be published in Financial Analysts Journal in 2012. Index investing has experienced tremendous growth over the past two decades. This phenomenon is undoubtedly due, in part, to the appeal of index mutual funds and exchangetraded funds; they generally offer lowcost, comprehensive, diversified exposure to various market segments. Indexing’s appeal
is compounded by the challenges of sourcing skilled active managers, which, of course, is a zero-sum—even negative sum—game after costs. The popularity of index funds and ETFs, however, comes at the cost of “trading commonality,” or “basket trading,” across the market. Many stocks within an index being traded are simultaneously bought and sold. As
a consequence, the stocks in an index tend to move together throughout the trading day. At the same time, there has been a steady increase and convergence of U.S. equity betas across size and styles since 1997. Exhibit 1 plots the time series of equal-weighted cross-sectional beta estimates for U.S. stocks in four major equity size and style groups. We will return to this figure in detail later as
60 Morningstar Advisor February/March 2012
Table of Contents for the Digital Edition of Morningstar Advisor - February/March 2012
Morningstar Advisor - February/March 2012
Contents
Contributors
Letter From the Editor
Make a Difference Stories, Not Debates
How Concerned Are You About Europe?
Analytical and Independent
What to Ask When a Fund Manager Leaves
Past, Present, Future
Have Financials Gotten Cheap Enough?
Four Picks for the Present
Investment Briefs
Tactical Funds Miss Their Chance
Specialty Retail: Ad Hoc Opportunity
How Europe Is Making Its Crisis Worse
Impact on U.S. Economy Will Be Minimal
European Banks: Bargains or Value Traps?
Don’t Count the Euro Out Yet
Europe on the Brink
GoodHaven Realizes Its Vision
How Index Trading Increases Market Vulnerability
Nonlisted REITS: Handle With Care
Safety Picks for the Many Moods of Mr. Market
On the Prowl for Large- Blend Index-Beaters
Our Favorite Mutual Funds
50 Most Popular ETFs
Undervalued Stocks With Wide Moats
The Math That Matters
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