Assets of exchange-traded funds have declined during the current market downturn, along with those of many mutual funds. That is no surprise. However, unlike stock mutual funds, which experienced net outflows in February, exchange-traded funds are being used more than ever, as average daily trading volume continues to rise.
That is somewhat of an anomaly because, in general, market trading goes down when stock prices go down, according to Donald Cassidy, senior analyst with Lipper of Summit, N.J. Another reason the increasing popularity of exchange-traded funds during the down market is surprising is that they are passively-managed, which can be a disadvantage during volatile and declining markets, according to Ramy Shaalan, mutual fund analyst at Wiesenberger/Thomson Financial of Rockville, Md.
"[Exchange-traded funds] are indexed based and one argument that actively-managed advocates always say is that during a downturn, an active fund manger can move out of meager sectors," said Shaalan. "Although buy and hold is a good discipline, during market downturns when things are so volatile, an active manager may be better at getting out of those bad sectors and capitalizing on short term opportunities. ETFs and index mutual funds won't have that advantage during a bear market."
Still, the trading volume of exchange-traded funds, including HOLDRs of Merrill Lynch of New York, listed on the American Stock Exchange, has increased dramatically recently, according to the AMEX. The total consolidated average daily trading volume was 19.4 million shares in 1999 and 45.8 million in 2000, according to the AMEX. As of the end of March, the year-to-date average for 2001 was 92.5 million shares a day. The average was 80.2 and 84.8 million for January and February, respectively, according to the AMEX. In March, it jumped to 110.6 million.
One obvious reason that number would go up is the increase in the number of exchange-traded funds in the marketplace. However, the increases in trading volume are very high and there have not been many new exchange-traded funds introduced in the last three months. Also, the average trading volume of individual exchange-traded funds that are not new has gone up, according to the AMEX. For example, the Bank of New York's Nasdaq-100 Index Tracking Stock, by far the most heavily traded exchange-traded fund in the market, has experienced an increase in average daily trading volume from 57.1 million in January, to 64.0 million in February, to 78.4 million in March, according to the AMEX.
There are a number of reasons the trading volume has gone up, according to Cassidy of Lipper. One of them is that, unlike regular mutual funds, investors can buy futures of exchange-traded funds so they can take advantage of the declining market, he said.
"If you have increasing amounts of hedging and shorting, which I think we do, that's definitely going to increase volume," he said.
Another reason is that exchange-traded funds can be traded constantly during the day, which can be attractive to investors, especially small ones, who want to gain access to the market when an event like the recent interest rate cut by the Fed occurs or pull out of funds if the market stumbles, according to Kunal Kapoor, senior fund analyst at Morningstar of Chicago.
"We all still have a long term perspective, but in many cases, you see the market drop 300 points in one day and you wish you had the ability to get out of your mutual fund at two o'clock," said Shaalan. "With an ETF you can do that, and as much of a short term focus as that sounds, it's an advantage nevertheless."
Another reason exchange-traded funds have been traded more heavily recently is that they have lower expenses and greater tax advantages than regular mutual funds, according to Shaalan.