The first ETF was launched in 1993. You would think by now we would have moved beyond the idea that this not-so-new structure is going to somehow implode the markets. Remember 2000-2001? What about 2008-2009? Neither had anything to do with ETFs. Both Cliff Asness and Josh Brown take issue with this argument:

You can expect to see the number of detractors dwindle among incumbent active managers once a viable non-transparent ETF structure is put into place for reluctant active managers. Even ETF critic, John Bogle recognizes the viability of the structure, even if he is worried about people overtrading ETFs. At this point, Jim Cramer is one of the few holdouts:

The rise of exchange-traded funds has made entire groups of stocks “nothing but chits in a bizarre game of stock market roulette,” CNBC’s Jim Cramer said Thursday…“At the end of the day, these ETFs can be very useful for day traders, but normal investors pay a terrible price because it makes the whole business of stock picking much more difficult, and, … yes, far more futile than it should be,” he said.

This argument doesn’t make sense because in the end investors buy (or sell) an ETF because they want (or don’t) the underlying exposure that ETF provides. ETFs are a tool. If an investor takes on undue risk because of the ease of entry, then they will feel that risk when trying to reverse the position. Most frequently mentioned in this light are high yield bond ETFs. Ron Baron of Baron Funds was quoted as such:

Of course if the credit markets at some point “freeze up” credit-related ETFs will not be immune. That seems obvious. The above argument seems to have more to do with leverage, than anything else. Market meltdowns typically have a leverage component attached. There are plenty of downsides to leveraged ETFs, but they are a non-factor when it comes to high yield bonds.

Dave Nadig at ETF.com took a look how ETFs performed in October and came to the conclusion that despite what amounted to a fair amount of volatility things went according to plan. Nadig writes:

I take comfort that in the dozens of ETFs I’ve checked on in October, everything seems to be working just like it’s supposed to: APs are stepping in, making markets, arbitraging out the price discrepancies, and yes, providing a kind of “liquidity buffer” for big market movements.

ETFs have played an instrumental role in the rising popularity of indexed portfolios. We can argue about when that trend might have deleterious effects on the smooth operation of the capital markets but we aren’t there yet. As Gregory Davis, CIO of Vanguard, wrote in the ETF:

Scaremongering about market crashes ignores the successes from the growth of indexing and ETFs. Index funds are an easy way for ordinary people to invest for their future. With one trade, individuals can own a portfolio that is broadly diversified and low cost — two features that improve investment returns and are core to our investment philosophy at Vanguard. Despite efforts to pin the blame for volatility on them, index funds are not going to go away. Neither, of course, is market volatility.

Market volatility isn’t going away. Neither are bear markets. They are both a feature of markets, not a bug. The next bear market will occur because investors no longer want to hold equities at then-current valuations. This will happen whether those investors own individual stocks, mutual funds, ETFs, equity index futures or some other yet to be invented vehicle. On the other side of that bear market, ETFs will still be here.

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