How Much Market Impact Do ETFs Have?

Matt - you raise an interesting point about ETFs affecting muni bond markets. They've been accused of the same in commodities. Here's what I think.

I've heard quite a bit of speculation about ETFs actually moving the markets. First of all, I'm not at all convinced that this is the case with gold and silver for example. But lets just for a moment say that it is so, and that ETFs can affect the market. How on earth is that a bad thing? The price of the market reflects to demand for the commodity. An ETF is an expression of demand for a commodity. Hey, that's capitalism: supply and demand.

In fact, I would take it a step further and say that effectively what ETFs are doing is opening inefficient and sheltered markets to free market forces. And at the same time, they're taking some notoriously opaque markets and bringing transparency and real time pricing to them. I love what ETFs do in the bond markets, where you can actually see in real time what bond price and interest rate movements mean in terms of real-time return. The same goes for international markets. In many cases ETFs are effectively serving as a price discovery mechanism in many places and at many times, where none was previously available.

So don't come to me with your sob stories about effectively wanting businesses that are subsidized by lower prices that would be reflected in true market demand. And if you really want to push that way, don't push against market forces, look with issuers at innovative ways to deal with the problem through, for example, note structures that might lessen direct market impact to market prices of the commodities if/when this becomes a real problem.

I'll warrant that for commodities you could make the case for demand to use the physical underlying commodity vs. demand for its returns may be different things and with a real crisis in supply, something that may be worth addressing. But by and large I think that market forces when demand exceeds supply in a way that makes use of a commodity in some process less than cost effective, will find another solution or raise prices. We're all grown-ups in the capitalist system...and free markets are remarkably resilient in finding new solutions.

In the case for munis, the increased transparency and demand can hardly be anything but a good thing in a such a remarkably NONtransparent asset class. Ultimately, these ETFs, like ETFs have done generally should bring transparency, liquidity and cost-effective diversification to yet another asset class.

Written by Jim Wiandt