ETFs are becoming ever more popular – for good reasons. But there’s criticism too. Some even see their growing spread as a danger to the markets. We talked about it with Prof. Dr. Stefan May, our head of investment strategy and product development.
Whether it’s mega-tariffs or doubts about the AI hype: even when the markets dip in between, they also keep setting records. Some fear a bubble and attribute it in particular to the growing spread of ETFs and ETF savings plans. Is there anything to that?
That’s a very bold thesis. And it’s wrong. Let’s start with the first part: excesses happen on the markets time and again. But whether something is an excess can only ever be judged in hindsight. A price only comes about when one side buys and another sells. So every transaction involves two opposing expectations. Only the future shows which side was right.
There’s a very fundamental reason why stock markets rise over the long term: shares give you a stake in companies, and thus in the economy. Individual companies can go bankrupt; industries and regions can slide into long crises. But the global economy as a whole is fundamentally geared toward growth. Reaching new record levels is just as normal as the excesses and corrections that occur in between.
What about ETFs distorting market developments?
Many people tend to chase current trends and thereby amplify them. That holds true regardless of the individual products involved. And regardless of which direction the trend is moving in. Incidentally, we see this among active fund managers too. Many of them behave very cyclically.
As for the growing spread of ETFs, you can observe this: it tends to have a stabilizing effect. An ETF savings plan runs automatically – whether prices rise or fall. Not frantically bailing out of the market at the first downturn is good for your long-term investment results. And good for the market.
Here and there, though, you hear that the popularity of index-based products is making the markets less efficient. Because they follow the markets blindly, the danger of mispricing is said to grow …
ETFs and ETF savings plans are nowhere near dominant enough to override the price-discovery mechanism on the markets. Critics like to point to the US, where passive index products already account for around 50% of the fund market. Yet on the US stock market, passive ETFs and index funds hold just 18%. What’s more, the segment of active approaches within ETFs is currently growing particularly strongly.
The claim that passive ETFs impair how the markets function is, of course, gladly made by people who feel threatened by the product category and who promote active security selection. But in what way do active funds make markets more efficient? Are fund managers really able to systematically identify and exploit mispricing? The statistics clearly say otherwise: the overwhelming majority of active funds perform worse than the market, especially over the long term. So they price the market wrongly, despite all their analysis and research. That does nothing to make the markets more efficient.
So what is the problem with active investment strategies?
That they’re based on forecasts, which are ultimately speculative. Whether it’s selecting securities or timing when to get in and out: no matter how rational your calculations are, it always comes down to expectations about the future. But even for the most plausible scenarios, there are always alternatives that point in a completely different direction.
Active securities management doesn’t deliver reliable excess returns. That has been known for decades from financial-market research. And when excess returns do arise, the results are usually not statistically significant. Which means they’re a matter of chance. On top of that, active funds charge dearly for the promise of excess returns. Weak results, higher risks, higher costs – about as bad a combination as you can get.
Do you have any criticism of the ETF market too?
The growing inclination toward active ETFs. And also the way people often act as if an optimal investment solution has already been found in individual ETFs. Because that’s not true. Statistical analyses show us that individual indices – and thus individual ETFs – always form uncontrolled, shifting concentrations. With the popular MSCI World, those have long been US stocks and technology stocks. Investing in such products, too, exposes investors to unnecessary risks.
How can unnecessary risks be avoided?
Through diversification based on scientific criteria. Ultimately, every stock has a set of characteristic features that determine both its return potential and its risks. Most of these risks can be more or less reduced through diversification. In science, these are known as unsystematic risks.
With a world portfolio diversified according to scientific criteria, however, only the systematic risk remains. Only that is appropriately rewarded, precisely because it can’t be filtered out through diversification. With our investment strategy, we aim for what’s known as an efficient portfolio. In it, the balance between return potential and risk is optimized. And ETFs, in turn, are the most efficient instrument for building such a world portfolio.
For those who want to know all the details: we describe them in our whitepaper.
