Passive investing makes for end-of-day whirlwinds on Wall Street
NEW YORK The rise of passive investing on Wall Street has concentrated stock market action in the final moments of the trading day - exacerbating steep, last-minute nosedives in stock values with increasing frequency.
Analysts say the trend could leave markets exposed to greater volatility when the current bull market eventually draws to an end.
"Over the last 15 years, we have seen volumes spike near the end of the day," said Mr Howard Silverblatt, a long-time analyst for S&P Dow Jones Indices.
Last-minute trading spurts have hit record levels. This year on the New York Stock Exchange and the Nasdaq, 22 percent of trades were concluded in the final half hour of each day, on average, according to Investment Technology Group. That is up from 19 percent in 2014.
The phenomenon has been driven by the flow of capital into index funds and exchange-traded funds (ETFs), so-called passive investments that track market-weighted indices or portfolios.
Such funds have experienced a boom in recent years, offering investors higher yields than traditional trading while at the same time saving on management fees.
Valued at US$800 billion (S$1.09 trillion) in 2008, ETFs and others have since reached US$5 trillion worldwide, according to JPMorgan Chase.
One quirk, however, is that the funds make market moves in the day's final moments.
"They match their benchmark typically at the close so they are trying to be as close to the close as possible," said ITG Managing Director Doug Clark.
Mr Silverblatt added that passive investments were not meant to be trading instruments: "So if you want to buy it, you will buy or sell it today, but it gets executed at an end-of-day price," he said.
With their rise, such funds have had a "gravitational effect," with volume swelling around them, according to Mr Brett Manning, an analyst at Briefing.com.
Hedge funds, in particular, have reduced mid-session trading in favour of the more animated last-minute dance.
This is because, like traditional traders, they are drawn to the larger volumes and greater volatility that the index funds create, and to the chance to profit in such choppy trade.
But slipping from juicy profits to heavy losses can sometimes be easy.
On Oct 10, the Nasdaq fell from a loss of 2.5 per cent to a 4 per cent loss in the last hour of trading - making for its worst day in two years.
Index funds exacerbated the sell-off in the final minutes by seeking to match the performance of shares that had already fallen sharply earlier that day.
"This shift from active to passive, and specifically the decline in active value investors, reduces the ability of the market to prevent and recover from large drawdowns," JPMorgan Chase analyst Marko Kolanovic said in a recent client note.
As a result, trading sessions can see sharp drops in volume.
When sellers outnumber buyers in light trading, stock prices can dive fast.
For the time being, experts agree current liquidity levels during Wall Street trading sessions are not grounds for major concern. - AFP