Your Complete Guide to Index Investing with Dan Bortolotti

Can ETFs Make the Market Go Up in Smoke?

2018-05-29T21:16:37+00:00April 1st, 2017|Categories: ETFs, Research|Tags: |18 Comments

[Note: This was an April Fool’s joke!]

Does the growing popularity of indexing and ETFs pose a real danger to the markets? As I discussed on a recent podcast, some market experts are concerned that the swelling ranks of index investors is creating a bubble. I used to brush off these concerns as the paranoid ramblings of money managers who are losing billions in assets as investors discover they add no value. But I’m starting to wonder if it might be true. After all, there are lots of articles on the Internet that say so.

A recent piece in the Globe and Mail, for example, featured billionaire hedge fund manager Seth Klarman, who worries that the growth of indexing is making markets less efficient: “The inherent irony of the efficient market theory is that the more people believe in it and correspondingly shun active management, the more inefficient the market is likely to become.”

I appreciate that index investors want to get broad diversification at the lowest possible cost, and that they’re attracted to a strategy that has the weight of academic evidence behind it. But this way bigger than you and me our ETFs: if what we’re doing is wrecking the capital markets, we all lose. Managers like Klarman are feeling real pain. Last year alone, some $106 billion USD flowed out of hedge funds last year, likely because their performance has largely been dreadful. I don’t want that on that blood on my hands.

The coming catastrophe

It’s not just about hedge fund managers. The bubble in indexing investing is also taking its toll on people who sell stock tips online. Consider Capital Wave Forecast, a newsletter that reports its readers have achieved exceptional (and remarkably specific) “gains of 218%, 238%, 371%, 455%, 456%, and more.” Well, no one is going to get returns like that anymore if millions of indexers rain on the parade. According to the newsletter’s creator, if markets tank hordes of ETF investors will sell in a panic. That would set off a catastrophic negative feedback loop that could bring down the whole market. The ETF providers and regulators don’t want you to know this, but now you’ve been warned.

Fortunately, there is a way to avoid getting sucked into the black hole of prudent, long-term investing: you can buy puts on leveraged ETFs. But heed this wise advice: “Just remember that markets can bounce back at any time, so if you buy put options and make a killing on a panic selloff, don’t get greedy. A few hundred percent gain is a nice payday.” You’re welcome.

Dude, it’s all good

I admit that evidence-free arguments like this are making me question whether ETF investing is the right strategy. Do I really want to wreck capital markets and forfeit gains of 456% or more? Fortunately, a new ETF will begin trading next week that is making me feel a lot more laid back about the coming apocalypse: the Horizons Medical Marijuana Life Sciences ETF.

I first heard about this fund when I was shredding the gnar with a couple of chill dudes, and they were like, “You’re into ETFs?” and I was like, “Duh,” and they were like, “Right on.” They told me the ticker symbol was HMMJ (POT was already taken) and that the index includes a bunch of cannabis-related companies in Canada and the US. Sure, there’s Canopy Growth Corp and Aphria, but the biggest holding is Scotts Miracle-Gro, because if anyone knows how to grow grass, it’s them. The guys said they bought the ETF together and were holding it in a joint account.

It’s too early to add this fund to my model portfolios, but maybe someday. I would totally read through the prospectus before investing in this ETF, but I’m not going to lie, it’s super boring. However, if ETFs are going to take down capitalism, this one would at least take the edge off.