How Is It Possible That There Are More ETFs Than Stocks in the U.S. Market?

This is a question many analyst have begun to pose, when looking at the way markets and Exchange Traded Funds (ETFs) are constructed currently. Traditionally, investors had a range of stocks to choose from and would make buying (or selling) decisions based on the fundamental strength of the underlying business supporting said companies. Today, ETFs take nearly all of the “pain” out of investing (researching companies, comparing a wide range of business models, understanding key elements of various businesses), allowing investors to simply “buy the market.”

While buying the market, at lower fees and with much lower hassle than dealing with a stockbroker, sounds like a great deal (and it generally is), risks associated with such behavior have begun to manifest themselves in the way the market has reacted to such exchange traded funds. For less liquid securities trading on the major U.S. exchanges, the influx of ETFs has resulted in situations where ETFs are not able to purchase enough of the underlying shares of a company (there are not enough shares available to buy at a given time), meaning the funds must purchase derivatives of the security, meaning the market is more than 100% exposed to certain blue chip stocks in the market at any given time, depending on the allocation of ETFs relative to the overall market weighting.

As we have seen in other economic experiments where derivatives trading becomes an avenue for taking excess risk on securities which may not necessarily otherwise be purchases for investors (but are only purchased to reflect the essence of the entire market), a pull back on the broader market may be in order sometime in the future to correct this trend.

Invest wisely, my friends.