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The Impact of Flows into Exchange-Traded Funds: Volumes and Correlations

Ananth Madhavan and Daniel Morillo
The Journal of Portfolio Management Summer 2018, 44 (7) 96-107; DOI: https://doi.org/10.3905/jpm.2018.44.7.096
Ananth Madhavan
is managing director and the global head of research, ETFs and index investing, at BlackRock Inc. in San Francisco, CA
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Daniel Morillo
is the head of equity quantitative research at Citadel in Chicago, IL
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Abstract

There is a common perception that the recent growth in passive index investing through exchange-traded funds (ETFs) has had detrimental effects on the market quality of the underlying basket securities. In particular, there is concern that ETF trading substitutes for and takes away from liquidity in the underlying securities and increases the co-movement in their returns. In turn, it is argued that increased pairwise correlation among stocks impairs price discovery and the ability of active managers to generate alpha. In this article, the authors find no evidence to support these perceptions. Volume changes in ETFs and their underlying securities are positively, not negatively, correlated. Furthermore, this research indicates that the rise in cross-stock correlations is due to the macro environment, not ETF growth.

TOPICS: Exchange-traded funds and applications, security analysis and valuation, statistical methods

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The Impact of Flows into Exchange-Traded Funds: Volumes and Correlations
Ananth Madhavan, Daniel Morillo
The Journal of Portfolio Management Jul 2018, 44 (7) 96-107; DOI: 10.3905/jpm.2018.44.7.096

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The Impact of Flows into Exchange-Traded Funds: Volumes and Correlations
Ananth Madhavan, Daniel Morillo
The Journal of Portfolio Management Jul 2018, 44 (7) 96-107; DOI: 10.3905/jpm.2018.44.7.096
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    • CONCEPTUAL FRAMEWORK
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