Institutional investors, such as mutual funds and hedge funds, now hold a record amount of ETFs​ and control almost half the market for ETF options, Bloomberg reports, based on research by Goldman Sachs. Counter-intuitive as it sounds, active fund managers are behind much of the surge in demand for passively-managed ETFs, which have enjoyed a net inflow of over $150 billion so far this year, according to Bloomberg. More interesting still, analysis by Bloomberg indicates that these same active fund managers currently have greater opportunities to outperform passive equity investments than ever before.

The percentage of trades involving ETFs has grown from 24% before the election to 27% in the period since, Bloomberg says. Additionally, the proportion of the S&P 500 Index (SPX) held by passive investors has increased from 9% in 2013 to 14% today. (For more, see also: Passive Funds are Killing Active Money Managers and ETFs Poised for $1.1 Trillion Asset Surge.)

A Market for Stock Pickers

Stock pickers theoretically have enhanced opportunities right now to beat the S&P 500 Index because correlations between the price movements of the individual stocks therein hit an all-time low in February, and they are 57% below their six-year average, according to data from Bloomberg. The lower the correlations, the more dispersion there will be in the percentage returns across individual stocks over a given period of time. This produces increased opportunity to find stocks that will outperform the index, but also raises the odds of choosing stocks that underperform.

But They're Picking Sector ETFs

Meanwhile, in December, for the first time since 2011, the correlations between the eleven S&P 500 industry sectors fell below the correlations between individual stocks in each sector, per Goldman research cited by Bloomberg. The upshot is that picking the right sector now seems more likely to produce returns in excess of the aggregate S&P 500 than picking the right individual stocks. To this end, ETFs recently have become a low-cost tool of choice for active investors and fund managers to allocate assets to their favored sectors.

Hedging Against Policy Uncertainty

Uncertainty over the direction of policy under the Trump administration seems to driving much of the investment in ETFs by active managers. Alan Gayle of Ridgeworth Investments in Atlanta told Bloomberg that the risks of picking individual stocks have been magnified by this uncertainty, making the use of sector ETFs a rational temporary response by active managers. Once policies become clearer, "it will turn into a stock picker's market," said Gayle. (For more, see also: Will the Policy Uncertainty Index Doom the Trump Rally?)

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