In Barron’s, James Allen, head of Capital Markets Policy at CFA Institute, explores a pressing question that emerged during the COVID-era market crisis: Are exchange-traded funds (ETFs) simply providing liquidity, or are they actually driving market volatility?
While ETF sponsors like BlackRock highlight the role these vehicles played in maintaining liquidity — with equity ETFs making up 38% of total U.S. trading volume during the worst week of early 2020 — others aren’t so sure that’s a good thing.
“ETFs are no longer a ‘passenger’ in the market, but rather the ‘driver’ of the market,” Allen writes, citing CFA Institute Research Foundation analysis.
This matters because when ETFs become price setters rather than price reflectors, the integrity of market valuations comes into question — particularly for ETFs backed by illiquid, opaque, or highly leveraged assets. During the crisis, some high-quality bond ETFs traded at steep discounts to their underlying assets, revealing cracks in what many assumed was a stable structure.
The Fed’s unprecedented decision to begin purchasing ETFs itself only deepened the concerns, turning the instruments from passive indexes into active components of monetary policy.
“The market turmoil and investors’ responses highlight the question over whether ETF prices are based on the value of the underlying basket, or whether they determine valuation for their underlying baskets.”
Allen calls for greater transparency — particularly around the net asset values of ETF holdings — to help investors better gauge risks when correlations break down and arbitrage mechanisms falter.
As ETF adoption continues to grow, Allen’s analysis underscores the need for regulatory attention not just to how ETFs are structured, but how they function under stress. Policymakers would be wise to ensure these tools don’t become systemic vulnerabilities masquerading as safe, liquid assets.