Are ETF’s Scaring Investors?

ghostLarge investors like hedge funds and pension funds have embraced ETFs, and Wall Street is now wondering if that’s good for business.

Since the credit crisis sent the stock market on its wild ride, ETFs — baskets of stocks that trade on exchanges — have grabbed a bigger and bigger share of overall stock trading volume. Today, they represent about one-third of daily volume, up from 14% in 2006, according to Barclays PLC’s iShares unit.

Big trading desks have been slow to react, for reasons ranging from the dire climate at investment banks to worries ETFs aren’t as profitable for these firms as other securities such as single stocks or options.

“It’s a problem we all created for ourselves. (ETFs) are a product with great liquidity and low margins, but we’d all rather have investors buying single names,” says a head trader at a Wall Street trading firm.

In interviews with nearly a dozen trading Wall Street firms, only one had hired more ETF market makers or traders in the last six months. Most have just moved around personnel and resources from other departments into their ETF trading operations.

Some question whether ETF volume can stay as high as it is right now. Large investors jumped at the chance to trade baskets of stocks last year when the market was at its most volatile and single stocks were perceived as too risky. One family of ETFs popular with hedge funds and other rapid-fire traders, the Select Sector SPDRs, now trades about 300 million shares a day, 10 times what they did several years ago, according to product manager Dan Dolan.

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