When Everything Trades As One: Goldman Declares War On ETFs, Says "May Generate Negative Alpha"

Tyler Durden's picture

Overnight, Goldman's Robert Boroujerdi released a report whose conclusion we have been warning about for the past 3 years, which also happens to be its title: "ETFs: An Imperfect Hedge?"  Goldman's findings in a nutshell: "The rise of investor usage of ETFs as hedges continues. In a bid to gain quick exposure to evolving markets, avoid single stock M&A risk or take sector views, we believe the use of “blunt force” hedging via ETFs may impair portfolio returns and potentially create negative alpha." Read that again: not zero alpha, i.e., same returns as market, but negative alpha. In other words, the great cottage industry that has been the basis for so many riches for the likes of BlackRock, and that has ensnared so many gullible retail investors, is essentially a guaranteed money losing get rich quick scheme?

Who da thunk it.

What is more curious, are Goldman's observations on historical cross industry correlations because they show that in the grand scheme of things, virtually everything trades as one!

To wit:

Given the rise in trading activity in ETFs, we compare and contrast where correlations sit for individual sectors against (1) one another, (2) versus history, and (3) the market as a whole.

To begin, we frame the basis of our discussion by providing a historical analysis of daily and weekly pair-wise correlation of ETFs versus one another, summarized in Exhibits 10 and 11 below. These matrices yield insights on the growing impact of price movements in certain sectors versus each other. They also highlight the unpredictable impact that “blunt force” ETF usage can have on portfolio construction and returns.

Indeed, of the 36 sector ETF pairs we examined, correlations on a 3-year basis are higher than 70% for 31 of the instances, emphasizing the importance for portfolio managers to choose sectors wisely when hedging at specific points in time.

Although correlations for the individual components of the S&P 500 are now broadly in line with their 1-year and 5-year medians (1-month correlations now stand at 53% versus 50% and 44% on a 1- and 5-year median) we see higher levels of correlations on a sector-to-sector basis (using ETFs as a proxy). To give some context, the average sector-pair correlation is 72% when measured on a 3-month basis.

In Exhibit 10, we show a 3-month daily correlation snapshot along with a guide to the most and least correlated pairs.

To gauge correlations on a longer horizon, we include a 3-year view in Exhibit 11. We note that these figures are calculated on a weekly basis.

Current (3m) cross-sector correlations and hedging takeaways…

  • Perhaps not surprisingly, we see among the least amount of dispersion between Industrials and Energy as well as Materials and Industrials. Surprising, however, is that less obviously paired ETFs exhibit strikingly high correlations. For example, we highlight: Financials & Industrials, Tech & Discretionary and Materials & Discretionary.
  • Utilities is the sector least correlated to others and, as such, may provide a more optimal hedge if an investor has a specific sector view on the group. We do note that Staples are the second least correlated.

We provide a full listing of 3-month and 3-year sector-pair correlations in the Appendix for those who wish to dig deeper.

… and how they’ve moved: now vs history (3 months vs 3-years)

  • Tech (XLK) and Industrials (XLI) show pockets of falling correlations to other sectors, albeit the figures remain high. In addition, the correlation between the Tech and Industrials fell to 77% on a 3-month basis from 89% on a 3-year basis. Among the notable examples of falling correlations, those between Tech and Energy fell to 72% from 83% over the same two periods.
  • Healthcare (XLV) has become more coupled to other sectors. While 32 of the examined 36 sector pairs showed decreases in correlations, all of the four that showed increases included Healthcare. As an example, correlations between Healthcare and Financials rose to 76% from 73%, versus an average decrease in correlations of 8% among all 36 pairs.

How sectors are correlated to the broader market

  • Utilities (XLU), Staples (XLP) and Tech (XLK) are the sector ETFs least correlated to the S&P 500, with current 3-month correlations of 47% each.
  • Energy (XLE) is the only sector with an increase in correlations to the S&P 500, having risen to 62% on a 3-month basis versus 56% on a 3-year. In contrast, Tech (XLK) and Discretionary (XLY) saw the greatest declines in correlations. They fell to 47% from 60% and 50% from 58%, respectively, on a 3-month and 3-year basis.

* * *

So... HFT is basically done now that GETCO liquidated a third of their sales force, and the focus is now shifting on ETFs which will be the next to fall under the knife. Which leads to the question: will anyone be left trading anything in the stock market in a few years time?

full report can be found here

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ihedgemyhedges's picture

Thanks TD, but do you happen to know which ones Gupta likes?????????

Carl Spackler's picture

My initial reaction was "Goldman in short a basket of ETFs" and trying to flush weak, long hands out of the market.

Then it I had a "V-8" moment...well of course ETFs generate negative alpha, somebody has to pay the overhead costs of the investment advisor running the ETF, and that is -naturally- the muppet who trades them.



monkeyshine's picture

That's what I was thinking. They have to pay the fees and the cost to rebalance, too.  I always viewed them as trading vehicles, not investment vehicles. And usually I trade the ones with liquid options (for leverage) not the shares themselves, so I expect negative Delta too!

But that's just me.

Dr Benway's picture

LOL the readers of the tea-leaves say that ETFs are bad and that we need dart throwing monkeys to choose our stocks instead?


Reaaally? LOL


Look the reason ETFs are bullshit is entirely different and it is this: The stockmarket for decades has been overinflated and bullshit.

philipat's picture

It couldn't be, gasp, that Goldman wants the Muppets to trade stocks and ETF's take business away?

Temporalist's picture

I consider ETFs to be like a six course meal...but in a blender.  Everyone thinks the six course meal sounds like a great idea as long as they don't know how it's prepared.  Nobody wants to consume it, they just like the thought of ordering it.

TrainWreck1's picture

Negative Alpha = Positive Ahpla, so we can expect glowing reports of increased Ahpla on the evening news.

"In a sign the recovery is accelerating, Ahpla jumped unexpectedly today, beating analysts' expectations..."

Hober Mallow's picture

GS doesn't like ETFs because ETFs have been driving business away from them.

junkyardjack's picture

Yes everything can provide negative alpha if you buy and hold it.  If you trade it then it just gives you more options, Goldman c'mon son


akak's picture

Yep, keep trying to suck the gullible and ignorant back into the rigged casino, asswipe.  Are you a sociopath, or just a paid shill?

I'm surprised you're not trying to pump Treasuries at the same time.

Duke of Con Dao's picture

did you say Goldman?

roll the video of the Goldman Sachs Skull Squid car ornament on the roadster pulling into the frame!

http://www.youtube.com/watch?v=AhfP3Sj0ROE         (14 seconds)

knukles's picture

Well of course ETFs are inferior to Goldilocks superb structuring and low transactions costs that ALWAYS deliver as expected.


RobotTrader's picture

They need to make an ETF tracking "Specialty Retail"


Names like Whole Foods, making world record highs today.

$10 - $94 in 3 years, sailing through at least 14 "Greece Worries, and Eurozone Fears"



Maybe they should start selling gasoline like Costco does, $2.89/gal. in Greenville, SC


Then the stock would probably go to $200.

firstdivision's picture

World Record High is $94?!?  Are you so inept that you do not know that 123,445.01 > 94.  So no, it is not a "World Record High". 

GolfHatesMe's picture

ETFs don't post perfect trading quarters either. 

Mercury's picture

Goldman Declares War On ETFs, Says "May Generate Negative Alpha"

Shit, listening to Goldman may generate negative alpha...

The entire US capital markets may as well be a tripple leveraged inverse ETF of it's former self.

Robslob's picture

Please Goldman Sux tell me something...anything we don't already know?


slewie the pi-rat's picture

whodathunk zeroHeads woulda known this already?  L0L!!!

tyler deconstructed this crap over a year ago and what happened on the site has been interesting since then (to say the least)

even tho tyler, the writers he chose to present the problems, the SEC/CFTC/flashCrashInvestigation, and the boggers who could understand that boilerplate needs reading ALL went negative on ETFs and warned readers to keep off, most of the 1-line-blogging social membership which is only capable, at best, of  slogan-parroting failed to grasp what was actually being said.  again

so, they keep talking about all the rilly smart ETF trades they are putting on to make moMoney...

...veddy toy-boy social, indeed... 

firstdivision's picture

WTI and 10Y are saying Monday is going to be a crappy day for longs.

Monti was last spotted at various casinos in the Detroit area.  http://www.local10.com/news/Bank-error-gives-man-unlimited-ATM-withdrawals-at-Detroit-casinos/-/1717324/14853520/-/10hrao8/-/index.html

chet's picture

Tough to miss that the prices of all ETFs seem to just drift slowly down towards zero.

MeanReversion's picture

Although you can still make money on ETFs.  All depends on whether the gain on the underlying basket of securities exceeds the management fee and what you entry and exit points are. 

Some are definitely worse than others.  Leveraged ETFs or ETFs  that hold futures that are in contango (i.e., VIX and oil) are hands down the worst for holding long term.  If you're savy you can make a killing on shorting leveraged ETFs over the long term (takes some positioning though and not just a simple short).  The decay is massive on some of these ETFs.

q99x2's picture

I agree. How bout you short the long ETF and go long the short ETF. Does that help?

Dorky's picture

Yeah, might as well take down the whole stock market.

Dr. Engali's picture

A good house cleaning of bullshit "investment vehicles " is what this market needs. That and for the central planners to get the fuck out.

Dorky's picture

ETF-bashing shit.

Soon, we will go back to square one where the only thing we can trade are stocks and bonds - no futures, no forex, no options, no ETFs.

Hey, I thought forex and futures are the only OTC.

What does it have to do with options and ETFs too, which are regulated?

Cupid Stunt's picture

Gotta love this crap coming from the worlds biggest boiler room.

MeanReversion's picture

What's the alpha on Tom Stolper's FX trade recommendations?

slewie the pi-rat's picture

that would equate to the cB's beta

we covered that last nite

Dens's picture

Can anyone explain what the (high) correlations between sectors means for the yield.

This piece seems to imply that high correlations between sectors make for bad hedging possibilities. Why is that? Wouldn't you wanna track the stocks in it vs the etf to measure hedging potential?


Standard Deviant's picture

If everything trades as one then when things are volatile I want to be in whatever has most LIQUIDITY.   I know I'm not the only one.   That's why ETFs trade at greater premium to components close to inflection points.  If I'm gonna be in the market right now then I will be trading whatever I can get out of quickly w/out too much slippage.

carbonmutant's picture

ETFs must be cutting into The Squid's profit margins...

Bob's picture

Negative Alpha!  Hilarious.

Nobody For President's picture

Market villian Negative Alpha, disguised as the mild-mannered and friendly London Whale, slips into a Wall Street phone booth at midnight to...

dcb's picture

duh, it's from the computers abd I disagree with goldman. the best way to make money is to know what things are going to do. the liquid leveraged etfs which trade onj thred lines almost to the penny are the best, you can almost literally trade them by computer in advance

now at 15.30 today firday we at at just about it, so you buy some inverse funds, and take some profits off the table. leave some in the pot, but with stops on either side so if you just happen to get fooled it works out.

since  all trades in such great correlation the key is to pick one and trade it in amounts woth doing to reduce trading costs, etc.


I disagree on the comment about crude. the levared funds in that segmane are my daily bread and butter because they move in such a regular manner. if you care a good charter, and have lots of cash you can trade on the hourley or 1/2 hour trend going ack and fourth all day long. Plys there was a time when you almost knew the max movement reach day, even when regular there is a 40 to 50 cent back and fourth each hour on the two.  call it a profit of 80 cents each way, 200 shares, 160 dollars, 8 hours / day trading.

this back and forth action on this security is my main wway of trading. something i have trouble, but over all the best way to pick up money each day with very little risk in total

dcb's picture

I will say I had to adjust my chart a bit today and am not sure exactly the channel anymore

DCFusor's picture

I hate nearly all ETFs because they increase correlation.  I like to go long best of breed when going long, and short the worst when shorting.  But say, trade copper miners - they all track more and more, not because SCCO has become FCX, but because so many people trade an ETF that has them both in there, so buys and sells are massive in both and simultaneous....

So, whether ETFs can have positive alpha or not, they remove alpha from the market for stock pickers!


Sure, I trade some of them and make money...FAS, FAZ, that kinda crap.  But I still don't like them.  Why should some news on JPM make my tiny regional bank go down?  That's why, it's stupid.



BlackholeDivestment's picture

Goldilocks, ...this bucket also has a hole in it. Lol. http://www.youtube.com/watch?v=vfY4JA9mvik


Grand Supercycle's picture

Rally warning continues...

SPX & EURUSD bullish daily charts dominate further.

As mentioned, shorts will be slaughtered next week.


Venerability's picture

ETFs which are double-, triple-, or Nth-tuple directional are pure gambling vehicles, with no place in any market. They should be banned outright around the world.

They exaggerate leverage at a time when less, not more, leverage is needed.

And they permit not just people but groups - rogue nations? rogue banks? Organized Crime? out-and-out terrorists? - to make "bets" based on political or geopolitical agendas.

The problem with Casino Markets in general is that they allow the "House" - whoever has the deepest pockets coupled with the highest conviction - to win much more easily.

Do We - We collectively, as a world - want that now?

And for that matter, are we really all that sure Who the House is?

mcguire's picture

We?!  we want the global reset.. now.