One Clear Winner Emerges From The Market Rout

And it's certainly not hedge funds.

As the following chart showing the performance of Goldman's famous (or infamous) hedge fund VIP index makes it clear, the Top 20 most popular stocks among the "hedge" fund community have cratered into year end, down 22% from their all-time highs, dragging with them not only most hedge funds but also virtually all other active investors, who will be relieved to finally put 2018 in the rearview mirror.

No, the winner from the historic Q4 rout and record December plunge in the S&P are passive investors, and especially ETF giant BlackRock, whose exchange-traded fund business attracted more than $25 billion in November inflows, a record monthly haul for the company.

Recall that whereas last week EPFR reported that total stock funds suffered record weekly outflows of $39 billion, this was the result of $53 billion in active fund outflows offset by $14 billion in ETF inflows, as the great rotation from active to passive continues.

The latest figures from BlackRock, the world’s largest money manager and biggest provider of ETFs, confirm that the shift away from expensive active investing, which has done little if anything to protect investors during the first bear market in a decade, to passive is indeed accelerating... and continuing: "we’re also seeing strong flows in December," Blackrock spokeswoman Melissa Garville told Bloomberg

The gains for BlackRock came in a month when investors bailed out of actively managed funds and piled into passive vehicles amid spikes in market volatility. Active funds had outflows of $57.4 billion in November while passive funds, a mix of index mutual funds and ETFs, attracted $55.9 billion, according to data from Morningstar.

The shift into passive was broad-based as BlackRock drew cash into both stock and bond ETFs, while the company's Emerging Markets ETF gained $3.3 billion and the IShares 1-3 Year Treasury Bond ETF added $2.4 billion as investors moved to short-term vehicles. Short-government funds, often seen as a safe-haven, received the most inflows last month in a decade, according to Morningstar.

The inherent paradox in this rotation is that if this is indeed "the big one", there may come a day - again - when like during the ETFlash Crash of August 2015, ETFs plunge sharply amid a disconnect between the synthetic product and the underlying securities as investors liquidate en masse, forcing fund managers to dump all constituent shares, not just those which have the weakest fundamentals, in the process exacerbating the selloff as high quality, highly liquid names end up being sold off disproportionately relative to stock of companies that truly deserve to be dumped yet have made their way into countless ETFs; in fact there are now (way) more passive funds tracking stocks (over 3.2 million) than there are stocks in all global markets (43,000)...

... an imbalance which various Wall Street icons such as Howard Marks  believe will end in tears. Should the recent selloff fail to find a bottom, we may soon find out if they were right because as Howard Marks' warned in 2017, "As a product of the last several years, ETFs’ promise of liquidity has yet to be tested in a major bear market, particularly in less-liquid fields like high yield bonds."

Well, today the longest bull market in history officially ended and the bear market has begun, and with it, the test of just how resilient ETF liquidity truly is.