The scale of this shift in market structure was underscored in JPMorgan research that concluded index and exchange-traded funds, quants and options-related strategies dominate all but 10 percent of U.S. stock trading. The amount invested in large-cap equity funds tracking indexes recently eclipsed cash in actively run funds of the same type.
Put another way, there’s a vanishing cohort of human-powered funds with the conviction to snap up single-stock names in a falling market. They would act as a brake on losses.
Paoloni’s Absolute Return Strategy fund primarily trades equity-index options and VIX contracts. It’s had some of its best days when the S&P 500 plummeted by more than 4 percent in a single session. The $64 million fund is getting more inquiries of late from financial advisers wary of another 2009-style crash.
The potential of a one-day decline of more than 5 percent has increased in recent years, according to the investor.
Defenders of funds programmed to sell or buy on volatility triggers point out they are reducing spreads and day-to-day price swings in part thanks to their growing arsenal of assets. But the risk is that when volatility reawakens, they’ll exit the market on a dime and expose its fragility, says Paoloni.
“The illusion of a lot of liquidity dampens volatility,” Haworth said. “When that illusion is broken, volatility will be a lot higher than it otherwise would have been.”
This article was provided by Bloomberg News.