Bank of America Corp (NYSE:BAC) Warns of Liquidity Issues with ETFs

July 10, 2017, 13:16 pm ET, BY Simon M.- Contributor| Editor: Thomas H. Kee Jr. (Follow on LinkedIn)

On July 5, 2017 Bank of America Corp (NYSE:BAC) issued a note warning investors of the liquidity risks associated with the increasing popularity of exchange traded funds (ETFs) in all US exchanges. The note issued by BofA’s Global Research department warned that US equity markets might face liquidity problems in a bear market given that a third of US stocks are traded through ETFs.

Passively managed ETFs have increased in popularity since they allow investors to get exposure to a basket of stocks or even an entire sector without purchasing individual stocks. However, the BofA warns that markets might fluctuate violently especially in bearish conditions when certain stocks held through ETFs are negatively affected.

Industry experts estimate that about $4 trillion is invested in passively managed ETFs, which makes up a significant portion of the US equity markets. The main problem with ETFs is that during a bear run investors may experience problems liquidating ETF positions.

The bank also warns that ETFs may create distorted price-earnings ratios for stocks that are largely owned through ETFs.

However, a dissenting view is offered, which cites Japan as a good example of a market where majority of assets are owned through ETFs. This position is supported by the fact that almost 70 percent of assets under management in Japan are in passively managed ETFs.

Therefore, ETFs in the United States still have a good opportunity for growth given that ETFs currently make up about a third of the entire market. ETFs also currently account for a quarter of the daily trading volume across all US exchanges.

Some analysts have downplayed the fears highlighted by the BofA note saying that it is a veiled complaint from investors who cannot get the prices that they want for individual stocks.

At Stock Traders Daily, our subscribers have reaped excellent results from investing in ETFs. We advise our readers to apply risk-controlled strategies in both their individual stocks and ETF investments. This has proven to work in both bullish and bearish market conditions.

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