How it trades affects how it behaves July 30, 2010 at 6:56 am

Part of a continuing series of facts that seem obvious, but are in fact news: the changing nature of equity market trading (more bots, more ETFs) has affected the dynamics of the market. (See here for a previous item.) Specifically, according to FT alphaville (who cite Barclays research) equity correlation has had a close relationship with the increased ETF volumes. Barclays say:

An important structural shift in the equity markets over the past few decades has been the advent of index funds as an alternative to actively managed mandates… Since the dominance of this kind of index-based component in the equity fund flows should logically lead to an increase in equity correlation, it is tempting to theorize that the secular shift in equity correlation documented above is driven by this effect.

Then do (a little) analysis and conclude

while equity correlation continues to be highly dependent on volatility, the rise in indexation has led to a permanent increase in its “base” level

File under ‘n’ for ‘not a surprise’ and ‘w’ for ‘why did you think you could count on a correlation to tell you very much about the comovement of the market anyway?’

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