BOSTON, Aug. 23, 2022 /PRNewswire/ — Cap8, the financial and technology firm that leverages scientific methodology to build investment solutions, has published its new research study ‘How have ETFs changed market macro efficiency and risk structure?’ in the summer issue of The Journal of Portfolio Management. In the study, Cap8’s principals Santiago Guzman and Joseph Peteul, together with Amir Rezaee, explore the rise of exchange-traded funds (ETFs) over the past 20 years, putting forth a theory that the increase in ETF adoption by investors has directly impacted the risk structure of the market in favor of macro-efficiency. In a moment when the discussion between active and passive management is as contentious as ever and ETFs (a form of passive management) are considered by many notable market participants as a source of distortions of value, this paper offers a view in which ETFs bring a form of efficiency that has been absent until their creation and further adoption. This research lends insights into the evolution of risk and its expression in the marketplace.

Cap8’s latest research is built upon the puzzle first presented by Nobel Laureate Paul Samuelson’s 1998 dictum on the difference between micro and macro inefficiencies. Samuelson theorized that though the equity market is micro efficient, it is also macro inefficient. This means that the efficiency of price behavior cannot be explained in the same way when analyzing an individual stock as when analyzing aggregates of stocks, and that at an aggregate level, the market does not accurately reflect the available information. In Samuelson’s view, examples such as options and derivatives have contributed to the efficiency of the market at the micro level, but have not necessarily eliminated macro inefficiencies.

Cap8’s research takes Samuelson’s notion of macro efficiency and analyzes it from a different perspective, measuring the behavior and evolution of systematic risk as a representation of the transmission of macro information into sectors and stocks in the U.S. market. This is considered from a viewpoint in which both the relative contribution of this risk and the macro efficiency of the stock market has increased considerably over the past 20 years. Cap8 has formulated a hypothesis which elaborates on why the market has become more efficient at the macro level when compared to the late 1990s, highlighting the importance of the introduction of new instruments that increase the ease of trade at the aggregate level. Similar to the option and derivative examples provided by Samuelson, ETFs have become a conduit of macro views into the marketplace, highly relevant for global investors, considering the influence of macro information in equity portfolios is greater today than it has ever been.

Cap8’s findings show that:

• The contribution of ETFs has been a determinant of the increase in macro efficiency in the U.S. equity market. ETFs integrate more information that pertains to macroeconomic and macrofinancial views by providing access to investments in the aggregate of stocks, such as sectors, countries and geographic regions.
• The creation of ETFs and the dynamics that come from them have led to the development of a new virtual marketplace. This allows investors to utilize their macro views in a more efficient manner.
• This evolution of ETFs, as core components of an investment portfolio, together with the broadening of investor participation, should not be set in a context of distortions in value. Rather, they should follow the outcome of a unique market constantly evolving towards efficiency.

“Financial markets are complex and in constant evolution – they are dynamic systems that feed from economic conditions, social trends, development of technologies, and constant innovation,” said Santiago Guzman, Cap8 co-founder, chief investment officer and head of research. “It will never stop and will not be subject to static theories or hypotheses built at different times, which is why we must be relentless in making sense of them and constantly challenge widely accepted views, even if we have followed them for years.”

‘How have ETFs changed market macro efficiency and risk structure?’ can be found in full here. For additional information and research from Cap8, please visit the website here.

Based in Boston, Cap8 is a financial and technology firm that leverages scientific methodology to build investment solutions and serve our partners. At Cap8, we fuse deep knowledge and experience across quantitative, technical, and market disciplines to navigate a financial environment that is continuously evolving. By harnessing the power of smart data, artificial intelligence, and analytics, we seek to extract hidden value from markets to design robust risk-reward solutions. Learn more at https://cap-8.com/.

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