The Revenge of the Stock Pickers

Abstract

When an exchange-traded fund (ETF) trades heavily around a theme, correlations among its constituents increase significantly. Even some securities that have little or negative exposure to the theme itself begin to trade in lockstep with other ETF constituents. In other words, because ETF investors are agnostic to security-level information, they often “throw the baby out with the bathwater.” As the prices of individual stocks get dragged up or down with ETFs, these mispricings can become significant, and the profits realized by taking advantage of them may present an opportunity for stock pickers.