The Rise of ETFs and Stock Market Correlation

However, David Abner, WisdomTree's head of capital markets, attributes increased correlation to macro events and changes in how people invest.

"Investors have changed from being single stock investors to investing in baskets," says Abner. ETFs alone have not caused more correlation among stocks, but the type of investing ETFs represent may have caused stocks to move together.

Abner also says that "correlations rise during periods of market turmoil" but eventually correlations will decrease again. The United States has seen high levels of correlation among stocks in the past that are mainly due to macro effects and not one individual security.

In a 2011 report, Credit Suisse found that "rather than ETFs causing high correlation, it's high correlation that has helped ETFs grow into popularity." Believing that ETFs lead to higher stock correlation is just a problem of correlation versus causation, according to Credit Suisse. ETFs do not control a large enough portion of the market to have any significant effect on correlation compared to other investment tools. Passive indexing only accounts for 15% of the market and US equity futures trade more than twice as much as ETFs.

Macro strategies, such as ETF trading, perform better during periods of high correlation, according to Credit Suisse. So ETF trading would naturally increase when stocks move together during market downturns.

Although correlation has closely followed ETF trading, this relationship may simply be due to investors' preferences for index-based securities in periods of market downturns and high stock correlation.

-- Written by Caitlyn Grudzinski in New York

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