Are ETFs Bad for Financial Health?

Exchange-traded Funds (ETFs) are easy to understand, cost-efficient, and liquid investment vehicles that have become very popular for various types of investors. They are important vehicles in the current trend towards passive investment strategies that make it easy to passively track market indices such as the S&P 500. The dynamics of the index and its underlying assets are closely interlinked based on the rebalancing effect and depend among others on the different types of traders in the market, price trends in individual stocks and the overall market, as well as over- or undervaluations of individual stocks and the index. Investing in an index of assets can generate quite complex and sometimes counterintuitive investment behaviors on the level of individual assets. Seemingly stabilizing investment strategies on the level of the ETF, such as a fundamentalist approach, might actually destabilize on the level of individual stocks. Given the dramatic growth of ETFs financial regulators increasingly ponder on potential effects on market governance and financial stability.