The market has a massive structural issue to worry about

There is a huge yet relatively staid part of the U.S. market that most investors haven’t been paying much attention to.

The events of the past few days might force them to sit up and take note.

U.S.-based exchange-traded funds have swelled in size and now hold more than $US2 trillion in assets.

There are stock ETFs designed to track the performance of indices like the S&P 500 and the Dow, and ETFs for bonds and other assets.

They are supposed to be relatively boring. They provide investors with a quick and inexpensive means of getting exposure to various markets.

But on Monday some stock ETFs fell further in value than the indices they were supposed to be tracking.

That means that ETFs, which are essentially baskets of stocks, ended up performing worse than the stocks inside the basket.

That set alarm bells ringing.

Deutsche Bank’s David Bianco said in a note on Tuesday: “We are a bit bothered by the extent of ‘flash’ dislocations in many large cap stocks and especially by huge disconnects (albeit brief) between several major broad market ETFs and their underlying indices.

“Corrections are never orderly, but this is a blow to both institutional and individual investor confidence.”

A separate computer glitch blocked mutual and exchange-traded funds from pricing their securities on Wednesday, according to a separate report in The Wall Street Journal.

The glitch hit a number of big mutual fund firms, including Federated Investors, Prudential, Guggenheim, and Voya Investment Management, according to the report.

It is a reminder of how structurally important ETFs have become to the market — and how big an impact they can have when there are problems.

There were 1,411 exchange-traded funds domiciled in the US at the end of 2014, according to data from trade body Investment Company Institute. The funds had assets of close to $US2 trillion, with an estimated 5.2 million US households holding ETFs.

Billionaire investor Carl Icahn has previously voiced concerns over bond ETFs, saying it isn’t clear how easily they could be liquidated in a period of stress.

Given the events of the past week you can expect more attention to be paid to the funds in future.

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