Passive investing may be causing market disruptions for institutions.

Exchange traded funds (ETFs) now top 1 billion in total assets. While passive investing has gained some traction among institutional investors, others largely argue for its unintended consequences.

“ETFs are most likely a reason for increased volatility in the markets,” said Murat Unal, senior board member of German-based institutional consultancy, Funds@Work. “The easier it gets to trade entire baskets of shares the higher its impact could be on trading in the markets.”

For this precise reason, Unal has observed institutions worldwide returning to their mandate of strict active management.

“Providers tried to make everything liquid and tradable even things that are long term investments per se,” he told Markets Media. “This calls for a critical re-examination of ETFs in the market. There is a conflict between trading a long term instrument at the speed of light.”

Typically, the pension, endowment and foundation community has mainly traded ETFs as a placeholder to preserve broad diversification while in between managers. Some have begun to utilize passive instruments for tactical purposes; a realm mainly held by smaller institutions such as family offices and fund of funds.

Unal is convinced that ETFs will remain a minimal part of the large institution’s mandate.

“I am convinced that investors will rethink their passive stance and become more active and selective again,” said Unal. “The ETF industry is no longer one homogeneous sector as it has brought about a variety of different vehicles, tied to active as well as passive indexes and to asset classes which should have not been made tradable due to their long term nature.”

Yet, some of the largest public pension plans, such as Canadian- based, Ontario Teachers’ Pension Plan (OTPP) reported that $41 billion of its 2009 allocation to equities includes both indexing and actively managed strategies. For 2010, the plan’s increased $48 billion allocation also incorporates indexing strategies. Yet, a spokesperson for OTPP nor a firm trader could not comment on specific ETF usage. The plan’s 2011 report has also not been released yet.