Using exchange traded fund flow data to gauge the sentiment of investors is problematic because of the various groups who use ETFs and the many strategies in which they’re employed.
For example, many institutional investors use the $97.8 billion SPDR S&P 500 (NYSEArca: SPY), the largest ETF, to park assets in the stock market while they are making portfolio shifts.
“They are not using ETFs as investing instruments in the same manner as individuals. They hold the instruments for much shorter time frames, and they can affect the size of the funds by hundreds of millions of dollars at a time,” writes Paul Justice, director of North American ETF research at Morningstar, in a newsletter sent to subscribers this week.
Buying and selling patterns in SPY can also be distorted by seasonal effects such as at year-end when investors are making moves for tax purposes.
“Unfortunately, those of us who analyze fund flow data are plagued by the problem of not knowing who owns these ETFs. Many of these purchases are transient in nature, made by market makers, high-frequency traders, and institutions putting cash to work either temporarily or permanently,” Justice notes.
ETFs are baskets of securities that combine the diversification of mutual funds with the ease of trading a single stock. Investors also like their relatively low fees and transparency.
In ETFs, the so-called smart money of institutional investors and hedge funds is mixed with individual investors.
Also, unlike U.S.-based mutual funds, many large ETFs are gathering assets from overseas.
“For many large U.S.-listed ETFs, a consistent stream of new money is flowing in from abroad,” Justice writes. “Many investors in places like Chile and Singapore are buying the same share class as you and I.”
Finally, the analyst points out that “more-tactical” investors and financial advisors are buying sector ETFs rather than individual companies to reduce single-stock risk.
“Perhaps that’s why ETF net fund inflows were twice as big as mutual fund flows. New money sources trumped the size differential of the two product universes. ETF assets remain just 12% of mutual funds, yet fund flows indicate that this scenario could be radically different in five to ten years,” Justice said.
Full disclosure: Tom Lydon’s clients own SPY.
The opinions and forecasts expressed herein are solely those of John Spence, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.