What do ETF Fund Flows tell us about Mr. Market?

by Wayne Ferbert on June 18th, 2013

There is a great tool on the IndexUniverse.com website. It is an ETF fund flow tool. You can select a date window and the tool will show which ETFs have had the most creations and redemptions over that time window. Here is a link to it: Click here.
Why are the creations and redemptions so important? When you buy a stock, there is not a creation or a redemption of the stock when it is handed to you. Instead, it just transfers from its seller to its buyer. The demand for the stock will drive the price up or down since there is a set number of shares available in the market.
But an ETF is a collection of other investment vehicles (mostly often stocks). It holds these investments and is worth the total value of the underlying investments. So, when a buyer comes in to the market, he might be purchasing the ETF from someone that wants to sell it. However, if the total demand for the ETFs exceeds the available shares, then new shares of the ETF are created. And the opposite can happen also: if more people want to sell the ETF than the demand exists to buy them, then the ETF shares are redeemed.
There are investment banks and investment managers on Wall Street that facilitate the creation and redemption of these shares. So, when we examine the creation and redemption data, we can see what the push and pull demands for different sectors in the market look like. Let’s look closely. Below is a snapshot of the trends Year-to-Date.
You could probably have guessed what it would look like: Gold, Emerging Markets, and High Yield Bonds have had the biggest out-flows (ie, redemptions). These have been among the biggest losers YTD (maybe the only losers??) and so money has chased out of them.
The biggest winners have been the Japanese Market, US Equities, and Short-term Bond Funds. This would also make sense. The Japanese market was up 80% off of its lows. You already know the US equity market story in 2013. The short-term bond fund story makes sense also: investors are rotating out of longer dated bond funds in to shorter duration bond funds which will carry a more stable price story as interest rates rise.
But let’s also look at just the last 6 weeks since the beginning of May. 
Does the flow story change? It does a little. You will see that the Gold outflows really did their damage earlier in the year. But about half of the High Yield Bond outflows and the Emerging Markets outflows really did their damage in just the last 6 weeks. The fear of the Fed slowing down QE is threatening bond values everywhere.
On the inflow side, the US Equity markets have had really big inflows in the last 6 weeks relative to earlier this year. In fact, Financials, Technology, and Consumer Discretionary all had healthy inflow spikes in the last 6 weeks. The Technology and Consumer Discretionary sectors are two sectors with a higher penetration of growth stocks – which are en vogue when markets get frothy like now.
These relative inflow/outflow data is interesting. On this data alone, you cannot conclude the ‘why’ money is moving – but it can be used to reinforce a hypothesis. Here is one:  Investors that traditionally invested in bonds are looking for interest rate protection – so they are rotating out of fixed income. They need to put the money to work - so they invest in US Equities. And when money flows to US Equities, people try to pick the winners in the equity space – because people think they are good stock pickers. When investors who usually invest in safer investments move to equities, it usually signals a turn down. So my hypothesis: this fund flow is not a positive for 6 to 12 month market outlook.
Take this opportunity to rotate out of some winners and invest in some losers. Remember: you will never get hurt taking some profit off of the table.

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