What is causing flows to domestic, sector index ETFs?

AbstractExchange traded funds (ETFs), initially created in 1993, have grown from 1 fund to nearly 5,000 funds worth $4.17 trillion in assets in 2017 (Krouse, 2017). Throughout the growth process of ETFs as an investment,... [ view full abstract ]

Abstract

Exchange traded funds (ETFs), initially created in 1993, have grown from 1 fund to nearly 5,000 funds worth $4.17 trillion in assets in 2017 (Krouse, 2017). Throughout the growth process of ETFs as an investment, various styles have been created. One style, the domestic, sector index ETF, has become attractive to investors interested in focusing their investments on the U.S. consumer (discretionary and staples), energy, financials, healthcare, industrials, materials, real estate, technology, telecommunications, or utilities markets. While they represent similar investment strategies, sector index ETFs differ from index mutual funds in two ways. First, ETF shares are created in a primary market by institutional investors. Second, shares of the created ETFs are bought and sold on market exchanges, just as stocks and bonds are traded, while mutual funds are purchased from a fund company or a broker.

Utilizing a data set of 40 domestic, sector index ETFs from the four largest ETF providers (BlackRock, Vanguard, State Street, and Invesco), who manage 86.4% of the $3 trillion U.S. ETF industry, this paper studies the effects of various market factors on fund flows to domestic, sector index ETFs (Terfis Team, 2017). Prior research on index mutual funds shows the phenomenon of return chasing, where increases in previous returns leads to increases in assets invested toward that mutual fund. However, in the case of mutual funds investors are chasing the skills of the fund manager. Since ETFs are a passively managed investment vehicle, return chasing that exists in ETFs is due to the naïve extrapolation bias. I show that return chasing does not exists in the case of domestic, sector index ETFs as it does for ETFs in general. Rather, fund flows to domestic, sector index ETFs are driven by changes in Total Net Assets (TNA), or the fund’s size, average daily bid-ask spread, and the Price/Net-Asset-Value (NAV) ratio.  

References 

Krouse, S., 2017, "ETFs Now Have $1 Trillion More Than Hedge Funds", The Wall Street

Journal. Dow Jones & Company

Terfis Team, 2017, “Five Largest ETF Providers Manage Almost 90% Of The $3 Trillion U.S.

ETF Industry”, Forbes