ETF Moving With Stocks

11/21/2016


Investors have piled into exchange-traded funds (ETFs). In the first 10 months of this year, some $176 billion poured into ETFs, compared to full-year increases of $242 billion in 2015 and $243 billion in 2014. Driving inflows is the increasing popularity of passive investing, as most ETFs track broad indexes and charge modest expense ratios.

ETFs' assets total about $2.4 trillion and are expected to approach $6 trillion by 2020. Outsized growth should help push expense ratios lower and spur product launches. However, research suggests asset flows impact security prices, and potentially affect fund performance.

ETFs GAINING ASSETS
3-Month
Net
Inflow
($Mil.)
-- Total Return --
ETF (Price; Ticker)
Fund
Score
Year-
To-Date
(%)
3 Years,
Annual.
(%)
Expense
Ratio
(%)
Energy Select SPDR ($71; XLE)
1,037
100
21.4
(4.1)
0.14
Financial Select SPDR ($22; XLF)
4,111
85
16.4
11.0
0.14
First Trust Nasdaq-100 Technology
($51; QTEC)
1,052
90
21.2
16.2
0.60
Health Care Select SPDR ($70; XLV)
1,207
90
(1.0)
10.7
0.14
Industrial Select SPDR ($61; XLI)
1,569
93
18.0
9.4
0.14
iShares Russell 2000 ($130; IWM)
4,466
84
16.3
6.8
0.20
iShares U.S. Aerospace & Defense
($140; ITA)
283
96
20.0
13.4
0.44
iShares U.S. Financials ($96; IYF)
441
83
11.3
9.5
0.44
Materials Select SPDR ($48; XLB)
477
93
13.1
4.7
0.14
SPDR S&P Biotech ($66; XBI)
568
82
(3.3)
19.3
0.35
Vanguard FTSE Emerging Mkt.
($35; VWO)
3,166
94
11.6
(2.3)
0.15
Vanguard Mid-Cap Index ($130; VO)
749
100
9.4
8.1
0.08
Note: Fund scores are percentile ranks, with 100 the best.

ETFs are designed to limit trading activity in their underlying securities. Most ETF trades are simple exchanges of ETF shares, with no trading in the underlying securities. But ETFs also use specialized traders to help keep share prices in line with the underlying value of their holdings. When traders create or redeem ETF shares to keep net asset values in line, they often buy or sell a lot of the underlying securities.

A study by Goldman Sachs estimates that ETFs typically account for roughly 25% of underlying stock trading, up from 10% to 15% in 2005. In niche sectors such as real estate, metals, and mining, ETFs can represent 50% or more of trading volume in illiquid securities. Importantly, increased trading appears to boost correlations between ETFs and stocks, with both moving in the same direction, regardless of a stock's fundamentals.

The rising influence and size of ETFs have investors wondering if the tail is wagging the dog. An academic study found a positive relation between ETF inflows and underlying stock returns. That research suggests investors might benefit from funds gaining assets, as inflows beget even more stock purchases — and push a fund's price higher. A dozen funds seeing sizable inflows are listed above.

In many cases, inflows and outflows are nonissues for ETFs that mirror diversified indexes of liquid securities. But be wary of funds in narrow corners of the market. For better or worse, investors often chase performance and stampede in or out of niche ETFs, potentially boosting trading and impacting returns. Low-volatility funds are a recent example. The funds have seen hefty outflows in recent months, which might have weighed on performance.

OUR RECOMMENDED MUTUAL FUNDS
-- Year-To-Date --
Target Weights
Fund (Price; Ticker)
Total
Return
(%)
Rank
Conser-
vative
(%)
Growth
(%)
Fund
Rating
Baird Core Plus Bond ($12; BCOSX)
4.6
A
9
4
91
Dreyfus MidCap Index ($37; PESPX)
15.3
A
0
0
76
Dreyfus Small Cap Stock Index
($30; DISSX)
19.1
A
0
0
95
Fidelity Overseas ($40; FOSFX)
(3.0)
D
9
9
97
iShares MSCI EAFE Small-Cap ETF
($49; SCZ)
0.8
D
4
6
100
PRIMECAP Odyssey Stock ($26; POSKX)
10.7
A
7
8
94
T. Rowe Price QM U.S. Small-Cap
($28; PRDSX)
9.4
C
4
4
93
Vanguard 500 Index ($202; VFINX)
8.6
B
9
10
80
Vanguard GNMA ($11; VFIIX)
2.4
A
0
0
100
Vanguard Growth Index ($56; VIGRX)
3.9
B
10
11
89
Vanguard High-Yield Corp.
($6; VWEHX)
9.0
D
5
6
97
Vanguard Inter.-Term Tax Exempt
($14; VWITX)
0.5
B
0
0
79
Vanguard Mid-Cap Value ($38; VMVIX)
12.5
C
7
10
94
Vanguard Short-Term Invest.
Grade ($11; VFSTX)
2.8
A
9
4
100
Vanguard Small Cap Value Index
($28; VISVX)
18.5
C
4
4
94
Vanguard Strategic Small-Cap
($33; VSTCX)
13.5
D
4
4
89
Vanguard Total Bond Mkt. Index
($11; VBMFX)
2.9
D
0
0
51
Vanguard Value Index ($35; VIVAX)
12.6
B
9
10
95
Vanguard Wellesley Income
($26; VWINX)
6.7
B
0
0
99
Vanguard Wellington ($39; VWELX)
8.3
A
10
10
98
* Through Nov. 15. Ranks compare funds with same objectives: A = top 20%; B = next 20%; C= middle 20%; D = next 20%; E = bottom 20%. Fund ratings are percentile ranks, with 100 the best.

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