That herd behavior tends to swell the valuation of the underlying assets in the ETFs, but eventually that valuation will revert back to normal and the asset eventually underperforms.
The equity-ETFs pattern doesn’t replicate when looking at fixed-income ETFs, Zhu notes. With fixed-income ETFs, the pattern of high-inflow/fixed-income ETFs versus the other fixed-income quintiles was flat since 2009.
She suggested the general pessimism investors have had toward fixed-income, along with dumping fixed-income ETFs that didn’t perform well, may have something to do with the pattern.
“Fixed-income investors are more risk averse. They want to protect their principal or protect their investment. So instead of return chasing, when things are not going well they may overreact [and sell],” Zhu says.
Regarding ETFs that invest in commodities and currencies, Zhu says there aren’t enough ETFs to make a meaningful analysis. But data show commodity ETFs seem to follow the equity-ETF pattern, while currency ETFs show a reverse relationship. Over nine years (April 2009 through April 2018), the back test showed investing in currency ETFs with the highest fund inflows netted investors a 37 percent cumulative return during the period tested, versus a loss of 15 percent for those buying ETFs with the largest fund outflows.
Zhu says she’ll need to do further analysis to ascertain why equity ETFs with high inflows relative to AUM underperformed, but for now she says it’s another reminder to be thoughtful when investing.
“It’s just something that you want to keep in mind when you are trying to build your portfolio, to probably avoid certain ETFs which are really hot,” she says.