Chase ETF Winners & Flows At Your Own Peril

Trying to read ETF tea leaves with data is foolhardy.

Trying to read ETF tea leaves with data is foolhardy.

It’s time for all the midyear ETF winner/loser stories. Here’s why you should take them with a mine’s worth of salt.

Human beings are for some reason hardwired to love keeping track of things. I don’t know where in the evolutionary process knowing whether Ooogla was doing better than Ook lodged in the human genome, but I admit I’m just as much a victim of the desire to keep score as anyone else.

And hey, it’s fun. How many people bring stat sheets to baseball games and keep the box score for themselves, even in the age of the Internet?

But when it comes to investing, keeping score can be a dangerous way to make decisions.

Consider our own midyear performance update at ETF.com. In it, we correctly point out that the iPath Dow Jones-UBS Coffee Total Return ETN (JO | B-94) was the best-performing ETF so far this year, with an eye-popping 62 percent return through last Thursday.

I get it. It’s interesting. But what I worry about is people trying to catch the tail end of rallies in tiny little niches—like coffee. Consider this chart on JO:

Source: Bloomberg

That’s what it looked like on April 22. If we’d written the story then, and you’d decided you had to get on this “coffee” thing before everyone switched to chai tea, here’s what you would have had to live with for the last two months:

Source: Bloomberg

Down 22%.

It’s easy to pick on the big winner, but we see a similar pattern time and time again. You don’t even have to cherry-pick. Let’s look at the best-performing sector last year—consumer cyclicals, and see how those ETFs have done year to date:

Source: ETF.com

There’s no question who the winner was—the PowerShares Dynamic Media ETF (PBS | B-47), up nearly 60 percent in 2013. And this year? The absolute worst of the bunch, down more than 7 percent. You can call it cyclicality, mean reversion or unknowable voodoo, but the reality is the same—time and time again, investors get burned chasing yesterday’s stories.

ETF investors can get hoodwinked by another scorekeeping nightmare—chasing fund flows. We publish ETF fund flows all over the place at ETF.com, because, as I said, everyone loves keeping score.

But one of the most common questions I get is whether ETF investors should look to flows as a “signal” that interest is strong and ongoing and will drive things higher. People look at flows as some sort of magical spirit animal that reads the market, and not the quirky sideshow of ETF structure that it is.

Consider this completely upside-down story from Bloomberg on flows into the Vanguard FTSE Emerging Markets ETF (VWO | C-90) that ran Friday: “Emerging Markets Show Biggest Premium Since ’12 With ETFs.” (Sorry to pick on Bloomberg; in general, their ETF-focused folks do an outstanding job.)

In the article, the author says: “ … asset managers have piled almost $11 billion into developing-nation exchange-traded funds listed in the U.S. this quarter, the most since 2012, according to data compiled by Bloomberg. That’s sent the premium of the biggest—Vanguard Group Inc.’s FTSE Emerging Markets ETF [VWO | A-91]—to an average 0.2 percentage-point over its underlying assets, the widest gap in two years.”

My first reaction was “20 basis points? Who cares? It’s an international ETF! You’re buying Malaysia, expect a slight bit of trading cost.” But then I went and pulled up the premium-and-discount chart for VWO on our analytics pages and found this:

Source: ETF.com

Indeed, VWO’s 20 basis points premium was a recent high … it hadn’t traded higher than 20 bps since Tuesday. Which is a far cry from “since 2012.”

OK, it’s easy to pick on people for making an error; I make mistakes all the time. And in the scorekeeping flows stories, I get that it’s all about trying to make a sticky headline and a story that gets people’s interest.

But, increasingly, ETF stories are being used as a kind of carrot to drag investor interest along. And more often then not, I see the stories going just like this one—where there’s this assumption that flows into the ETF are the tail wagging the dog, single-handedly driving up whatever asset class is the ETF flavor of the month. Fully half the time, they don’t even get the data right.

There are plenty of reasons to be excited about emerging markets, or almost any other asset class. But please, don’t base your investment decisions on league tables, scorecards and money flows. Base them on where you actually want exposure to achieve your investment objectives. A radical idea, I know.

At the time this article was written, the author held no positions in the securities mentioned. Contact Dave Nadig at [email protected].

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