The iShares MSCI Emerging Markets ETF (EEM) may be one of the oldest and most liquid emerging market ETFs, but it seems to be somehow standing still, with zero asset flows in 2021.
In fact, there have been zero flows in or out of EEM since Dec. 15. It’s nearing three months of no action. There are several reasons why this may be happening, all of them par for the course in the trading world. But it does confirm a trend we’ve seen develop over time in this fund: EEM is now a bona fide trading vehicle.
The number of shares outstanding in this fund have sat at an unchanged 546.3 million since mid-December, according to iShares data. That’s not totally unusual. Historical data on this fund shows that EEM has periodic stretches lasting anywhere from a few days to a few months when share inventory doesn’t change.
The previous stint happened between Oct. 8 and Dec. 14, 2020, when shares sat at 540.45 million. (And it’s not the only ETF to go through this, either.)
This is noteworthy in the context that zero flows into this veteran ETF stands in stark contrast to the asset gathering we’re seeing in other broad emerging market ETFs this year.
EEM Vs. The Rest
Counterpart iShares Core MSCI Emerging Markets ETF (IEMG), for instance, has now taken in almost $5 billion in net creations in 2021, facing not a single day of outflows thus far. A look at the five biggest broad emerging market ETFs (below) shows flows across the board except for EEM.
(For a larger view, click on the image above)
Liquidity Not In Question
The lack of flows doesn’t suggest there has been no trading in this fund—quite the contrary. EEM trades about $2 billion on average every day. That activity refers to the fund’s liquidity in the secondary market, which is the turf of investors trading the existing supply of ETF shares all day.
Over the years, EEM has gone from an investment vehicle to a trading tool, giving way to the much cheaper IEMG—which came to market some nine years after EEM first launched—to attract the lion’s share of new assets coming into iShares products. EEM boasts roughly three times the daily liquidity of IEMG—a trader’s dream—but it costs almost seven times as much. EEM has a 0.70% expense ratio versus 0.11% for IEMG.
The lack of flows does suggest, however, that authorized participants and market makers—those who work daily to ensure adequate inventory by creating or redeeming ETF shares, and who provide liquidity—are probably finding better opportunity for profit outside the creation/redemption process for EEM.
Note that liquidity in one market—primary or secondary—is not indicative of liquidity in the other market. You can have a massively liquid ETF such as EEM that goes long periods without triggering the creation process.
Motivators Of Flows Creation
There are typically four main reasons this zero-flow phenomenon can happen, according to Elisabeth Kashner, director of ETF research at FactSet:
- Low investor interest, generally reflected in low trading volumes
- Balanced two-way markets, where “natural” buyers and sellers transact, leaving no opportunity for APs
- High competition among market makers and APs pushes them to tighten spreads to the extent that arbitrage is no longer profitable
- APs build inventory, but hedge with futures rather than transact in the primary market
It looks like there may be more than one of those reasons at play. Clearly investor interest isn’t in question, because daily trading volumes are healthy.
But creating new shares of EEM isn’t cheap. The creation unit size is massive—450,000 shares, or about $24.5 million—and the creation fee per unit, which the ETF issuer charges the AP, is $7,700, FactSet data show. That’s a lot of capital that goes to work to create a share of EEM.
When APs step in to the market to create/redeem ETF shares in response to changes in supply/demand, they pay all the trading costs and associated fees. (Read “What Is The Creations/Redemption Mechanism” for more details.)
One ETF trader told us these costs such as the creation unit fee, among others associated with this process, are one of the factors behind this recent lack of creations at the moment. APs are liquidity providers, but they work for a profit.
There’s also the cost of managing position risk. Kashner noted that APs and liquidity providers will often hold ETF inventory, long or short, and hedge the risk of holding these positions in their book through futures or options contracts, for example.
In the case of EEM, at least according to one ETF trader, some APs may be doing just that—sitting on EEM share inventory and hedging that position with other instruments such as futures or options, seeking better profit opportunities than the creation/redemption mechanism offers right now.
Nothing New Here
All of this is common practice—just another day at a trading desk. APs will always choose the best money-making trade because that’s their business.
As Kashner put it, “If you’re an AP, you figure out how you’re going to make money. If you can trade the basket at a better price than the bid/ask, you are going to do it, and if it’s cheaper not to do a full create/redeem but better to trade against other instruments, you’ll do that.”
“If there’s an imbalance between supply/demand and APs can take advantage of it without having to create a basket, they’re going to do it,” she said. “With liquid futures and options markets, trading firms have lots of choices.”
Does any of this matter to you, the end investor?
Yes, and, not really.
If nothing else, EEM’s strange-looking zero flows offer an opportunity to dust off your understanding of how ETFs trade. (We have lots of content on this topic in our ETF Education Center, and it is more complicated than it looks.)
This is also a great reminder that the costs and risks APs face when they keep the supply an of ETF elastic by creating and redeeming shares are a "key determinant" of bid/ask spreads in the secondary market, Kashner noted. Those spreads impact how much it ultimately costs you, the investor, to transact in that ETF.
In an ideal frictionless world, competition among liquidity providers for the business would push spreads toward zero. But fees, hedging costs, etc., prevent that from happening as liquidity providers face these costs. The wider the spread, the higher the cost to trade.
And finally, there’s a simple cautionary tale here of assigning too much meaning to ETF asset flows. We like to say flows are a great, laggard indicator of investor sentiment. But a look at EEM in isolation could have been interpreted as a sign that there's no investor interest in emerging market equities. That’s not the case.
“All of this is capital markets behaving as they usually do,” Kashner said.
Contact Cinthia Murphy at [email protected]