Large flows to and from ETFs that are significant shareholders in their underlying constituents relative to those constituents’ average daily trading volumes are likely to impact the share prices of the those constituents, according to research from investment bank Keefe, Bruyette & Woods (KBW).
KBW reports on share price impact of ETF flows
To illustrate this point, KBW highlights the impact of recent outflows recorded from two SPDR ETFs focused on the US financials sector.
On 7 November, the Financial Select Sector SPDR ETF (XLF US) and the SPDR S&P Regional Banks ETF (KRE US) saw outflows of $309 million and $39m respectively, on what was the fifteenth worst day of outflows from financials ETFs in 2017 so far. Broader ETF flows were subdued by comparison. Financials broadly underperformed on 7 November and the impact of XLF outflows is noted as XLF financials lagged their benchmark by the greatest margin as compared to small- and mid-cap financials. XLF financials underperformed by 1.3% while mid-cap and small-cap financials lagged by 1.0% and 0.7%, respectively.
With nearly $28.6 billion in assets, XLF is almost eight times larger than KRE. However, the members of KRE are significantly less liquid than the members of XLF. KRE ownership represents 2.1x the average trading volume for the underlying members of KRE, while XLF ownership represents only 1.1x the average daily volume for the underlying members of XLF. Therefore, KRE flows can more meaningfully impact underlying KRE members than XLF flows can for XLF members. While KRE outflows on the Tuesday was just 13% of those for XLF, KRE members saw a greater performance drag, owing to their lower liquidity.
KBW reports that due to this lower liquidity, the relatively small outflows from KRE had a larger impact on the underlying stocks. Banks in both XLF and KRE lagged banks only in XLF by more than double on the day, falling 2.9% on average as XLF banks declined 1.3%.
KRE was launched in June 2006 and has $3.5bn in assets with a total expense ratio (TER) of 0.35%. In the 12 months to 9 November, the ETF has gained 18.9%, thanks in large part to a significant rally in the two months directly following the election of Donald Trump. Since then, however, the ETF has traded sideways, losing approximately 1.0% so far in 2017.
XLF was launched in December 1998 and has a TER of 0.14%. The ETF tracks the Financial Select Sector Index and has returned 27.6% in the 12 months to 9 November. The ETF also saw a Trump bump, although it has performed better than KRE so far in 2017, returning 13.8% in the year-to-date.