What Drives ETF Flows?

Date01 August 2014
Published date01 August 2014
The Financial Review 49 (2014) 619–642
What Drives ETF Flows?
Christopher P. Clifford
University of Kentucky
Jon A. Fulkerson
Loyola University Maryland
Bradford D. Jordan
University of Kentucky
The value of exchange traded fund (ETF) assets has increased from $66 billion in 2000
to almost a trillion dollars in 2010. We use this massiveexpansion in ETF assets to study what
drives ETF flows. Using a data set of over 500 ETFs from 2001 to 2010, we show that ETF
investorschase returns in the same way as mutual fund investors. While there is an active debate
about whether return chasing by mutual fund investors represents the pursuit of superior talent,
the existence of return chasing in this passively managed environment should not represent a
search for skilled managers. We also show that ETF flows increase following high volume,
small spreads, and high price/net asset value ratios. Finally, we findlittle evidence of superior
market timing in ETF flows. Our results suggest that return chasing in both mutual funds and
ETFs is more likely the result of na¨
ıve extrapolation bias on the part of investors that has
contributed to the growth of the ETF industry.
Keywords: ETF, mutual fund, cash flow
JEL Classifications: G11, G12
Corresponding author: Sellinger School of Business and Management, Sellinger Hall, Loyola University
Maryland, 4501 N. Charles Street, Baltimore, MD 21210; Phone: (410) 617-2818; Fax: (410) 617-5035;
E-mail: jafulkerson@loyola.edu.
We thank Xin Hong and Monika Rabarison for valuableresearch assistance.
C2014 The Eastern Finance Association 619
620 C. P.Clifford et al./The Financial Review 49 (2014) 619–642
1. Introduction
Exchange traded funds (ETFs) are one of the fastest growing sectors of the
mutual fund industry, growing from $66 billion in assets in 2000 to almost a trillion
dollars by the end of 2010. By way of comparison, traditional equity mutual funds
increased in assets from $4 trillion to $5.7 trillion over the same period. The number
of equity ETFs grew from one in 1993 to 923 in 2010.1In early 2012, the SPDR
S&P 500 ETF, with assets of just under $100 billion, was bigger than most U.S.
equity mutual funds.
ETFs have several distinguishing features relative to mutual funds. Primarily,
shares of ETFs trade on exchanges while open-end mutual funds do not. Because
of this difference, ETF shares can (and do) sell for more or less than net asset
value (NAV). Further, because ETFs are exchange traded, we are able to observe,
and explore the effect of market-related variables such as trading volume, bid-ask
spreads, and historical returns.
Weuse a large sample of equity ETFs as a test environment to explore the growth
of ETFs over the past decade and to address return chasing as discussed in the mutual
fund literature. Like Elton, Gruber and Busse (2004) use a subset of S&P 500 index
mutual funds to examine investor choice, ETFs provide a unique laboratory for ad-
dressing cash flow behaviorbecause of the generally passive investment goals. Passive
investment means that the typical ETF tries to match—not beat—a particular market
index and precludes any purposeful intent to create alpha. By eliminating any search
for alpha, we can investigate how passive investors react to prior performance (and
other characteristics). If we are to find behaviorsimilar to mutual funds, it would imply
that investors have either consistently ignored or misevaluated active management.
We model ETF growthsimilar to cash flow studies in the mutual fund literature.
Our data include implied flows for more than 500 ETFs over the period 2001–
2010 and actual inflows and outflows for over 300 ETFs. Differences between ETF
structure and mutual fund structure mean these flows can haveadditional determinants
not present in mutual funds. However, as we discuss more fully later, ETF flow
has an essential relationship with individual investor behavior, despite part of this
relationship resulting from microstructure factors and the existence of “authorized
participants” (APs) as the sole intermediaries.
Using this large data set, we find that like mutual fund investors, ETF flow de-
creases with increases in fund size, expenses, and turnover. Our results are consistent
for both ETF gross inflows and outflows and when examining different styles of
ETFs (e.g., sector or foreign). Most of our results are driven by gross inflows and
are relatively consistent across the different ETF styles. Generally, the characteristics
shared by mutual funds and ETFs have the same qualitative influence on ETF flows
as the literature has previously demonstrated for mutual fund flows.
1All data come from the ICI Institute 2011 Factbook at http://www.ici.org/pdf/2011_factbook.pdf.

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