The transparency afforded by ETFs provides for unique analysis on the time-varying preferences of passive investors — useful knowledge for asset managers and product issuers.
A new paper[1] from Hamish Seegopaul, Global Head of Index Product Innovation at STOXX, takes on the objective of deciphering those preferences, by analyzing ETF flows but also looking through to the underlying holdings. The exercise presents a view of investors’ granular preferences, ex-post, and can be a valuable source of information that comes closer to investors’ revealed preferences, as opposed to broad ETF categories, which may be closer to their stated preferences.
The study looks at US ETFs and employs a taxonomy of preferences across style, industry and regional factors. The author creates a ‘Flow Portfolio,’ which is comprised of securities that were theoretically bought or sold each year to facilitate ETF’s net flows. Key findings in the study of Flow Portfolios are:
- There has been a high degree of year-on-year variability in style, industry and regional exposures
- There is evidence of ongoing appetite for broad-based exposure
- Over longer time horizons, there is little clear preference for specific exposures
- No matter the time frame examined, investors favored ETFs with strong in-year performances
Performance rules all preferences
Some trends are persistent over time, Hamish writes. For example, across years the Flow Portfolios show a preference for ‘more’ – more holdings and more performance – compared to the entire ETF universe. The preference for higher returns is probably of little surprise, and the paper does not imply that investors were able to capture it.
That preference also coincides with a relatively constant preference for Momentum. The factor remains somewhat of an outlier, as all other styles show a degree of variability year after year (although that variability mostly disappears when measured over time). Sectors and regions exposures preferences, too, change over time but are fairly neutral over the long run.
“In the short run, preferences can be highly variable,” Hamish writes. “In the long run, there is one preference to rule them all – and that is performance.”
One other notable shift in aggregate exposure over time is the move away from Americas-based holdings and towards EMEA and Asia/Pacific ones, the report says, a sign of diversification preference.
“These findings support a rich product landscape, however, pose challenges for the industry,” the author adds. “Some challenges – such as the ‘returns gap’ – have been sticky. Others, such as understanding preferences prior to investment decisions, will lead to further innovation.”
We invite you to download the paper and explore its methodology and results.
[1] STOXX, “Understanding Investor Preferences through Passive Investment Flows,” February 2024.
