You've probably warned clients against buying the hottest exchange-traded funds. You should also warn them against buying stock ETFs with the largest inflows, according to a study by the Leuthold Group.
The stock ETFs that had the highest inflows over the previous one, two and three months underperformed during the next 12 months, Leuthold found. The research group looked at inflows as a percentage of month-end assets and then divided the ETFs into fifths, or quintiles, according to inflows.
Stock ETFs with the highest one-month inflows lost an average 0.1% over the next month, versus average gains of 0.37% to 0.41% for those in the other four quintiles. The study looked at ETFs from 2006 through April of this year. A similar pattern emerged using two- and three-month flows. From April 2006 to April 2018, investing in the ETFs with the largest inflows resulted in an 8% loss.
"The main story behind the numbers is the old classic that investors are return chasers, and in a bull market, they throw money at whatever is working," said Scott Opsal, director of research and equities at Leuthold. (The study was created by Leuthold research analyst Jun Zhu.)
Unfortunately, they also tend to come late to the party, and often invest just as the fund is peaking.
The problem is particularly acute with stock ETFs, Mr. Opsal said. "As [Vanguard founder] Jack Bogle said, ETFs are too easy to trade and to trade quickly. You're betting on an idea and a price chart — you're not trying to understand the real business because there isn't one. They draw people in to chase the chart, and that's not an optimal strategy."
The study found little relationship between bond inflows and performance, Mr. Opsal said. "Investors don't usually buy bonds for short-term returns — they buy for stability and income, and they don't think of trading in and out every three months."
For advisers, checking monthly flows for stock funds might be a useful exercise.
"If I were going to put an ETF in a portfolio and saw it had a high inflow, I'd be willing to wait it out a couple months and see what happens," Mr. Opsal said. Doing so might lead to a more level-headed approach — and increase returns over the long run.
(More: International ETFs ready for takeoff)