Passive investors are dumping emerging-markets stocks, including China's, exacerbating the recent fall in prices, said analysts.
They have sold US$15.3 billion worth of emerging-markets shares so far this year, much more than active investors, who have offloaded US$9 billion, according to funds tracker EPFR.
Passive investors theoretically buy and hold stocks no matter what the direction of markets, accepting average returns. However, fund flows data shows that they tend to crack under pressure, and many end up buying high and selling low.
A popular tool used by passive investors is index-tracking exchange-traded funds (ETFs), which are baskets of stocks. Index-tracking ETFs allow big money managers, such as pension funds and insurance companies, to switch in and out of markets quickly, on a large scale and at a cheaper cost than calling stock brokers.
The S&P 500 Index plummeted 12 per cent on Monday, the most since 1987, to 30 per cent below its all-time high. Meanwhile Hong Kong's Hang Seng Index fell into its first bear market since 2015 on Friday.
"If you are a simple ETF hanging on the market, you've [linked yourself] to a collapsing index," said Benjamin Quinlan, chief executive of strategy consultancy Quinlan & Associates. "It's not a smart investing strategy" compared with active stock picking in times like these, he said.
In China, ETF funds outflows hit US$780 million last week, higher than non-ETF outflows of US$590 million, according to EPFR and analysts at Morgan Stanley.
A man stands by a display board showing the Hang Seng Index in Hong Kong on March 13, 2020. Photo: AFP alt=A man stands by a display board showing the Hang Seng Index in Hong Kong on March 13, 2020. Photo: AFP
Passive investment using index-tracking ETFs surged during the 11-year bull market. By January 2020, ETFs in Asia had topped US$293 billion, up from US$54 billion in 2010, according to consultancy ETFGI.
"ETFs have a self-reinforcing bias on the way up and the way down," said Quinlan.
Since the 2007-2008 financial crisis, fund managers have turned en masse to passive investment tools as a way to cut costs and boost flexibility.
"It's easier to de-risk," said Sean Taylor, chief investment officer for the Asia-Pacific region at global asset manager DWS. "ETFs are a very good way to get out of a position and into a position."
When emerging markets are rising, ETFs flourish. However, in periods of turbulence and downswings, they tend to mirror the performance of the underlying assets, according to analysis of EPFR data by Morgan Stanley.
Allocations to ETFs as a proportion of Asian institutional portfolios have also ballooned. Average ETF allocations grew to 23 per cent of total assets in 2018 from 14 per cent in 2017, according to consultancy Greenwich Associates's Asian ETF survey.
ETFs can concentrate in parts of the market, such as blue-chip stocks that are components of major indices. During a violent correction in markets, this amplifies the force of passive investors' selling out.
"ETFs can drive a lot of buying and selling in blue-chip stocks, so they see pressure [when sentiment turns,]" noted DWS's Taylor. He thinks there could be bargains among quality stocks once the dust settles.
ETFs in the US and Japan saw a new rush of investment last week, as they represented safe havens, according to research from broker Jefferies based on data from EPFR.
The growth in ETFs in Asia is still dwarfed by the more than US$4 trillion worth of ETFs in the US as of January, a record high, according ETFGI.
More broadly, electronic trading is also more limited in Asia than in the US but is growing fast.
Single stock electronic trading in Asian ex-Japan cash equities grew to 43 per cent in 2019 from 37 per cent the previous year, based on interviews conducted by Greenwich Associates in the third quarter of last year.
The consultancy expects electronic trading to hit 50 per cent of single stock trading by 2022.
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