ETF Demand

Discussion in 'ETFs' started by TwosComplement, Oct 21, 2012.

  1. ETFs have become quite popular in recent years. They offer an opportunity to trade in a basket of equities in an affordable way. Gain access to an index or sector thereof. ETFs open the door to markets such as commodities that otherwise would be difficult for the small investor. However, ETFs are a much different instrument than what we normally trade. They are sometimes misunderstood. They are simply, a much different animal. Because they are different, there is an opportunity to evaluate demand in a way we could not for stocks. My attached report contains demand analysis for more than 300 ETFs.

    I believe it to be common knowledge (well at least among our readers) that an ETF is designed to track the changing value of an asset. But how does an instrument that is exposed to the pressures of supply and demand, track the value of something else? It would seem impossible. But there we have the ETF. The answer is simple. To keep the ETF price in line with its assets, there is a built in process known as an arbitrage that is available to “Authorized Participants,” not you and me. This process either creates more shares or redeems existing shares through an exchange of assets for shares, hence Exchange Traded Fund. There are fees associated with this exchange, which is why ETFs should only be considered for short term trades. I will not bore you with the details of this as there is already plenty of material available on the subject. I only wish to explain what you would need to know to understand the data in the attached report. The three points that I am going to discuss here are Net Asset Value (NAV), Shares Outstanding and Flow.

    NAV is the value of the assets less the value of its liabilities. In other words, it is the value of the asset the ETF is tracking. It is an important to understand before purchasing any ETF because an ETF cannot track exactly; there is always a premium or discount attached to the ETF. There is a column for this in the report.

    Now let’s take a look at outstanding shares. As discussed, the number of shares is not fixed. When aggregate demand for an ETF is increasing, more shares are created to meet that demand. If we were to see a trend of outstanding shares increasing week over week, we might infer that there is a trend of increased demand for the fund. However, we cannot assume to know the AP’s interest. So, looking at the number of shares exclusively could be misleading.

    Next, I like to look at the flow. Here I just multiply the current price by the outstanding shares and then subtract the same calculation taken from a previous date. I am just looking for a change in value of the fund by share price.

    Now I like to take this one step further. If the fund’s value is increasing at the same rate as the asset, does that really show an increased demand for the fund? Well, it’s definitely not a leading indicator. For each week I subtract the change in value of the underlying assets from the flow. I call that Adjusted Flow. This number shows me how the value of the fund changed without consideration to the change in assets. When we look at the data in this view, it tells a much different story.

    I think that the above explanations should be enough to understand the columns in the report. If not, let me know. I would like to receive some feedback in regards to this report. I have formatted it in Excel. If you do not have Excel, let me know and I can send it to you formatted in Open Document (a free program.)
  2. After additional analysis, it seems clear that having four weeks of trending data provides a better picture. Although, there are no strong signals in this week’s data, there are a couple that look decent.
  3. My Attachment wasn’t included. Thanks Joe
  4. Joe


    It is included, in your initial post, please email me the attachment.
  5. many of us prefer mutual funds, because we don't have to pay the expenses of day to day trading