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Expectations of growth have changed dramatically in the last year. One year ago, we had a bright outlook for the global economy, most of the commentators were talking about Goldilocks scenario where higher growth and lower inflation would be here to stay. Most of the market participants were also convinced that the FED would continue to increase rates. One year later, we are all talking about recession risks – global institutions are cutting their global growth forecasts. More interestingly, market expectations from FED have totally reversed. FED Fund Futures are now predicting an almost 50 percent chance that the FED is going to cut rates in 2020.

These fundamental changes in the global growth outlook change the return expectations of different asset classes between investors. In theory, prices reflect these forward-looking expectations of market participants and they integrate all the available fundamental information. This prophecy of the classical theory might hold in the long-term. But in practice, and in shorter periods, prices tend to deviate from their equilibrium prices due to non-fundamental factors.

Passive funds and their effects on asset prices have been in the interest of researchers & quants in recent years. Which asset class was affected by the passive fund flows mostly- in the last year? How big was this effect compared to previous periods? To answer these questions, using the EPFR database, we run simple regressions between weekly fund flows (as % of AUM) and returns of different asset classes. Using this basic setup, we calculate 52-week moving flow-betas of 6 different equity regions (Asia Ex-Japan, Japan, UK, US, Europe Ex-UK, Emerging Markets) and 5 different fixed income asset classes (EM Hard Currency, EM Local Currency, US High Yield, US Investment Grade and US Treasuries). The period we use begins from 2012. We only use passive fund flows to calculate betas and all returns are in USD.

In the below box-plots, we plot historical distributions of passive flow-betas for different asset classes. The mid-point of the historical betas are the lines that divide the box into two parts. Upper and lower edges of the boxes show 75th and 25th percentiles of betas. Blue dots are the most recent observations of 52-week rolling betas (last weekly observation by 10th of April 2019).

 Quant Corner   

As expected, equities have higher flow betas compared to fixed income instruments. But interestingly, the size of this flow-beta varies between different equity geographies. The median flow-beta of US and EM is larger than one showing a strong positive relation between flows and returns. For Japan Equities, the median flow-beta is close to zero and 25th percentile is negative, which shows the low pass-through effect of Bank of Japan’s ETF-buying programme on equity prices.

For fixed income securities, the highest flow-beta is around EM Hard Currency looking at the median of distributions and lowest flow-beta is in US-Treasuries. All these flow-betas tend to be higher than zero and have relatively stable intervals compared to equities.

Recent flow-beta calculations suggest that passive flows have been less-effective on prices in all equity regions except emerging markets. Most recent flow-betas are negative in Japan and UK Equities and close to the lowest levels in US Equities. On the contrary, larger passive flows to Emerging Market Equities have coincided with larger returns with a multiple that has only rarely seen before. Fixed income asset class prices have also been affected by passive flows at the highest levels, compared to the last 7 years.

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