BLK BlackRock Inc

By Asjylyn Loder 

A popular BlackRock Inc. exchange-traded fund that tracks companies with healthy balance sheets shed $1.5 billion on a single day last week, the largest outflow in its six-year history.

The $10.5 billion iShares Edge MSCI USA Quality Factor ETF invests in companies that have stable earnings and lower debt levels. It wasn't that investors suddenly became disillusioned by such companies. Rather, the outflows were just one leg of a $3 billion two-way trade that began days earlier, and had little to do with market sentiment.

The real force behind the trade wasn't an investor at all. It was index provider MSCI Inc. Popular benchmarks created by one of the world's largest index providers were undergoing their semiannual rebalancing, triggering massive money shifts as portfolio managers realigned their holdings with the updated indexes.

The outsize trades show the power wielded by index providers as low-cost passive investing gobbles up more and more of the market. There's now almost as much money in U.S. stock index funds as there is in the hands of fund managers that try to pick individual stocks, according to Morningstar.

ETFs aren't necessarily the biggest index investors, but they are the most visible. Most ETFs disclose their portfolios and investment flows on a daily basis, unlike mutual funds and big institutional investors, such as pensions and insurance companies who use the benchmarks as performance yardsticks.

For ETFs, rebalancing can trigger matching in-then-out trades that resemble the peaks and valleys on an electrocardiogram, earning them the nickname "heartbeat flows."

The trades are most often seen in funds that track specialized indexes where companies are frequently added or dropped from the portfolio, said Elisabeth Kashner, director of ETF research at FactSet.

"This is more of a phenomenon not just for indexing, but for complex indexing where there's a high turnover," she said.

The iShares quality ETF is part of a suite of funds that rely on so-called smart MSCI indexes that try to pick stocks based on specific factors. Other funds in the series saw similar outsize trades. About $230 million made a roundtrip through the iShares ETF that tries to pick undervalued stocks, and more than $800 million each way washed through an iShares ETF that invests in stocks that are less vulnerable to market turbulence.

Portfolio managers use the trades to realign the ETF's holdings with any changes in the underlying index. For example, the iShares quality ETF cut its Facebook Inc. holdings, nearly doubled its shares of 3M Corp., dropped Starbucks Corp. and added Baker Hughes.

Also called "kickers" or "friendlies," these sizable trades are typically arranged between portfolio managers and some of the largest market makers on Wall Street, often big banks that are comfortable tying up billions of dollars over several days. By swapping out large blocks of stocks, the ETFs are also able to shed shares that might otherwise trigger a taxable gain.

Big money shifts don't necessarily mean big price moves, especially in large U.S. stocks. The changes are typically understood well in advance, and portfolio managers have plenty of time to prepare.

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Write to Asjylyn Loder at asjylyn.loder@wsj.com

(END) Dow Jones Newswires

June 05, 2019 08:14 ET (12:14 GMT)

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