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ETF Flows Turn Positive in the First Quarter

Yield-hungry investors also loaded up on junk bonds, while rate hike fears push fixed-income investors to the short end of the yield curve.

John Gabriel, 04/20/2010

Investors plowed some $19.7 billion into ETFs in March. Those inflows helped push total net inflows for the ETF industry to $7.7 billion for the first quarter of 2010.

At month's end, total ETF assets stood at $815 billion, up from $764.6 billion at the end of February and up from $484 billion a year ago.

Short Duration and Junk Bonds Rule in March
After 30 consecutive months of net inflows, iShares Barclays TIPS Bond's TIP streak came to an end in March, as the fund experienced $73.6 million in net outflows. It's worth noting that owner's equivalent rent has increased to 24% of the reported CPI figures and has a disproportionate influence on this statistic. Remember that principal adjustments for TIPS are linked to changes in the CPI, but most investors own their homes and have seen other daily expenditures (such as energy and food prices) rise. As such, many could be hunting for inflation protection elsewhere--namely in equities and commodities.

Potential interest-rate hikes are on investors' minds as they continue to shift their fixed-income exposures to the short end of the yield curve. IShares Barclays Short Treasury Bond SHV led the taxable bond asset class with $1.7 billion in net inflows in March, followed by iShares Barclays 1-3 Year Credit Bond CSJ, which added another $423.1 million in March. Conversely, iShares Barclays 20+ Year Treasury Bond TLT led taxable bond outflows with $133.0 in net redemptions for the month.

Yield-hungry investors also loaded up on junk bonds, as iShares iBoxx $ High Yield Corporate Bond HYG and SPDR Barclays Capital High Yield Bond JNK took in $464.3 million and $451.7 million last month, respectively. With trailing one-year returns of about 30%, it is possible that new shares were created to be lent to short sellers. However, we would wager that most of the inflows represented "long" demand, as shorting these funds would be rather expensive (relative to say, credit default swaps) because of their hefty coupon payments.

Investors Pile into the SPDRs and Cubes and Dump Small-Caps
Funds offering broad index exposure fared well in March, with SPDRs SPY, PowerShares QQQ QQQQ, and iShares S&P MidCap 400 IJH all making the overall top-10 inflows list for the month, pulling in $3.4 billion, $1.7 billion, and $451.1 million, respectively. On the flipside, iShares Russell 2000 Index IWM and Vanguard Small Cap VB saw net outflows of about $996.4 million and $441.0 million, respectively.PAGEBREAK

VWO Continues to Chip Away at EEM
Vanguard Emerging Markets VWO attracted another $784.0 million last month and $2.8 billion in the first quarter. The bifurcation of flows between VWO and iShares MSCI Emerging Markets EEM is well documented by now. Last month EEM shed another $719.4 million and through the first quarter has seen more than $4.2 billion head for the exits. Single-country funds topping international equity inflows with more than $200 million in net inflows included iShares MSCI Hong Kong EWH, iShares MSCI Australia EWA, iShares MSCI Canada EWC, Market Vectors Russia RSX, and iShares MSCI Mexico Investable Market EWW. In contrast, iShares FTSE/Xinhua China 25 FXI and iShares MSCI Japan EWJ saw net outflows $289.2 million and $119.2 million, respectively.

Investors Resume Gold Buying Last Month
After kicking off the year with $902.4 million in net outflows in January and February, SPDR Gold Trust GLD reversed course and pulled in $826.8 million in net inflows in March. United States Oil USO led outflows for the commodity asset class with net outflows of $186.7 million.

Demand for Short Exposure Trounces Longs in Leveraged ETFs
Leveraged ETFs with bullish exposure (2 times and 3 times) experienced outflows of roughly $1.8 billion. Direxion Daily financial Bull 3X Shares FAS led the way with $646.9 million in outflows, followed by Ultra Financials ProShares UYG which saw $269.0 million in outflows. Demand for long-biased leverage was decidedly weak in March; top inflows went to PowerShares DB Gold Double Long DGP with just $21.7 million in net inflows.

Investors favored leveraged ETFs with bearish exposure (negative 2 times and negative 3 times); those funds pulled in a total of $1.4 billion in net new assets in March. Top inflows here went to Direxion Daily Financial Bear 3x Shares FAZ by a wide margin at $448.9 million in net inflows. Next up were Direxion Daily Small Cap Bear 3x Shares TZA and UltraShort 20+ Year Treasury ProShares TBT, which attracted net inflows of $169.4 million and $164.7 million, respectively.

A Busy Month for New ETF Launches
March was a busy month for ETF providers; a total of 18 new ETFs launched:

--Claymore (now a Guggenheim company) launched Wilshire 5000 Total Market (WFVK), Wilshire 4500 Completion (WXSP), and Wilshire US REIT (WREI) on March 9.

--On March 11, Direxion Funds launched six funds offering leveraged long and short exposure to a BRIC portfolio (Brazil, Russia, India, and China), India alone, and the semiconductor industry. With the addition of these ETFs, Direxion now offers 34 leveraged and inverse ETFs.

--On March 10, State Street launched SPDR S&P Russia RBL. This ETF will track the S&P Russia Capped BMI Index, which includes publicly traded companies domiciled in Russia. This fund will compete with Market Vectors Russia ETF, which is Market Vectors' largest ETF, with more than $1.7 billion in assets.

--On March 12, First Trust launched two funds--First Trust ISE Global Copper Index CU and First Trust ISE Global Platinum Index (PLTM). Both of these funds will invest in the equities of mining companies as opposed to buying the metal itself.

--IndexIQ, which is generally known for its hedge fund strategies ETFs, launched two ETFs on March 23--IQ Canada Small Cap ETF (CNDA) and IQ Australia ETF (KROO).

--On March 18, ProShares launched Short FTSE/Xinhua China 25 (YXI), Short Real Estate REK and Short Basic Materials SBM, which provide one times daily inverse exposure to the FTSE/Xinhua China 25 Index, the Dow Jones U.S. Real Estate Index, and the Dow Jones U.S. Basic Materials Index, respectively.

--On April 1, UBS launched UBS E-TRACS Alerian MLP Infrastructure Index (MLPI). This exchange-traded note is designed to track the total return of 25 energy infrastructure master-limited partnerships and offers a current yield of about 7%. The fund will go head-to-head with JPMorgan Alerian MLP Index ETN AMJ, which has seen healthy inflows from yield-seeking investors and currently has $1.0 billion in total net assets.

More Fund Firms Join the ETF Party
In addition to these new funds, March saw two more prominent fund firms, J.P. Morgan Chase and Eaton Vance, toss their hats into the actively managed ETF ring, joining the likes of Goldman Sachs, Legg Mason, and T. Rowe Price.

On March 10, J.P. Morgan filed for exemptive relief with the SEC--initial steps needed for firms planning to offer ETFs for the first time. In its filings, J.P. Morgan, which has about $100 billion in long-term mutual fund assets, disclosed that it plans to offer both index-based and actively managed ETFs.

Eaton Vance, popular for its closed-end funds and mutual funds, filed for exemptive relief with the SEC on March 5. In its filing, the company, with about $150 billion in total assets under management, disclosed it plans to initially launch five actively managed ETFs: Enhanced Short Maturity, Government Limited Maturity, Intermediate Municipal Bond, Prime Limited Maturity, and Short Term Municipal Bond. This will put the firm in direct competition with another recent (and very successful) entrant into the ETF industry: PIMCO.

John Gabriel is an ETF analyst with Morningstar and contributor to Morningstar's ETFInvestor newsletter.

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Disclosure: Morningstar licenses its indexes to certain ETF and ETN providers, including Barclays Global Investors (BGI), First Trust, and ELEMENTS, for use in exchange-traded funds and notes. These ETFs and ETNs are not sponsored, issued, or sold by Morningstar. Morningstar does not make any representation regarding the advisability of investing in ETFs or ETNs that are based on Morningstar indexes.

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