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2008's ETF Winners

ETFs are gathering assets amid the market malaise.

John Gabriel, 01/20/2009

In 2008, ETFs experienced total cash inflows of approximately $160 billion, with much of the action occurring in the back half of the year when fear trumped greed and markets went into panic mode. Despite the huge inflows that ETFs enjoyed during the year, assets under management still fell about 7% year over year--simply a function of the broad-based declines in the markets.

While the new year is a perfect time to look ahead and plan accordingly for what we think is in store for 2009, we first thought it would be interesting to take a look back at 2008 to see which ETFs were the top performers in their respective categories. We also examined which funds gathered the most assets throughout the year.

Not surprisingly, the top-performing equity-focused ETFs came predominantly from funds offering exposure to the health-care and biotechnology sectors. This was to be expected as these are two classically defensive industries in which demand is relatively unaffected by the overall economic climate. In our view, health care is poised to continue performing well over the next few years and still represents a compelling value, hence our overweight position in iShares Global Health Care IXJ in our ETFInvestor Hands-On Portfolio.

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What jumps out at us is that a banking ETF made the cut for the top-five performing equity ETFs. We've highlighted just how PowerShares Dynamic Banking PJB managed to outperform its peers by such a wide margin in our analyst report as well as in the November issue of Morningstar's ETFInvestor newsletter. We'd encourage interested readers to check out our analysis to get more detail on this counterintuitive top performer.

 Equity ETFs
 

2008
% Return

2008 Cash
Inflows (MM)
AUM
(MM)
SPDR S&P Pharmaceuticals XPH
-7.94
34.559 43.656
SPDR S&P Biotech XBI
-8.81
283.645 465.899
PowerShares Dynamic Pharmaceuticals PJP
-10.56
72.313 147.122
PowerShares Dynamic Banking PJB
-12.58
77.847 114.987
iShares Nasdaq Biotechnology IBB
-12.68
229.484 1,475.195
* Data as of 12-31-2008.

The usual suspects populated the list of top performers in the commodity complex. Precious metals (primarily gold) were the big winners among commodities, as investors fled risky assets and parked their cash in so-called safe havens. Fears of excessive inflation (down the road) probably played a role as well, considering the unprecedented level of money printing by the Federal Reserve in an attempt to rescue the ailing financial system. Separately, the precipitous drop in the price of energy, basic materials, and metals in the back half of the year paved the way for PowerShares DB Agriculture DBA to make the cut, despite posting a loss of almost 20% in 2008.

 Commodity ETFs
 

2008
% Return

2008 Cash
Inflows (MM)
AUM
(MM)
iShares COMEX Gold Trust IAU
5.42
338.798 1,896.305
SPDR Gold Shares GLD
2.99
4,658.863 21,691.122
PowerShares DB Gold DGL
2.83
39.265 83.663
PowerShares DB Precious Metals DBP
-2.99
33.877 77.297
PowerShares DB Agriculture DBA
-19.51
476.023 1,063.897

* Data as of 12-31-2008.

The performance of currency ETFs was all over the map during the course of the past year as we saw a massive unwinding of the carry trade--a popular hedge fund strategy where investors borrow in (or short) low-yielding currencies and invest (or go long) in higher-yielding currencies. The trick was that many of the hedge funds that crowded into this trade used excessive leverage in order to magnify the spreads they were earning. However, when the reality of the grim economic landscape set in (and commodity prices plunged through the floor), these hedge funds couldn't unwind their trades fast enough. Investor redemptions and margin calls greatly exacerbated this effect. PAGEBREAK

In the end, the Japanese yen topped the charts, in terms of currency appreciation, thanks to the mad rush of hedge funds buying the yen to cover their short positions. The reverse was true for the commodity-based, high-yielding currencies that were used for the other side of this trade. In the desperate race to unwind the ubiquitous carry trade, hedge funds were forced to sell high-yielding currencies like the Aussie, New Zealand, and Canadian dollar, ultimately leading to a devaluation of these commodity-based currencies.

 Currency ETFs
 

2008
% Return

2008 Cash
Inflows (MM)
AUM
(MM)
CurrencyShares Japenese Yen Trust FXY
22.98
(451.874) 703.570
iPath JPY/USD Exchange Rate ETN JYN
22.90
(67.156) 12.951
CurrencyShares Swiss Franc Trust FXF
7.51
218.185 436.675
CurrencyShares Euro Trust FXE
-1.65
(239.663) 682.204
iPath EUR/USD Exchange Rate ETN ERO
-2.24
(89.311) 8.185
* Data as of 12-31-2008.

Through the malaise and credit crisis of 2008, U.S. Treasuries proved to be the save haven of choice for risk-averse investors. In fact, as investors fled for safety, the yield on the 10-year Treasury note fell to just marginally above 2%--the lowest level seen in more than 70 years. This is a testament to just how much fear was in the markets in 2008. Investors are willing to accept real negative yields on their money in exchange for the comfort of having the explicit backing of the U.S. government. With large banking institutions failing left and right over the course of the year, it's no wonder investors were hesitant to simply park their cash in the bank. Now, the question is whether Treasuries are in a bubble. We think this will continue to be a hot subject as we move through 2009.

 Fixed-Income ETFs
 

2008
% Return

2008 Cash
Inflows (MM)
AUM
(MM)
Vanguard Extended Dur Tre Index EDV
55.46
21.221 51.519
iShares Barclays 20+Yr Treas Bond TLT
33.77
(167.925) 1,892.624
SPDR Lehman Long Term Treasury TLO
24.14
(0.608) 25.409
PowerShares 1-30 Laddered Treasury PLW
21.82
69.150 99.137
iShares Barclays 10-20 Yr Treasury Bond TLH
20.10
58.174 169.224
* Data as of 12-31-2008.

As expected, the top-performing leveraged or inverse ETFs were all designed to produce double the inverse of their respective index's daily return. The relatively steady downturn in semiconductor demand and the technology sector in general caused by dwindling corporate profits and a weak business environment helped these UltraShort Proshares ETFs post strong gains. While it may be tempting to dabble in these aggressive products after seeing the eye-popping returns in the table below, we strongly urge investors to exercise extreme caution and understand what they're getting into. One aspect many individual investors likely overlooked this year was the relative tax inefficiency of these alternative products.PAGEBREAK

A few days after we published an article discussing the huge capital gains distributions made this year by leveraged and inverse ETFs (namely Rydex), ProShares announced that it too would be making pretty significant capital gains distributions on 35 of the 76 ETFs it offers. We cannot stress enough that these aggressively leveraged products are not suitable as long-term investments. The reality is that it is extremely difficult--no matter how much of an expert one may be--to not only accurately call the price movement of a given asset from point A to point B, but to also project the path that it will take in the interim. Stay tuned for more details and discussion to come on this subject--in particular how the volatility drag of these daily compounding returns can eat away at long-term performance. ETFInvestor newsletter subscribers can learn more about this topic by checking out the soon-to-be-released January issue.

 Leveraged and Inverse ETFs
 

2008
% Return

2008 Cash
Inflows (MM)
AUM
(MM)
UltraShort Semiconductor ProShares SSG
112.65
(11.387) 23.365
UltraShort Technology ProShares REW
97.83
7.259 58.573
UltraShort Russell MidCap Gr ProShares SDK
95.83
(11.647) 5.890
UltraShort Russell1000 Gr ProShares SFK
82.94
(16.032) 18.134
UltraShort Industrials ProShares SIJ
80.20
(35.561) 45.129
* Data as of 12-31-2008.

The table below displays the top 10 ETFs, in terms of 2008 cash inflows. Judging by its constituents it would seem that there are many investors out there looking to gain exposure to the badly battered financial sector, emerging markets, and small-cap stocks. This makes sense as contrarian or longer-term-focused investors look to step up their exposure to the hardest-hit sectors. Otherwise, investors appear to be looking for general market exposure via the S&P 500. Interestingly, SPDR Gold Shares GLD and iShares Barclays TIPS Bond TIP also made the list. In our view, this says something about what investors believe could be the long-term inflationary ramifications of the loose monetary policy currently being employed by the Federal Reserve.

 Fund Flows
 

2008
% Return

2008 Cash
Inflows (MM)
AUM
(MM)
SPDRs SPY
-37.38
33,499.165 93,922.171
Financial Select Sector SPDR XLF
-55.21
9,117.615 7,791.799
iShares S&P 500 Index IVV
-36.94
5,052.260 15,652.552
Ultra Financials ProShares UYG
-85.19
5,002.495 2,412.270
iShares Russell 2000 Index IWM
-33.65
4,757.001 10,694.481
SPDR Gold Shares GLD
2.99
4,658.863 21,691.122
Ultra S&P 500 ProShares SSO
-67.79
4,493.606 3,545.485
iShares MSCI Emer Mkts Index EEM
-50.00
4,232.178 19,210.404
iShares Russell 1000 Index IWB
-37.57
3,672.500 5,724.536
iShares Barclays TIPS Bond TIP
-2.52
3,667.306 8,676.305
* Data as of 12-31-2008.

Looking ahead, we expect to see continued inflows for the ETF industry. As investors begin to regain their appetite for risk and look to dip their toes back into the market, we suspect that the rock-bottom pricing, unparalleled transparency, extreme tax efficiency, and intraday liquidity that the ETF structure offers will appeal to the masses.

John Gabriel is an ETF analyst with Morningstar.

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