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ETF Specialist

ETFs Continue to See Strong Inflows Despite the Market

We have some theories as to why.

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As my colleague Karen Dolan recently wrote, it has been a tough haul for open-end funds this year and more particularly the past two months. But while investors have been pulling money from open-end funds like mad, the situation with ETFs has been quite different.

Believe it or not, year to date, money has actually been flowing into ETF funds. As of September of this year, ETFs had scored an estimated $82 billion of net inflows. Even with the market down as much as it is, our Market Intelligence team estimates that from September 2007 to September 2008, total ETF assets under management are actually up slightly, having grown from $541 billion in 2007 to $549 billion in 2008. This stands in stark contrast to the open-end market (sans money market funds) where we saw a decline of nearly $1.5 trillion.

Now, since the real market declines happened in early October, I expect the amount of assets under management to decline significantly from September's level. Still, we expect that the fund flows will tell an entirely different story. We did a preliminary check of the iShares group of funds and found that month to date through Oct. 22, the fund family saw estimated net outflows of only $595 million. Given that the iShares family started the month with approximately $275 billion in assets under management, this is less than 1% of the total. We expect that the State Street family of ETFs, more commonly known as the SPDR ("Spiders") family, will actually see positive inflows given the trading volume that we are witnessing in the  SPDR  (SPY), which tracks the S&P 500, and sector-specific ETFs such as the  Financial SPDR (XLF), and the  Energy Select SPDR (XLE).

It is worth mentioning that ETFs aren't the only types of funds holding up well. ETFs' open-end index fund brethren are also holding their own and experienced positive inflows in September.

So what does this all mean? Well, we have a few theories:

1. With broad index volatility being what it is, institutional money managers are getting stock-like daily price movement with the benefit of diversification. When the S&P 500 and other broad indexes gyrate 5% to 10% on any given day, why would you buy  Apple (AAPL) when you could just buy  PowerShares Nasdaq 100 (QQQQ)? The fact that the SPDR accounted for $19 billion of total ETF inflows in September alone would help support this theory.

2. Asset allocators are sticking to their guns. Most individual investors and financial advisors using ETFs are doing so in a long-term asset allocation strategy that requires disciplined investing through the ups and the downs of the market. This means that they are less likely to panic during these downturns and continue to put money into their strategies. We would expect them to rebalance at some time, but they will most likely be selling bond ETFs to buy equity ETFs. Our preliminary look at the iShares fund flows helps support this, as  iShares Lehman Aggregate Bond (AGG) actually had outflows, while some of the firms' more beaten-up indexes, like  iShares MSCI Emerging Markets (EEM), actually posted significant inflows.

3. This is the continuation of the secular move into indexing strategies and away from active fund management. ETFs have been growing like weeds for the past four years as more and more individuals, advisors, and institutions embrace the low-cost, tax-efficient asset allocation strategies that ETFs enable. My colleague Dan Culloton, who is the editor of our Vanguard Fund Family Report, commented to me that the index world saw a similar acceleration in fund accumulation after the dot-com crash in 1999. It only makes sense that overzealous investors would get a little gun shy about active managers and their fees after being burned in a market crash.

We will get the final tally on October fund flows this weekend and will report back to you early next week. This has undoubtedly been one of the craziest months in stock market, and I can't wait to see what happened to ETFs. Still, I have a feeling that the results will surprise more than a few skeptics and proponents alike.

Do you have your own theories on why ETFs continue to gather assets? Share them with us on our ETF forum at this thread.

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Scott Burns does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.