ETF Investors Buy in May

ETF investors seemingly ignored the old stock market adage: "Sell in May and go away." In fact, the ETF industry posted its best month of the year, in terms of net inflows, attracting more than $14 billion in new assets during the month. For some context, this compares with May 2008 net ETF inflows of about $3.3 billion. Leveraged and inverse ETFs accounted for about 11% of the month's net inflows, versus 27% last month. The impressive inflows of the past month helped push the industry's year-to-date total net inflows to more than $20.5 billion. With the markets showing resiliency in holding on to gains from its recent rally, we're seeing investors start to regain their appetites for risk. A sign that optimism about the economy is growing can be seen in the bond markets; the yield on the 10-year Treasury note is now at its highest level since November, rising almost a complete percentage point since the end of April.

Emerging markets continued to shine in May. As seen in the table below, five emerging-markets ETFs-- iShares MSCI Emerging Markets (EEM),  iShares FTSE/Xinhua China 25 Index  (FXI),  iShares MSCI Brazil (EWZ),  Vanguard Emerging Markets Stock ETF  (VWO), and  iShares MSCI Taiwan (EWT)--made the top 10 and, combined, accounted for about $5 billion in total net inflows for the month (about 35% of total industry flows). These developing economies have certainly led the global stock market rally over the past several weeks (check out the year-to-date performances in the far right-hand column of the table). However, those considering allocating fresh capital to the group might wish to exercise some patience here. Emerging markets were slammed the hardest in 2008, but jumping in here after the group has rallied so much in such a short time span almost smacks of performance-chasing.

 IShares Barclays TIPS Bond (TIP) has been another familiar face on the top ETF inflows list over the past several months and has now reached more than $13 billion in assets. The screaming bargain we highlighted in TIPS at the end of last year is steadily disappearing. The break-even rate implied by 10-year indexed government bonds is now close to its 10-year average, now sitting at about 1.6%. While not as attractive as when the break-even rate was implying less than 1% inflation over the next 10 years, we still like TIPS relative to traditional U.S. Treasuries.

Top ETF Inflows in May 2009
	Estimated Net Inflow ($MIL)	AUM ($Mil)	YTD % Change
iShares MSCI Emerging Markets Index (EEM)	1,142	30,793	38
iShares FTSE/Xinhua China 25 Index (FXI)	1,123	9,295	34
iShares MSCI Brazil Index (EWZ)	1,065	8,417	68
United States Natural Gas (UNG)	929	2,187	-33
iShares Barclays TIPS Bond (TIP)	865	13,185	6
Vanguard Emerging Markets Stock ETF (VWO)	800	8,801	41
Direxion Daily Financial Bear 3X Shares (FAZ)	791	1,529	-87
iShares MSCI Taiwan Index (EWT)	746	2,795	49
UltraShort S&P500 ProShares (SDS)	669	3,860	-25
iShares Russell 2000 Index (IWM)	505	9,234	6

As shown in the table below,  United States Oil (USO) topped the list of largest redemptions in May. With the price per barrel of crude oil approximately doubling over the past couple of months, this might have some observers scratching their heads. If we had to guess, though, we'd say that the investors who piled into the fund during the first quarter in hopes of playing the rebound in oil were sorely disappointed to learn that dealing with the negative monthly roll yield in the futures markets can wreak havoc on their expected returns. Because of the persistence of contango in the oil futures markets, USO has posted a year-to-date return of about 9% while the price of oil has soared nearly 100% from its lows. For more on this often-misunderstood market dynamic, check out my colleague Paul Justice's recent video report, "What's the Best Way to Invest in Oil?"

Not surprisingly,  Financial Select Sector SPDR (XLF) was also near the top of the list for net redemptions. Keep in mind that although the year-to-date performance of XLF is about flat, it's the financials sector that has led the S&P 500's impressive rally off of its March 9 lows. XLF has risen almost 100% since bottoming in March, with  Materials Select Sector SPDR (XLB),  Industrial Select Sector SPDR (XLI), and  Consumer Discretionary Select Sector SPDR  (XLY) next in line with gains ranging from 40% to 50% over the same period. Selling the financials at this juncture strikes us as prudent profit-taking considering the tough regulatory environment and uncertain economic backdrop.

Top ETF Outflows in May 2009
	Estimated Net Outflow ($MIL)	AUM ($Mil)	YTD % Change
United States Oil (USO)	-911	2,799	9
MidCap SPDRs (MDY)	-589	6,532	12
Financial Select Sector SPDR (XLF)	-531	5,245	-2
Ultra S&P500 ProShares (SSO)	-505	2,406	5
PowerShares QQQ	-441	13,357	23
iShares Dow Jones US Real Estate (IYR)	-395	1,401	-5
SPDRs (SPY)	-366	63,692	6
iShares Barclays 1-3 Year Treasury Bond (SHY)	-342	7,059	0
iShares Russell Midcap Index (IWR)	-330	3,612	14
Energy Select Sector SPDR (XLE)	-327	4,492	12

While the industry's net asset inflows might appear muted in comparison to the huge inflows that we saw in the fourth quarter of 2008 amid the height of the crisis, the ETF industry is still well ahead of last year in terms of asset gathering. ETFs attracted approximately $176 billion in net inflows last year, but through the end of May 2008 total inflows were just $10 billion--about half of where we stand today. Although we're off to a decent start, it's far too early to start drawing conclusions about the ETF industry for the full year. Still, it seems apparent that investors and financial advisors alike continue to be drawn to the transparency, low costs, and tax efficiency that passive ETF strategies afford them.

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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.