Leveraged ETFs See Outflows in July

Overall, the ETF industry attracted more than $9 billion in new assets in July, bringing the year-to-date net inflows to about $43 billion. This, along with the market's impressive rally, propelled total industry assets under management to nearly $653 billion from just over $500 billion at the beginning of the year.

After several months of explosive growth, leveraged and inverse ETFs experienced their first month of net outflows in July. These aggressive products, which have been the center of controversy in the ETF industry over the past several weeks, had taken in about $11.4 billion in net inflows through the first half of the year (through the end of June, leveraged and inverse products made up more than 33% of total industry inflows). Since the beginning of 2007, there have been only two other months in which these popular products experienced net outflows: December 2007 and September 2008.

Before getting into the outflows though, let's first take a look at the ETFs that investors were snapping up in July. Following an impressive May and June that saw approximately $2.5 billion in net new assets flow into the fund,  United States Natural Gas (UNG) topped the list again last month. We found this interesting, considering that the fund halted share creations on July 7 and has traded at a premium to NAV throughout much of the month. The future for UNG--as well as that of its sister fund,  United States Oil (USO)--remains unclear, as the CFTC's probe into the matter has yet to be concluded.

Top ETF Inflows--July 2009
	Est Net In-Flow ($Mil)	AUM ($Mil)	1 Month % Change (July)	YTD % Change
United States Natural Gas (UNG)	1,078.7	4,377.7	-8.66	-45.84
PowerShares QQQ	967.7	16,193.2	8.56	32.80
SPDRs (SPY)	894.9	69,439.9	7.54	10.84
Vanguard Emerging Mkts Stock ETF (VWO)	799.9	11,397.3	11.60	49.92
Technology Select Sector SPDR (XLK)	785.2	3,918.4	8.40	29.03
iShares Russell 2000 Index (IWM)	770.1	10,680.6	9.65	12.57
iShares Barclays TIPS Bond (TIP)	542.1	14,720.3	0.10	6.36
iShares Barclays 1-3 Yr Credit Bond (CSJ)	440.4	2,821.3	1.26	7.63
iShares FTSE/Xinhua China 25 Index (FXI)	398.2	11,300.7	10.16	48.93
Vanguard Total Bond Mkt ETF (BND)	351.1	4,853.9	1.52	3.65

Though it is nearly impossible to confirm, the ETF research team has been batting around a thesis as to how the fund could continue to top the list. One possibility is that institutional investors were rushing to short the fund during the month--either for fundamental reasons or an attempt to capture the spread between the market price and NAV. Now this might be a bit counterintuitive; but, let's say Trader X wanted to take a large short position in the fund. In this case, he could go to an authorized participant who would be happy to create a basket and lend it to Trader X. The authorized participant who facilitates the transaction would then hedge the newly created shares and collect interest payments from Trader X. The end result is an increase in assets under management for UNG.

Again, this is difficult to quantify, but worth considering when analyzing ETF flow data. We should note though that this really would apply only to large institutional traders who wanted to short enough shares to justify a creation basket (typically 50,000 shares). Conversely, an average investor who shorts a couple hundred shares of an ETF probably wouldn't impact the ETFs assets--they could simply borrow the shares from the existing inventory at their brokerage house.

As shown in the table, technology--represented by  PowerShares QQQ  and  Technology Select Sector SPDR (XLK)--had another strong showing and continues to be one of the market's bright spots. Fixed-income ETFs are also well represented in the top 10 ETF inflows list. ETFs covering the bond market that didn't make the top 10, but still had impressive inflows included: (LQD), (BSV), (JNK), (AGG), (PVI), and (CIU), which, combined, kicked in an additional $1.2 billion in net inflows for the month.

While we always find it interesting to track where the money is flowing, this month it was where the money was NOT flowing that caught our attention. Notice that there aren't any leveraged or inverse funds in the top 10. The first leveraged fund to show up on the inflows list comes in at the number 18 slot-- UltraShort QQQ ProShares (QID). Still, we should note that over the past three months QID has traded an average of 73% of its AUM, on a daily basis. With such high turnover rates, we won't put too much weight behind its fund flow results.

This brings us to the ETFs that investors were dumping in July; nine of the top 20 and 11 of the top 22 ETFs on the outflows list were leveraged or inverse funds. We'd venture to guess that FINRA's regulatory notice and sweeping investigation into the sales practices of these non-traditional ETFs had a lot to do with the outflows. Furthermore, major distributors and financial advisor networks including LPL, Edward Jones, UBS, and Ameriprise have recently imposed restrictions on the funds.

Top ETF Outflows--July 2009
	Est Net Out-Flow ($Mil)	AUM ($Mil)	1 Month % Change (July)	YTD % Change
iShares S&P 500 Index (IVV)	-1,567.4	18,153.7	7.55	10.98
SPDR Gold Shares (GLD)	-1,428.3	32,377.3	0.45	8.30
Direxion Daily Financial Bull 3x Shares (FAS)	-1,089.8	1,061.4	24.92	-54.09
iShares MSCI Brazil Index (EWZ)	-537.1	8,864.3	9.57	70.80
Ultra S&P500 ProShares (SSO)	-402.7	2,259.3	15.10	14.32
Ultra Financials ProShares (UYG)	-359.5	2,344.8	17.15	-22.66
SPDR S&P Retail (XRT)	-285.6	791.1	8.56	6.36
DIAMONDS Trust, Series 1 (DIA)	-224.5	7,314.2	8.56	6.36
Ultra Real Estate ProShares (URE)	-175.4	435.7	20.45	-30.95
iShares Barclays 20+ Yr Treas Bond (TLT)	-168.1	2,083.6	0.41	-18.98

While the saga surrounding leveraged ETFs has stirred up plenty of controversy, these moves look prudent to us. After all, following the hubbub surrounding auction rate securities and the wave of lawsuits, investor protection should be top of mind for these financial intermediaries. (On a side note, we found it very interesting that many of the firms that took this proactive stance were also the top rated firms in the J.D. Power and Associates 2009 U.S. Full Service Investor Satisfaction Study.)

Besides the broad-based redemptions we witnessed in leveraged and inverse ETFs, we also saw some heavy selling in some popular broad market funds--namely  iShares S&P 500 Index (IVV) and  DIAMONDS Trust (DIA). However, after a big rally for both indexes in July, we wouldn't be surprised if this was simply profit taking. Moreover, this raises another question: How could  SPDRs (SPY) post the third-largest inflow for the month and IVV post the largest outflow when they track the exact same index?

This is a good question that also highlights one of the key shortcomings of looking at snapshot fund flows in isolation. While there's certainly some overlap, these two funds generally serve different types of investors. SPDRs is the most heavily traded security on the planet and the fund is often used by large institutions as a short-term cash substitute thanks to its unparalleled liquidity. IVV, on the other hand, is home to more buy-and-hold investors and can usually paint a better picture for tracking investor sentiment. To help illustrate the differences in the investor base of these funds, we calculated what percent of their AUM is traded daily. Lo and behold, over the past three months SPY has traded 33% of its nearly $70 billion in assets every day, while IVV traded only 2% of its $18 billion in AUM daily.

Some large investors made headlines in July by shifting from  SPDR Gold Shares (GLD) to actually holding the physical bullion. For instance, David Einhorn of Greenlight Capital decided recently it would be more cost effective for him to store the bullion himself rather than accept GLD's 40 basis-point net annual expense ratio. It is reported that Einhorn redeemed almost $400 million worth of GLD, or 4.2 million shares, and some other large investors are following suit. Of course, this would be practical only for investors holding millions of dollars worth of GLD. Investors in GLD can take comfort in the fact that the big redemptions aren't necessarily a change in investment strategy for these professional investors, who still maintain their gold positions.

As always, we urge investors to take this information for what it is: A simple snapshot of ETF asset flows. Also note that the data tell us nothing in isolation, so be careful when analyzing the data and drawing your own conclusions. 

Note: A revision to this article was made following original publication. Click here for details. 

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