ETFs Roll On

The U.S. ETF industry closed out 2009 with $785 billion in assets under management, up from $744 billion at the end of November, and $533 billion at the end of 2008. This represents year-over-year total ETF asset growth of nearly 50%. Roughly 40% of this asset growth is attributable to net inflows during the past year while the remaining 60% was the result of strong market performance.

Domestic-Equity Funds Lead the Way in December, Thanks to the SPDR
Despite being the only broad asset class to show net outflows in 2009, U.S. stock ETFs closed out the year with nearly $20 billion in net inflows in December. Helping bolster the category's flows was the ubiquitous  SPDRs (SPY), which attracted more than $11.2 billion in net new assets last month. Still, for the full year, SPY saw approximately $21 billion in net outflows. Note that excluding SPY, which--because of its unrivaled liquidity--is a favored tool among money managers looking to temporarily "equitize" cash positions and manage investor inflows and redemptions, the U.S. stock category would have actually shown net inflows of roughly $6.2 billion for the 2009 calendar year.

Taxable Bond ETFs Close 2009 as the Most Popular Asset Class of the Year
It was much of the same story for taxable fixed income in December--Treasury Inflation-Protected Securities and short-duration ETFs continued to be the top asset gatherers. The stampede into TIPS funds is directly attributable to investors' concerns over future inflation. There's really no consensus on when this looming bout of inflation will rear its ugly head, as the velocity of money remains muted. However, in exchange for this portfolio protection today, many are clearly willing to accept flat-to-negative real yields while they wait. One needs to look no further than the massive stimulus packages out of Washington and the explosion of the Federal Reserve's balance sheet to find the source of these concerns. This fear of potential inflation led investors to steer $8.4 billion of net new assets into  iShares Barclays TIPS Bond (TIP).

The recent rush into the short end of the yield curve is an example of investors looking to temper the interest-rate risk in their fixed-income allocations. In 2009, investors poured a combined $6.3 billion into the short end of the Treasuries curve via  iShares Barclays 1-3 Year Credit Bond (CSJ) and  Vanguard Short-Term Bond ETF (BSV). With rates still hovering around zero and the picture remaining unclear as to when the Fed might begin tightening, many are looking to limit their duration exposure. Remember, bonds further out on the yield curve are much more sensitive to a change in interest rates. While there are plenty of folks out there who believe Ben Bernanke and company are going to stand pat on rates through 2010, one thing is certain: Interest rates can't go any lower.

Emerging Markets Continue to Boost International Equity ETFs
Following their explosive performance during the last year, investors continued to pile into emerging markets last month.  Vanguard Emerging Markets Stock ETF (VWO) and  iShares MSCI Emerging Markets Index (EEM) saw net inflows of about $1.0 billion and $420.1 million in December, respectively. For the 2009 calendar year, VWO took in $9.0 billion in net new assets ($19.5 billion in total assets under management), while EEM brought in approximately $4.4 billion ($39.2 billion in assets under management). Again, we'd point to the large discrepancy in expenses between the two funds to explain why VWO continues to close the gap: EEM, which enjoys the first-mover advantage in the category, charges 0.72% in net annual expenses versus the 0.27% charged by VWO. Keep in mind that these two funds track the same underlying index.

Still, thanks to its massive size, EEM takes the crown for creating the most wealth for shareholders over the past year. Note that EEM combined its massive $19.2 billion in December 2008 assets and $4.4 billion in inflows through 2009 with a year-long market return of 69% to generate more than $15.5 billion in wealth for shareholders (where I calculate the wealth generated as the difference between the 2009 year-end assets and the 2008 year-end assets, minus the net cash inflows to the fund through 2009).

The rebound of emerging-markets equities was one of the major stories of 2009. However, several single-country ETFs were quietly amassing assets during the last year. In particular, we saw investors flock toward resource-rich countries. These included investments in  iShares MSCI Brazil Index (EWZ) ($1.7 billion in total net inflows in 2009),  iShares MSCI Australia Index (EWA) ($1.2 billion),  iShares MSCI Canada Index (EWC) ($1.1 billion), and  iShares MSCI Taiwan Index (EWT) ($1.1 billion).

Demand for Gold and Other Inflationary Hedges Bode Well for Commodity ETFs
 SPDR Gold Shares (GLD), which saw roughly $11 billion in total net inflows in 2009 and currently has more than $40.2 billion in assets under management, was easily the most popular ETF last year, in terms of total asset flows. Along the same lines of the rush into TIPS, GLD was a major beneficiary of investors seeking to hedge out the risk of inflation stemming from monetary easing by central banks around the world.

 United States Natural Gas (UNG) had a good story going into 2009, as new shale gas production came on line in the U.S. in 2008 while falling energy consumption and a mild winter combined to push gas prices down to incredible lows. As such, many investors aimed to capitalize on what they viewed as overly depressed prices. UNG took in more than $5.3 billion in net new assets in 2009, making it the fourth most popular ETF for the year in terms of flows (behind GLD, VWO, and TIP). However, the trade was far too crowded, so the futures prices kept staying higher than the spot and this fund was forced to buy high and sell low each month. Even as spot prices on natural gas ended up even for the year, this fund lost 57% because of the effects of rolling the futures contracts each month. This miserable performance, as a result of steep contango, led to the destruction of approximately $1.5 billion of investor wealth in 2009.

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Disclosure: Morningstar licenses its indexes to certain ETF and ETN providers, including Barclays Global Investors (BGI), Claymore Securities, 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.