Inflows into ETFs can guide future success

ANNIVERSARIES are dominating the thoughts of investors this week. Yesterday marked 10 years since the Nasdaq crashed in the wake of the dotcom bubble. And a year ago this week, the US and UK stock markets both troughed, heralding the start of an almost miraculous rise in equities over the past year which many observers have struggled to accept.

A year on from the nadir for equity markets in the developed world, it is well worth taking stock of which sectors and assets have done best and managed to bounce back the most quickly as well as looking at those that could do well over the next 12 months.

One way of measuring their performance is to look at the net new asset flows into exchange-traded funds (ETFs). These reveal investors’ appetite over time and you are able to pinpoint where their interests lie from the flows.

Nizam Hamid, head of sales strategy at BlackRock’s iShares, says that new assets have flowed into a broad range of exposures rather than one single category being a standout performer. Broad ETFs have become very popular, such as the iShares’ ETFs which track the MSCI World and the MSCI Emerging Markets indices. “Investors didn’t have a strong idea of where the individual pockets of recovery would be and were looking at equities as a broad asset class rather than wanting to trade individual countries as they might have done in the past,” he explains.

Investors were also happier to take on more risk in their portfolios as the global recovery gathered pace in the second half of 2009. Emerging markets saw plenty of interest and are continuing to do so, while basic resources ETFs also attracted new assets.

In contrast, iShares saw outflows from defensive sector ETFs as tactical considerations outweighed risk aversion. Emerging markets, which rebounded far more strongly from the crisis than developed markets, were extremely popular among investors and continue to be desirable additions to portfolios.

Actual performance data from investment fund research company Morningstar vindicates investors’ choices for a broad range of ETFs that give exposure to sectors and assets that will do well in a cyclical upturn. Morningstar’s top 10 performing ETFs globally include coal, steel, small caps, and specific emerging markets such as Turkey and Russia.

In contrast, the worst ETFs in terms of performance were dominated by short funds, which give the inverse performance of the underlying index. Understandably, these performed badly in a rising market.

Besides short ETFs, the poorest ETFs tended to be those that focused on a specific commodity index such as natural gas or grains as well as government bonds. The latter did less well as investors looked for higher returns.

Hamid says that ETF investors are choosing corporate bonds rather than government bonds – both of iShares’ corporate bonds funds attracted heavy new inflows last year – as a way of gaining further exposure to company performance beyond equities.

He adds that investors are continuing to buy corporate bond ETFs, particularly those funds that give exposure to industrial firms’ corporate bonds rather than those of financial companies, where much of the potential value is thought to have been exhausted.

While past performance is certainly no guide to the future, looking at which sectors have done well during the market’s recovery and why over the past year is valuable in understanding how they have got to that point. And net flows can show us, at least partially, where investors expect the next top peformers to be.


1. Rydex S&P SmallCap 600 Pure Value – 271.10%
2. PowerShares Financial Preferred – 260.71%
3. Market Vectors Coal ETF – 228.32%
4. Market Vectors Indonesia Index ETF – 208.92%
5. Rydex S&P Midcap 400 Pure Value – 202.72%
6. Rydex S&P 500 Pure Value – 197.23%
7. Market Vectors Steel ETF – 183.96%
8. iShares MSCI Turkey Invest Mkt Index – 182.51%
9. Market Vectors Russia ETF – 177.61%
10. iShares S&P U.S. Preferred Stock Index – 177.34%