ETFs Defied Stereotypes in 2008

By Murray Coleman

The flight to safety in stocks and mutual funds dominated investment trends in 2008.

But investors in exchange-traded funds made their own way last year. Based on an analysis of money movements into and out of ETFs, the past 12 months shaped up as a dramatic period of separation for the fast-growing industry.

For one, so-called net flows—which compare redemptions against creation activity—moved in exact opposite directions as those of traditional open-end mutual funds. That's not the first time such an occurrence has taken place. But last year marks what appears to be the biggest such reversal in fortunes for money flows between ETFs and more established mutual funds ever seen.

Setting the stage was a stock market in which the S&P 500 lost some 37% in 2008. And bonds, plagued by an ongoing global credit crisis, struggled mightily with increased volatility. Some segments, such as high-yield bonds, performed almost as poorly as the broader stock market. The SPDR Lehman High Yield Bond (NYSE: JNK) slipped more than 30%.

But for growth-minded investors who weren't worried about slim yields, bond ETFs did afford some shade from the oncoming recessionary storm. For example, the Vanguard Extended Duration Treasury Index ETF (NYSE: EDV) returned 50%-plus last year. And that was with less than a 2.6% yield.

Still, that market environment would suggest that ETF investors would flock to bonds, right? After all, critics of the new up-and-coming fund industry argue that their popularity is largely being driven by traders, not long-term-oriented investors.

Read on. Tapping into the National Stock Exchange's database, a major theme in 2008 seems to be that ETF investors not only put more money into their funds, but they also flocked by large margins into the worst-performing categories.

So here's our initial year-end review. At the end of this report is a link to a number of tables, breaking down almost every type of data point available through NSX's database of 848 ETFs and exchange-traded notes. These include flow and asset numbers for providers of ETFs and exchange-traded notes as well as category figures. Specific individual ETF and ETN data is also listed in the accompanying charts.

Fund Flows: ETFs Vs. Mutual Funds

Investors kept pumping more money into U.S.-based exchange-traded funds in December, finishing 2008 with a flourish as the fund industry's fastest-growing marketplace attracted nearly $178.4 billion in net inflows for the year. That was a record, some 20% more than the previous high, which was set in 2007.

The latest National Stock Exchange data estimated that in last year's final month, ETFs had a record $42.8 billion. That was a significant increase from the previous month's $26.4 billion net inflow. But it wasn't quite up to September's $50 billion-plus in record inflows.

By contrast, U.S.-based long-term mutual funds had record net outflows in October 2008 of $127.55 billion. That was followed by November's $41.31 billion net outflow, according to the Investment Company Institute, the industry's largest trade group. Its tracking of monthly flows includes more than 8,000 traditional mutual funds—by far the most extensive such survey in the country. That isn't surprising since it's the industry's largest trade group and doesn't break out numbers for individual companies.

The ICI hasn't released its December survey data yet. But analysts at Emerging Portfolio Funds Research, which tracks both institutional and retail fund flows around the world, is estimating a record $320 billion in net outflow for mutual funds worldwide in 2008. And TrimTabs Investment Research is projecting that while last month's outflows subsided from November's torrid pace, U.S.-based mutual funds were still on pace to record net outflows in December.

Trends Continue To Rise For ETFs & ETNs

Although facing the same market conditions, ETFs offered a stark contrast by ending the year with a flourish. Even struggling exchange-traded notes, which are typically issued by large banks and represent unsecured debt, produced $823 million in net inflow during December. For the year, ETNs finished with slightly more than $2 billion inflow. That was off about a third from the previous year's totals, however, as fears of the ongoing global credit crisis crimped the growth of ETNs in 2008.

Two players—Barclays (BCS) Global Investors and State Street (STT) Global Advisors—dominated final inflow results. In December, the pair combined to account for more than $32 billion of the industry's $42.8 billion total net inflow. In distant third place was Vanguard, with $3.8 billion.

Four out of 25 ETF providers actually had net outflow in the final month of 2008. But those were relatively minor, led by Merrill HOLDRs losing $46 million. Invesco (IVZ) PowerShares was the next biggest in the red, with outflows of $33 million. But both were solidly in positive territory for the year, marking a reversal of fortune in the case of the HOLDRs. In 2007, those exchange-traded products had about $3.7 billion in net outflow.

In fact, the only other ETF sponsor with net outflows two years ago also reversed course in 2008. Fidelity Investments, with one ETF, had $8 million inflow during 2008 to top the previous year's $30 million net outflow from the Fidelity NASDAQ Composite Index Tracking Stock ETF (NasdaqGM: ONEQ).

Assets At BGI, Rydex Slip In 2008

Overall, industry assets for all U.S.-based ETFs gained some $50 million in December from a month earlier as a result of improving market conditions and continued inflows. That pushed year-end totals to $534.6 billion, less than in 2007 when stronger first-half market performance helped push assets past $617.7 billion.

BGI and SSgA combined to dominate asset numbers among sponsors with a total of $414 billion at the end of December. But while BGI's assets slipped by more than $75 million from 2007 to $254.6 billion, SSgA's actually showed a slight gain to $159.5 billion.

The top five sponsors finished the year with double-digit asset levels. Of those, PowerShares also slipped in 2008, while ProFunds—through its white-hot ProShares ETFs unit—was clearly the biggest gainer.

Not only did ProShares' ETF assets more than double to $20.5 billion in 2008, its net inflow soared to $20.4 billion. A year earlier, ProShares had less than $8 billion inflows. For December, it had net inflow of $3.5 billion.

By comparison, the firm's big rival in the inverse ETF field had much smaller numbers. Rydex recorded $4.2 billion in assets at the end of 2008 (versus $5.5 billion in 2007) and net inflow of $148 million last month. Also, the ETF sponsor ended the year with $101 million in net outflow as opposed to 2007's net inflow of nearly $1.6 billion.

Interestingly, Direxion—a new entrant into the inverse and leveraged field—produced $496 million inflows in December. It ended 2008 with $896 million in assets.

In ETNs, two firms dominated both asset totals and inflows. Those were Barclays Capital, a sister unit of BGI, and Deutsche Bank. But the latter as the newer competitor clearly recorded the most growth during a year of decline for that marketplace. (See tables here.)

Where The Money's Going

It's important to note when reviewing these industrywide numbers that top-performing bond ETFs was the leading style category to realize net gains in assets last year. But they weren't enough to overcome much larger totals for stock funds, which fell sharply from 2007 levels. Currencies were flat on the year.

Despite those losses in assets, both domestic and international stock funds dominated net inflows into ETFs in 2008. The two combined for inflows of more than $35.6 billion in December and almost $144 billion (of $180.4 billion total for all categories) in 2008.

Top Funds Take Divergent Paths

The biggest ETF is still the SPDR Index 500 (NYSE: SPY) at $93.9 billion in assets. But that was basically flat from December 2007's $99.4 billion total. In fact, the much smaller iShares S&P 500 Index (NYSE: IVV)—which tracks the exact same benchmark—shed more than $3 billion to $15.7 billion during 2008. (IVV actually rebounded from generating net outflow the year before to gaining $5.3 billion net inflow last year.)

But it would still take the combined assets of the four next-biggest ETFs to reach SPY's war chest. With SPY's better-than $16.3 billion haul in December, the popular fund wound up the year with slightly more inflows ($34.6 billion) than in 2007.

An even harder-hit stock ETF last year was the iShares MSCI EAFE Index (NYSE: EFA). But it was the second-biggest gainer in terms of collecting net inflows in December ($2.9 billion) and finished the year with $1.7 billion on the positive side of flows.

It's worth noting, though, that with total return losses of more than 40% in 2008, EFA's asset and inflow totals were way down from a year earlier. So were several other funds that were slammed by the market, including the iShares MSCI Emerging Markets Index (NYSE: EEM) and the PowerShares QQQ (Nasdaq: QQQQ).

But all of the 10 biggest ETFs managed to stay above water in 2008 in terms of money flows. And the biggest loser of the group in 2007, the iShares Russell 2000 Index (NYSE: IWM) had an almost 180-degree turnaround with net inflow of $5.6 billion last year.

The picture wasn't all positive, however. Some 176 ETFs had net outflow in 2008, up from 121 a year earlier. Part of that 55-fund difference can be traced to sheer numbers—there were 112 more ETFs last year compared to 2007.

Also, less than half of ETFs on the market at the end of December 2008 had more than $100 million in assets. In such a highly fragmented market, it's not surprising that a rise in consolidation and closings of ETFs in the past 12 months left many smaller funds experiencing trouble attracting more investment dollars.

Trading volumes for ETFs were off the charts in 2008. Just less than $25 trillion worth of ETF trades took place on U.S.-based exchanges during the year, which was 70% greater than 2007.

By contrast, U.S. equities (ex-ETFs) volume increased just 10%. On a shares traded basis, ETF volumes increased by 123%, compared to a rise in U.S. equities volume of 37% (not counting ETFs).

See tables pertaining to this article here.

Comments

[Prudent Man...:]

Who is auditing that the ETF owns what is says it owns?

Too many issues that no one is researching. Will it take a sponsor to collapse to wake some folks up? Madoff worked his scam for at a minimum of 16 years and only got caught when the money coming in was less than that going out or he would still be in business.

I learned 50 years ago that the NYSE and its member were a bunch of thugs being overtaken in magnitude by NASDQ. I always invest with the idea that some is trying to screw me. Since Levitt's 1998 I thought the SEC would do something about off balance sheet accounting but the Wall Street/Congress conspiracy continues.

Time for Congress Term Limits.

Jan 07 05:24 PM

[James Wilson:]

Let's see Companys like BCS that is invested in thousands of businesses around the world, actually helps set the long term value of the British Pound, Euro, and the Dollar only carrys a $10.00+ stock price?

One day I will understand how companys that invest in building things of value are valued less than the destructive things like the ProSHORTS that sell everything short. Everyone know it is easier to destory than to build things.

Jan 08 07:52 AM

[Al-USA:]

--- PrudentMan

Indeed, your suspicions are correct. The "financial crisis" is nothing but the largest "screw" job on the American taxpayer since the history of capitalism...

To top it all off, not only did the ruling class, or capitalist elites, engage in activities that might yet bring down the greates civilization in the history of the planet, but they "screwed" the "peasants" into bailing them out to the the of $trillions of newly printed FED money which will, in time, result in the final "screw job" of all: a terrible hyperinflation scenario which will crush hard-working American families and evaporate whatever savings they have left.

Sad...

Jan 08 03:27 PM