lighthouse etf report - 2013 - june

7/28/2019 Lighthouse ETF Report - 2013 - June

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Lighthouse Investment Management

ETF Report - US listed - June 2013

ETF Report

Exchange Traded Funds - US listed - June 2013





Contents

Introduction .................................................................................................................................................. 3

Flows by Asset Class: Dollars ......................................................................................................................... 4

Flows by Asset Class: % of Assets.................................................................................................................. 5

IG Bonds: Flows in % of Assets ...................................................................................................................... 6

HY Bonds: Flows in % of Assets ..................................................................................................................... 7

US Equities: Flows in % of Assets .................................................................................................................. 8

International Equities: Flows in % of Assets ................................................................................................. 9

Precious Metals: Flows in % of Assets ........................................................................................................ 10

Risk Appetite: High ...................................................................................................................................... 11

Mutual Fund Flows: Domestic Equity ......................................................................................................... 12

Correlation: Equity MF Flows and S&P 500 ................................................................................................ 13

Mutual Funds Flows: International Equity .................................................................................................. 14

Mutual Fund Flows: Taxable Bond Funds ................................................................................................... 15

Mutual Fund Flows: Equity Versus Bond .................................................................................................... 16

Mutual Fund Flows: Municipal Bonds ......................................................................................................... 17

Conclusions ................................................................................................................................................. 18





Introduction

Since the 'birth' of the first ETF (Exchange-

Traded Fund) in 1993 their march towardssuccess has been uninterrupted. As of

February 2013, US listed ETF's contained

over $1.4 trillion in assets under

'management'1.

With more than $9 trillion in managed

assets23, US mutual funds are still

command a much larger pile. However,

outflows from mutual funds investing in

domestic equities have persisted over thelast 6 years.

Investors, discouraged by

underperformance of actively managed

funds, are switching to ETF's with

significantly lower fees than comparable

mutual funds.

It is fair to assume ETF's will continue to

grow rapidly and will impact market

performance due to their sheer size.

To get insights into investors behavior we

look at flows in and out of the 20 largest ETF's, covering over 40%

of all ETF assets.

Looking simply at assets under management is misleading, since

performance can have a significant impact on the value of assets.

We therefore look at pure flow data, ignoring the impact of

performance. For example: the 57% increase in assets for EEM

(Emerging Markets ETF) could be entirely due to performance, or

flows or a mix of both. The increase in assets of ETF's tracked from $520bn to $605bn from July 2012 to

January 2013 consisted of $40bn of inflows and $45bn in performance.

1Source: IndexUniverse.com

2Source: Morningstar Direct US Open-end asset flows update, January 2013

3Excluding $2.6 trillion in US Money Market Mutual Funds





Flows by Asset Class: Dollars

One way to analyze flows is to aggregate them by asset class in dollar terms. Above you see cumulative

flows over the last 12 months.

Observations:

• Real-estate inflows reduced to $4bn (from $5bn)

• Precious metal-related ETF's saw outflows of $12bn (11bn)

• International equities experienced $2bn (previous month: $9) billion in inflows

• Domestic equities saw inflows of $22bn ($27bn)

• Flows into high-yield bond ETF's turned negative with -$1bn (+$1bn)

• Investment-grade (IG) bonds reported outflows of $7bn (-$1bn)





Flows by Asset Class: % of Assets

An inflow of $1bn does not matter much for SPY with assets over $100bn. However, it might matter for

the $5bn Russel MidCap ETF (IWR). It therefore makes sense to look at flows relative to assets.

Observations:

• Real estate shows the strongest relative inflows of 34% (previous report: 47%) of their assets.

• Precious-metal related ETF's saw outflows of 11% (-10%)

• International equity ETF's enjoyed inflows of 20% (26%)

• US equity ETF's grew by 23% (27%)

• Inflows into high-yield bond ETF's increased by 3% of AuM (12%)

• Investment grade ETF's saw flows of 11% (-3%) of their assets





IG Bonds: Flows in % of Assets

Investor preferences change, and so do flows. Looking at rolling changes in flows can reveal interesting

trends.

Observations:

• TLT (20+ year Treasury bonds) had the largest inflows ($1bn) on record (since January 2011)

• TIP (Treasury inflation-protected bonds) had outflows (-$1.8bn) on record

• Enthusiasm for BND (total bond market) continued to cool off; largest outflow on record

• LQD (investment-grade corporate bonds) had its seventh month of consecutive outflows, losing

$2.4bn (largest on record)

• Even municipal bond ETF "MUB" had its first outflow (-$53m) after 21 consecutive months of

inflows





HY Bonds: Flows in % of Assets

Observations:

• The massive inflows into speculative bond ETF's seen in 2012 have reversed

• Junk-bond ETF (JNK) had five consecutive months of outflows of $3bn or 28% of today's assets

• High-yield ETF (HYG) saw outflows during six out of the past nine months

• Waning demand from high-yield ETF's might make it more difficult for lowly rated borrowers to

access capital markets or could lead to stricter covenants

• Leveraged buy-outs (LBO's) depend on a receptive high-yield market for financing; if inflows

stop, additional supply would likely be absorbed only at higher yields





US Equities: Flows in % of Assets

Observations:

• Nasdaq (QQQ) and Dow Jones (DIA) related ETF's have lagged overall inflows into domestic

equity ETF's. This might have to do with the end of the bubble in the stock price of Apple, which

is heavily weighted in Nasdaq benchmark indices. For the Dow Jones we can only speculate

investors might finally realize the nonsensical nature of a price-weighted index.

• Inflows into IWR (Russell MidCap) have caught up with its large-cap brothers





International Equities: Flows in % of Assets

Observations:

• In good times, investors feel confident and venture abroad in search of higher returns

• Broad international equity ETF (EFA) saw inflows for a second consecutive month ($0.6bn)

• Emerging Markets ETF (EEM) continued to experience large outflows ($11.6bn, or 27% of

today's assets, over past five months)

• Emerging Markets ETF (VWO) also had large outflows ($4.7bn, or 9% of assets, over the past

four months)





Precious Metals: Flows in % of Assets

Observations:

• Interest in "paper gold" ETF's continues to wane, while gold mining stock ETF's enjoy signs of

revival

• Flows into the Senior Gold Miners ETF (GDX) were concentrated over two months (August and

September 2011), coinciding with the all-time high in spot gold prices ($1,923/oz)

• Despite horrific performance of underlying stocks, GDX has seen inflows for the fifth consecutive

month

• GLD experienced six consecutive month of outflows with a combined $18bn, or 40% of today's

assets, leaving the ETF

• Silver ETF (SLV) reported mild outflows (-$50m)





Risk Appetite: High

Here, we calculate the ratio between two sub-groups of the same asset class:

• speculative bond (HYG, JNK) to non-speculative bond ETF's (TLT,TIP, BND, LQD, MUB)

• international equity (VWO, EFA, EEM) to domestic equity ETF's (SPY, QQQ, IVV, VTI, DIA, IWR)

We used relative assets under management instead of relative flows as the time series are quite volatile.

Observations:

• Risk appetite is cooling off based on investor's preference for domestic over international

equities.





Mutual Fund Flows: Domestic Equity

Observations:

• Long-term domestic equity mutual fund outflows continued for the third consecutive month

(data up to mid-June)

• Outflows have occurred on 24 out of the past 26 months.

Conclusions:

• Retail investors see little value in paying elevated fees for active management as most funds

underperform over longer periods

• Global stock markets seem to be more driven by central bank action, which is hard to predict for

the individual investor





Correlation: Equity MF Flows and S&P 500

Observations:

• Despite few months of equity MF inflows (dots above the horizontal zero line) a certain positive

correlation exists with the performance of the S&P 500 Index

• However, excluding the two extremes (October 2008, April 2009), the coefficient of determination

declines considerably (r2 = 0.28 instead of 0.45)

• Using 3-months data does not lead to significant improvements in the coefficient of determination

(r2 = 0.51; 0.26 excluding extremes)





Mutual Funds Flows: International Equity

Observations:

• Inflows into long-term international equity mutual funds continued for the sixth consecutive

month





Mutual Fund Flows: Taxable Bond Funds

Observations:

• Taxable bond mutual funds had the largest outflows (-$23bn up to June 19) since October 2008

(-$33bn)

Factors contributing to sharp increase in 10-year US Treasuries (from 1.6% to 2.6% since May):

• Selling of TIPS (Treasury Inflation Protected Securities) as Fed seems to have given up on N-GDP

(and implicit inflation-) targeting introduced only at the end of 2012

• Selling of Treasury bonds as a hedge for rising mortgage rates ("convexity vortex")

• Investors no longer willing to hold bonds at negative real yields as Fed's talk of tapering QE

sowed doubt regarding its credibility in terms of fighting deflationary trends

• Unwinding of long bond positions by macro hedge funds ('risk parity strategy')

• Unwinding of carry trade in Eurodollar futures





Mutual Fund Flows: Equity Versus Bond

Observations:

• Outflows from domestic equity mutual funds have slowed down

• As investors also withdrew from bond funds, around $20bn have been added to retail money

market mutual funds until mid-June





Mutual Fund Flows: Municipal Bonds

Observations:

• Municipal bond mutual funds experienced the largest outflows since the "Whitney" crash (on

December 19, 2010, Meredith Whitney predicted hundreds of billions in losses from defaults on

TV)

• Rating agencies are waking up to the growing hole of underfunded pension plans

• A rise in income tax rates would make muni bonds (tax-exempt) more attractive

• An abolishment of tax-preferred status of muni bonds would lead to significant losses for theirowners

• Private investors owning muni bonds directly have usually not the capability to adequately judge

the risks associated with individual bonds





Conclusions

• Risk appetite has cooled off further, but is still considered high.

• Emerging market equity ETF's, as indicated in last months' report, continue to experience

significant outflows.

• Inflows into high-yield bond ETF's have cooled off considerably, with the leading junk-bonds ETF

(JNK) losing 28% of its assets over the past four months.

• "Paper-gold" ETF (GLD) continues to see large outflows and has lost 40% of today's assets over

the past six months. Despite horrible performance, the gold mining stock ETF (GDX) benefited

from inflows for the fifth consecutive month.

• Both mutual equity and bonds funds experienced outflows in June, with the proceeds

apparently going in to money market mutual funds (yielding zero).

• A prudent or contrarian investor would use the opportunity to shift positions into more

defensive ETF's

Any questions or feedback welcome.

[email protected]

Disclaimer: It should be self-evident this is for informational and educational purposes only and shall not be

taken as investment advice. Nothing posted here shall constitute a solicitation, recommendation or

endorsement to buy or sell any security or other financial instrument. You shouldn't be surprised that

accounts managed by Lighthouse Investment Management or the author may have financial interests in any

instruments mentioned in these posts. We may buy or sell at any time, might not disclose those actions and

we might not necessarily disclose updated information should we discover a fault with our analysis. The

author has no obligation to update any information posted here. We reserve the right to make investment

decisions inconsistent with the views expressed here. We can't make any representations or warranties as to

the accuracy, completeness or timeliness of the information posted. All liability for errors, omissions,

misinterpretation or misuse of any information posted is excluded.

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lighthouse etf report - 2013 - june

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