lighthouse etf report - 2013 - may

Lighthouse Investment Management

ETF Report - US listed - May 2013 Page 1

ETF Report

Exchange Traded Funds - US listed - May 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

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



Introduction

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

Traded Fund) in 1993 their march towards

success 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 the

last 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.

1 Source: IndexUniverse.com

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

3 Excluding $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 remained at $5bn of inflows.

Precious metal-related ETF's saw outflows of $11bn (7bn outflows)

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

Domestic equities saw inflows of $27bn ($21bn)

Flows into high-yield bond ETF's are barely positive. HYG (high-yield ETF) had its third

consecutive month of inflows while JNK (junk) experienced its fourth consecutive month of

outflows.

Investment-grade (IG) bonds reported outflows of $1bn ($3bn inflows)



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 47% (previous report: 48%) of their assets.

Precious-metal related ETF's saw outflows of 10% (-6%)

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

US equity ETF's grew by 27% (23%)

Inflows into high-yield bond ETF's increased to 12% of AuM (5%)

Investment grade ETF's saw flows of- 3% (+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 first outflows after three consecutive months of inflows

TIP (Treasury inflation-protected bonds) had outflows in 10 out of the last 12 months

Enthusiasm for BND (total bond market) continued to cool off

LQD (investment-grade corporate bonds) had six months of consecutive outflows

Municipal bond ETF (MUB) had 21 consecutive months of inflows



HY Bonds: Flows in % of Assets

Observations:

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

Junk-bond ETF (JNK) had four consecutive months of outflows of $2bn or 16% of assets

High-yield ETF (HYG) saw three months of inflows after five consecutive months of outflows

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 IVV remained strong as indices made new all-time highs in May

Inflows into IWR (Russell MidCap) cannot keep pace with the large cap ETF's



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 after two consecutive month of outflows

Emerging Markets ETF (EEM) continued to experience large outflows ($8bn, or 16% of assets,

over past four months)

Emerging Markets ETF (VWO) also had large outflows ($3bn, or 6% of assets, over the past three

months)



Precious Metals: Flows in % of Assets

Observations:

Interest in precious-metal related investments is, with the exception of silver, close to a freezing

point

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 negative performance, GDX has not seen any outflows for the fourth consecutive month

GLD experienced five consecutive month of outflows with a combined $16bn, or 35% of today's

assets, leaving the ETF

Silver ETF (SLV) had the worst monthly outflow (-$330m) since June 2011



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 second consecutive months

Outflows have occurred on 23 out of the past 25 months.

Conclusions:

The retail investor has realized two things:

Paying fees for active management does not pay (majority underperforms over longer periods)

Global stock markets have been propped up by central bank actions and are overvalued



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 fifth consecutive

month



Mutual Fund Flows: Taxable Bond Funds

Observations:

Taxable bond mutual funds have shown inflows in 51 out of the past 53 months

Despite record-low yields and negative real returns, investors seem to prefer the "sparrow in

the hand"



Mutual Fund Flows: Equity Versus Bond

Observations:

Outflows from domestic equity mutual funds have slowed down

Investors still prefer taxable bond funds



Mutual Fund Flows: Municipal Bonds

Observations:

Municipal bond mutual funds recovered from the "Whitney" crash (on December 19, 2010,

Meredith Whitney predicted hundreds of billions in losses from defaults on TV)

However, 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 their

owners

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

the risks associated with individual bonds



Conclusions

Risk appetite has begun to cool off

International equity ETF's are seeing significantly less inflows than domestic equity ETF's in

absolute dollar terms (but similar inflows relative to their asset base)

Emerging market equity ETF's experienced significant outflows

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

(JNK) losing 16% of its assets over the past four months

Interest in precious metal-related ETF's remains low; GLD saw the largest outflow of all ETF's we

cover for the second month in a row and has lost 35% of today's assets over the past five

months

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.

+ + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + +

All clients have their own individual accounts held at an independent, well-known brokerage company (US)

or bank (Europe). This institution executes trades, sends confirms and statements. Lighthouse Investment

Management does not take custody of any client assets.

lighthouse etf report - 2013 - may

Documents