Morningstar
submits:
By John Gabriel
After taking a breather in August, inflows into ETFs really
picked up steam in September. Last month, investors poured more
than $25 billion into U.S.-listed ETFs, boosting total year-to-date
net inflows to roughly $65 billion. Strong demand from investors as
well as advances of 8% and 10% for the S&P 500 and MSCI EAFE in
September helped the U.S. ETF industry top $900 billion for the
first time.
Each month it is an interesting exercise to observe where
investors are putting their money to work, and also what
investments they might be selling. There have been a few pronounced
trends that have persisted in the ETF flow data for some time now
that are worth thinking about. We'll discuss a couple of those
trends here and what they are signaling to the markets. But before
we dive in, remember that the flow data often contain "noise" and
won't always be the best determinant of true investor
sentiment.
For that reason, we'll focus more on the clear and broader
trends that have recently dominated ETF flows (and mutual fund
flows for that matter). For our purposes, we're less concerned with
exact dollar figures than we are with capturing general fund flow
trends for a perspective on current investor behavior.
Juicy Yields Drive Investors to Junk Bonds
In this low-yield environment, we've seen many ETF investors
step out a little further on the risk curve--to junk bonds--in an
effort to capture higher yields. While flows into high-yield bond
ETFs tend to be a little more volatile than some other fixed-income
categories, the trend has been decidedly positive in recent months
(and seems to be gaining steam).
Last month, investors poured another $415.7 million into iShares
iBoxx $ High Yield Corporate Bond (
HYG
), bringing the year-to-date total to $1.9 billion. Similarly, SPDR
Barclays Capital High Yield Bond (
JNK
) attracted $375.8 million in net inflows last month and $2.1
billion since the beginning of the year. Those less optimistic on
the prospects for high-yield bonds might suggest that recent flows
smack of performance chasing. While the asset class has rebounded
spectacularly from its 2009 lows, we still think there's a solid
case to owning junk bonds as part of your fixed-income
allocation.
Indeed, after non-investment grade bonds exploded alongside the
2009 market rally, their spreads have compressed from the record
highs witnessed during the heights of the financial crisis. With a
good portion of the high-yield bond market trading close to par,
investors who are piling in at this point of the cycle should be
cognizant of the fact that most, if not all, of the positive
portion of future returns will come from coupon payments. However,
that alone is no reason to scratch the asset class off of your
watchlist, considering that junk-bond yields are currently hovering
around 10%. If you're in the camp that believes that, going
forward, the average return for equities will be in the low
single-digits, then a 10% yield is certainly nothing to sneeze
at.
Default risk should be the primary concern of investors getting
into junk bonds at this time. Despite growing economic uncertainty
and stubbornly soft labor markets, there is room for optimism on
this front. First, the corporate sector should benefit from the
generous helping hand of the government (that is, a monumental dose
of fiscal and monetary stimulus). Access to low-cost funds has
helped many firms recapitalize and shore up their balance sheets.
This "lifeline" allowed many firms to survive the darkest days of
the crisis. While non-investment-grade firms will likely face some
challenges ahead as a result of an uneven economic recovery, it's
hard to dispute the fact that they are in far better shape today
than they were 18 months or so ago.
Some might even be surprised that non-investment-grade bond
issuances are on pace to top the all-time high recorded in 2009.
(The massive parade of credit downgrades during this period likely
helped contribute, but that's beside the point.) This is
significant in that we're seeing many firms taking advantage of
current accommodations to refinance at lower rates and extend their
debt maturities. Such activity bodes well for high-yield issuers,
as they can better avoid potential liquidity constraints and
maintain healthy balance sheets in anticipation of recovering
demand. Investors here don't need the economy to go gangbusters for
their junk-bond exposure to pay off. Even a "muddle through"
recovery would be fine, as we care only that the company stays in
business and can service its debt payments.
TIPS--Not So Popular Anymore
After 30 consecutive months of inflows, iShares Barclays TIPS
Bond's (
TIP
) extraordinary streak came to an end in March of this year. Since
March, investors have yanked more than $1 billion out of TIP, of
which $673 million was redeemed in August and September. The
original thesis was that the explosion of the Federal Reserve's
balance sheet would lead to a bout of inflation down the road.
However, the velocity of money remains subdued and the inflation
scenario has turned into more of a longer-term story. In the near
term, the concern has actually turned to deflation, which might
have led some to pull back on their Treasury Inflation-Protected
Securities exposure.
Surely there's a place for TIPS in the bond portion of any
portfolio, but it's worrisome to hear that many investors were
"backing up the truck" on TIPS. The case for an inflation-protected
investment strategy is to preserve the purchasing power of one's
savings. TIPS achieve this through principal adjustments based on
changes in the CPI. But, it's worth noting that owner's equivalent
rent has increased to 24% of the reported CPI figures and has a
disproportionate influence on this statistic. Something to consider
is that many investors own their homes and have seen other daily
expenditures (such as energy and food prices) rise.
In our view, there seems to be a relationship between the
decreased popularity of TIPS and the increased popularity of
commodities, REITs, and dividend-paying stocks. Owning hard assets
could be another good inflation hedge, but we caution investors not
to lean too far in one direction. Remember that TIPS are
government-backed securities that exhibit much lower volatility
than commodities or REITs. For many investors, particularly those
nearing retirement, the defensive nature of TIPS is a benefit that
should not be overlooked.
Precious Metals Shine
The gold rush is still on. But, in terms of fund flows, it was a
silver ETF that shone brightest in September. Last month, iShares
Silver Trust (
SLV
) saw more than $420 million in net inflows. Leading the physical
gold bullion ETF pack was iShares Gold Trust (
IAU
), which recently dropped its fee to 0.25% to better compete with
the mammoth SPDR Gold Shares (
GLD
), which charges 0.40%. The three major gold funds--GLD, IAU, and
ETFS Physical Swiss Gold Shares (
SGOL
)--saw combined inflows of approximately $465 million last
month.
In comparison to gold, silver is not a perfect substitute.
Silver's industrial uses make it a much more dilute "safe haven"
asset than gold and a less effective hedge against inflation. If
companies that use silver in their manufacturing processes scale
back production, silver prices are likely to suffer. The prices of
these two metals have exhibited a correlation of 0.73 over the last
10 years and do not move in lock step. As of this writing, gold
prices are roughly 63 times greater than silver per ounce, and gold
has averaged a ratio of 61 times higher than silver over the last
decade. The range has been from 81 times to 44 times higher over
the same time frame. To put that in longer-term perspective, gold
was fixed at 16 times higher than silver until the gold standard
was abandoned, and gold tended to trade at about 40 times more than
silver for the decades following that event.
Whether you go with gold or silver, we always like to remind
investors that unlike equities or bonds, commodities are nonearning
assets that are worth only what another party is willing to pay.
That said, they do offer diversification benefits within a broadly
diversified portfolio. When considered as a long-term core holding,
we recommend keeping only a small allocation to precious metals, if
at all. Our research suggests that a 4%-10% total weighting for all
direct commodities exposure is sufficient, and the majority of that
weighting should be split among energy, agricultural, and
industrial and precious metals. That said, we wouldn't be opposed
to tactically owning precious metals periodically as a satellite
holding as an inflation hedge or store of value during periods of
currency valuation uncertainty.
Fund flow trends can reveal interesting themes. But the crowd
isn't always right. As always, it's important to consider our own
individual circumstances and goals before deciding to go with, or
against, the crowd.
Disclosure:
Morningstar licenses its indexes to certain ETF and ETN providers,
including Barclays Global Investors ((
BGI
)), 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.
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