Another year is almost in the books and 2015 was most certainly a wild ride for ETF investors. Nearly every corner of the market experienced its fair share of volatility this year. However, several unique corners of the ETF landscape significantly diverged from the mainstream. This created dynamic trends that were persistent over the last twelve months and will likely shape the early stages of 2016 as well.
Soaring Demand For Currency Hedges
The continued strength in the U.S. dollar index fueled demand for currency-hedged ETFs throughout 2015. The WisdomTree Europe Hedge Equity ETF (HEDJ) and Deutsche X-trackers MSCI EAFE Hedged Equity ETF (DBEF) standout as the largest gainers of net new assets this year, with nearly $28 billion of combined inflows.
Both of these funds own a diversified basket of international stocks alongside short positions in the home currency of the underlying portfolio. This creates a tailwind effect for international equities when foreign currencies are falling versus the U.S. dollar.
Investors in these ETFs are betting that further price devaluation in the euro, yen, and other foreign currencies will be driven by quantitative easing efforts from overseas central banks. That thesis proved to be true this year as the PowerShares U.S. Dollar Bullish Index Fund (UUP) has risen 6.55% so far in 2015.
Internet Stocks Dominate
In a year where the S&P 500 Index is slightly underwater, the dominance of many internet stocks has been a consistent theme. Companies such as Amazon.com Inc (AMZN) and Netflix Inc (NFLX) have notched triple digit gains and continue to show superior strength.
Both of these stocks are top holdings in the First Trust Dow Jones Internet Index Fund (FDN), which measures an index of 42 companies providing goods and services online. FDN has risen 20% in 2015 and consistently been one of the strongest U.S.-based ETFs in terms of overall momentum.
FDN has accumulated $2.6 billion in new inflows this year and now stands at $4.7 billion in total assets under management. The question now is will this dominance continue in 2016 or is this group ready to take a breather?
High Yield Woes Accelerate
Most investors have been worried about the turning of the tide in interest rates, but a more prominent theme in 2015 was the collapse in high yield assets. Funds that track junk bonds, master limited partnerships, and other esoteric income sectors felt the pinch of credit risk aversion.
The SPDR Barclays High Yield Corporate Bond ETF (JNK) has fallen more than 8% on a year-to-date basis and continues to indicate a lack of enthusiasm for high yield bonds. Not to be outdone, the Alerian MLP ETF (AMLP) has lost more than 35% of its value in 2015. The price action of both funds is a major source of concern in credit fundamentals moving forward.
The weakness in these two sectors highlights the crowded nature of the search for income and additional risk that is assumed when stretching for additional marginal yield.
Commodity Collapse Continues
One of the driving forces for the route in high yield assets has been the continued destruction of commodity prices. The United States Oil Fund (USO) has lost nearly half its value this year, while the SPDR Gold Shares ETF (GLD) is down another 9% in 2015. The devaluation of commodities filters through to the companies that rely on these markets to generate revenue and service their debt as well.
For example, the Energy Select Sector SPDR (XLE) is the worst performing of all the major S&P sector groups this year with a decline of 24%. Investors in the energy sector were certainly not rewarded the same way consumers were at the gas pump in 2015.
The Bottom Line
The markets were full of hits and misses this year, which translated to very subdued returns in the major indices. The tug of war between areas of strength and weakness ultimately creates pockets of opportunity and concomitant hazards to avoid.
With the major change of U.S. central bank interest rate policy now implemented, it will be interesting to see how these current trends persist or turn in 2016.
P.S. The wizards at Stocktwits (an online social community for investors) have put together a fantastic video lookback at 2015 that includes many of these hot-button topics as well. It’s a great 3-minute visual review of the entire year.