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ETF News And Commentary

ETFs’ popularity continues to grow, as increasing number of retail and institutional investors embrace them in view of their low cost and convenience, among other reasons.  A close look at ETF fund flows can now fairly indicate market trends and investor sentiment.

This year has been great so far for U.S. stocks with their best first-half performance since 1998. However most of these gains were recorded during the first quarter. While stocks did manage to continue their uptrend, the second quarter was marked by increased volatility.  

Concerns about ‘tapering’ of the Fed’s massive stimulus—which had the main driving force behind the market’s surge—led to a spike in bond yields and sell-off in many emerging markets funds.

This year has been bad for gold and the second quarter in particular was terrible. The precious metal tumbled more than 25%--its biggest quarterly price decline in recent history—as a rising US dollar and prospects of QE slowdown took off some of its shine. As investors rushed for exits, once ultra-popular Gold ETF (GLD) lost $11.6 billion in assets, making it the most unpopular ETF during the quarter.

Below we take a look at the top asset gainers during the second quarter.

The Sun continues to shine on Japan ETFs

It appears that aggressive expansionary measures taken by the Abe government, including “unlimited” easing in order to weaken the currency, make exports competitive and pull the country out of its deflationary spiral, are delivering results. Japan’s GDP grew at an annualized rate of 3.5% during the first quarter of 2013, up sharply from 1% growth recorded during the previous quarter and substantially stronger than estimates.  

Recent economic numbers including industrial production and consumer spending suggest that the growth momentum continued in the second quarter too. (Read: DXJ or DBJP-which is the better hedged Japan ETF)

Though long lasting results will depend on how policymakers address the underlying structural problems that have been affecting the economy for decades, investors have been positive on Japan’s turnaround.

WisdomTree Japan Hedged Equity Fund (DXJ - ETF report)—which provides exposure to Japan’s equity market but hedges the currency risk—was the top asset gainer for the second quarter too, after a very impressive performance in the first quarter. It gained $4.2 billion in AUM during the quarter.

iShares Japan ETF (EWJ - ETF report) came in at the second place, adding $3.5 billion to its asset base.

Financial ETFs gain assets as the sector outlook brightens

Financials are expected to continue as one of the top performing sectors in the coming months. 

Per Zacks estimates, finance sector earnings are expected to increase 19.1% during the second quarter from the prior-year quarter.

Banks are in the best position to benefit in the current environment of rising longer-term rates and steepening yield curve. A steepening yield curve means that banks can borrow at very low rates and lend at much higher rates so it improves banks’ net interest margin. 

Higher interest rates also benefit insurance companies as they are able to earn higher returns on their investment portfolio. (Read: Buy these ETFs for improved insurance sector outlook)

Another reason to be bullish on the financial sector is its potential for increasing dividends and buybacks. 

It’s thus no surprise that the most popular financial ETF—Financial Sector Select SPDR ETF (XLF - ETF report) gathered about $2.1 billion during the quarter—making it the third largest asset gainer.

Rate increase worries benefit Bank Loan and Short Duration Bond ETFs

Due to concerns about the Fed finally scaling down its asset purchases, interest rates have been going up in the past few weeks.  10 year treasury yield touched 2.69% this morning, the highest since August 2011.

As interest rates continued to inch up, investors have been switching to shorter duration products or other products like Senior Loans ETFs that provide protection against interest rate rise. (Read: Winning ETF Strategies for the second half)

Senior loans are floating rate loans so they usually pay a spread over some benchmark rate like LIBOR.  Thus, in the event of rise in interest rates, coupons on senior loans increase while the value of the investment remains stable. On the other hand, bonds lose value if the interest rates go up.

So, investors in senior loans or in senior loans ETFs get the benefit of high yields with protection against any interest rate rise. Further, they carry lower credit risk compared with most other assets with similar level of yield.  Additionally senior loans have low correlations with other asset classes. 

PowerShares Senior Loan ETF (BKLN - ETF report) increased its AUM by $1.6 billion during Q2—putting it in the fourth spot from the top.

Many investors moved to shorter duration bond ETFs, which are less sensitive to interest rate changes. iShares 1-3 Treasury Bond ETF (SHV - ETF report) with an effective duration of just 0.47 has lost only 0.02% year-to-date, which looks very respectable compared with about 8.5% loss for theBarclays 20+ years treasury bond ETF (TLT). SHV was the fifth most popular ETF during the quarter, judging by its AUM gains of $1.5 billion.

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