Three Lessons Learned in 2013 From US ETF Fund Flows (Part 1)

U.S.-listed exchange-traded funds attracted US$188.4 billion in 2013, just shy of 2012’s record US$190.1 billion haul. Those inflows represent a growth rate of about 14% of beginning assets compared with the projected growth of about 3% for long-term mutual funds. Strong inflows, combined with market appreciation, have allowed ETF assets to hit US$1.7 trillion, or about 13% of long-term mutual fund and ETF industry assets. Let's take a look at some things we can learn from these strong ETF flows.

ETF Investors Are Different From Mutual Fund Investors
Interest in emerging markets has been strong over the past decade, thanks to improving economic fundamentals and soaring stock markets. Naturally, investment flows have followed. The investment prospects for emerging markets dimmed in 2013 as the bull market in commodities ended, the Fed's talk of tapering created liquidity concerns, and developed-markets economies improved. Investors following a tactical, market-timing model would likely have sold emerging markets, whereas long-term investors should have rebalanced into emerging-markets stocks. ETF investors sold roughly US$6.6 billion out of funds in the diversified emerging-markets category while mutual fund investors bought US$39.0 billion. ETFs such as Vanguard FTSE Emerging Markets (VWO, listed in the US) and iShares MSCI Emerging Markets (EEM, listed in the US) are heavily owned by institutions, at least 65% for each. In contrast, it is likely that the mutual funds are predominately owned by individual investors.

ETFs Hold Up Remarkably Well in the Face of Massive Redemptions
Any time a new structured financial product comes along, you should be skeptical, particularly of those created by banks that can easily tilt the playing field in their favor through complex pricing terms and legal jargon. But this skepticism can also be taken too far, in my opinion. A case in point surrounds the issue of whether there is enough physical gold to back the SPDR Gold Shares (GLD, listed in the US; also listed in Hong Kong, Singapore and Japan). One version of the conspiracy suggests that the gold backing SPDR Gold Shares is not actually in the vaults. It is always difficult to disprove a conspiracy theory, but strong evidence of the stability of the ETP structure was provided in 2013. Slow but steady economic improvement, benign inflation, and signals from the Fed that the printing press would eventually be shut deflated the fear bubble and the fear trade’s favorite asset: gold. 17,766,650 ounces of gold exited the vaults of GLD in 2013. In just one week in April, 1,503,272 ounces was pulled out. All the while GLD traded without interruption or a significant premium or discount. Gold bulls may not have liked the result, but neither did the “your ETF might collapse” conspiracy theorists.