[This article originally appeared in our August issue of ETF Report.]
At the start of each year, we like to gaze into the crystal ball and forecast the most exciting developments coming to the ETF space. But there is so much going on this year—record flows, new launches, the prospect of exchange-traded flows, new launches, the prospect of exchange-traded managed funds—that I thought it worthwhile to take a midyear snapshot as well.
Here are three themes that will shape the ETF market in the second half of the year.
Nº 1 Investors Will Look Abroad
If one trend stands out among ETF investors recently, it is their love afor international stocks. ETF investors poured $48 billion in net new money into international equity ETFs in the second quarter alone. For reference, that's more than they invested in international equities in all of 2014. Who cares about a collapsing Greece, a challenged Russia or a bubble bursting in China?
There were roughly $15 billion of inflows into currency-hedged ETFs, led by the most popular ETF of the quarter, the Deutsche X-Trackers MSCI EAFE Hedged Equity ETF (DBEF | B-65), which attracted $5.5 billion in inflows.
But really, the flows came from every direction. Eight of the top 10 ETFs for inflows in the second quarter were international equity funds, including the boring-as-dirt iShares MSCI EAFE (EFA | A-93), which pulled in $4.3 billion. Japan, China, Germany, India, Hong Kong and Spain were among the single-country funds seeing lots of love.
In all, 28 international equity ETFs had more than $500 million in inflows for the quarter, while zero had that much in outflows. The worst was the iShares MSCI Brazil Capped ETF (EWZ | B-96), which lost $335 million as that nation tumbled toward economic chaos.
This trend will accelerate in the second half of the year, thanks to three big factors driving this growth:
The Rise Of Currency-Hedged Etfs
Currency-hedged ETFs were the biggest story of the first half of the year, and with industry behemoths like BlackRock and ProShares launching their own currency-hedged ETFs recently, there's no reason to expect things to slow down.
More than anything else, currency-hedged ETFs are an easy sale for advisors. Every day, it seems, there is a terrible headline about Europe in the Wall Street Journal. Meanwhile, for the year ending June 30, 2015, currency-hedged exposure to the EAFE Index outperformed nonhedged exposure by more than 14%.
Advisors are always looking for ways to appear smart to their clients. Is there an easier way than calling them up to talk about currency-hedged exposure?
International Markets Remain Cheap
Despite the flood of inflows, international equity markets remain cheap in comparison with the U.S. Based on data from FactSet, the broad U.S. market was trading at a price-to-earnings ratio over 21 as of June 30. By comparison, the developed international market was trading at just 18.6, and emerging markets were trading under 10.
It'll be interesting to see how flows into the beaten-down emerging market space develop in the second half of the year. Will the bursting of the China bubble scare investors off, or will bargain hunters emerge? Emerging markets had $5 billion in net new flows in the second quarter.
Bet on net inflows as investors abandon the U.S. and start looking around for a bargain.
Worries About The Us Bull Market
On an anecdotal basis, we're hearing increased concerns that the U.S. equity bull market is long in the tooth. Virtually none of the presenters at ETF.com's Global Macro conference in June wanted anything to do with U.S. equity markets, preferring to embrace former laggards like Spain, Italy and Japan. Normally, I'd discount my anecdotal experiences, but in this case, they line up with the data.