5 Hot ETF Trends That Are Cooling Down

October 11, 2016

Some of the most popular ETF trades this year seem to be cooling down. The shift in momentum is a case of mean-reversion triggered by valuations and overcrowding—too many people chasing the same strategies.

We’re talking about these five pockets of the ETF market:

  • Dividends
  • Utilities
  • Low Volatility
  • REITs
  • Gold

A look at asset flows and performance in these segments points to a slowdown if not a complete change in momentum. To Wes Gray, head of Alpha Architect and an active manager, this all has to do with value.

“After a cooling down period, on a fundamental basis, the median PE [in most of these segments] is already now more in line with the broader market, so one could argue this was a valuation mean-reversion effect,” Gray said.

How much in line? The median price/earnings ratio on the SPDR S&P 500 (SPY) is now 20.82. The PE on some of the biggest ETFs in each of these segments—funds such as the Vanguard Dividend Appreciation Index Fund (VIG), the Utilities Select Sector SPDR Fund (XLU) and the PowerShares S&P 500 Low Volatility Portfolio (SPLV)—are now all “in that ballpark of SPY [SPDR S&P 500 ETF Trust (SPY)],” Gray said.

But REITs, as measured by what’s going on with the Vanguard REIT Index Fund (VNQ) “are still at high valuation ratios,” he said, even with the recent slowdown.

Some key points to consider specifically about each segment:

Dividends

The Vanguard Dividend Appreciation Index Fund (VIG) and the iShares Select Dividend ETF (DVY) have together attracted more than $2.5 billion in net inflows year-to-date. Combined, the two ETFs—the largest in the ETF dividend space—have more than $38 billion in AUM.

But since Sept. 1, the pace of asset inflows has significantly slowed down. The two ETFs have attracted less than $100 million combined in the past six weeks or so. Hand in hand with the slowdown in net inflows has been range-bound price performance, as the chart below shows. 

 

 

The dividend space is suffering from two problems. One is what David Dziekanski, portfolio manager at Toroso Investments, calls over-ownership. Popularity of this trade has led to overconcentration. In the case of a mass exodus, things could get ugly quickly.

The other is a lack of fundamental support to back up lofty values.

“Big dividend stocks are stretched out, and they don’t have the growth prospects to keep this going,” he said. “There’s some overconcentration in this segment, and lack of fundamental support going forward.”

According to him, a lot of companies have been artificially raising dividends, stretching themselves too much, and hurting their ability to grow earnings and put money into research and development, “which is the future of their business.”

 

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