Midyear Report: Risk-Off ETFs Capturing Most Assets In 2016

Plenty has been said about the dangers of reading too much into ETF asset flows. And yet there's really no other way to slice it: ETF investors are playing it safe—defensively, even—in 2016.

Perhaps it's because the equity market hasn't done all that much. The S&P 500 rallied only some 3% in five months amid highly volatile, choppy action. In that period, U.S. equity ETFs gathered a paltry $3.9 billion in fresh net inflows, a muted demand that largely centered on funds focused on things like dividends and value stocks—the more defensive-type fare within equity plays.

The most popular equity ETF so far this year, in fact, is the iShares Edge MSCI Min Vol USA ETF (USMV | A-69), attracting more than $5.3 billion in five months, according to FactSet data. USMV is only No. 2 in terms of assets gathered (within the entire 1,900-plus fund universe in 2016) to an even more risk-off play: the SPDR Gold Trust (GLD | A-100), which raked in more than $8.8 billion in net inflows in the January-to-May period.

'The Beauty Of USMV'

USMV is a low-volatility strategy that looks to capture as much upside in the equity as possible while protecting investors from downside action by focusing on low-volatility names. As InsideETFs CEO Matt Hougan wrote on ETF.com, "The beauty of USMV is that, by lowering the overall volatility of the portfolio, it should help investors ride out short-term volatility and therefore hold their positions for the long haul."

In a way, demand for USMV speaks to investors' desire to stay invested even when the market isn't making it easy to do so in the short run.

When it came to equity exposure, large-cap equity ETFs weren't all that popular in the first five months of the year. Developed-market equities, by and large, weren't either. International equities—including emerging market stocks—were even less hot. As an asset class, foreign stock funds lost more than $14.6 billion in assets—the biggest net redemptions of any asset class tracked by FactSet in the period.

But through it all, USMV reigned supreme, holding on to the No. 2 spot with positive net creations month after month, growing to become a $13.25 billion ETF.

'Aged And Overvalued Bull Market'

"The cyclical bull market is aged and overvalued," Steve Blumenthal, chairman and chief executive officer of CMG Capital Management, said of the risk aversion among investors. He noted that  of the 36 cyclical bull market moves since 1900, the current cyclical bull is already the third-longest bull-run.

"The flows tell me that money is growing cautious. And it should," Blumenthal said. "My personal view is that there's a growing loss of confidence in central back policy."

Nothing suggests caution like a stampede into gold. GLD has been the most popular ETF so far this year, with $8.8 billion in inflows. And as investors rushed in, the fund didn't disappoint, rallying more than 14% in five months.

Also hugely popular were broad, investment-grade fixed-income strategies such as the iShares Core U.S. Aggregate Bond ETF (AGG | A-98), the iShares TIPS Bond ETF (TIP | A-99) and the Vanguard Total Bond Market Index Fund (BND | A-94), or funds investing into Treasurys and TIPS.

In all, U.S. fixed-income ETFs raked in an impressive $37.4 billion in net assets in five months—or more than 75% of total inflows into U.S.-listed ETFs in that period.

"What's the story here? Well, I read the positive inflows into the ETF market as a sign that investors still want to put their money to work," said Dave Nadig, director of ETFs for FactSet. "They're not running for exits. But they are playing defense."

Top Gainers

Biggest Losers

The first half of the year also brought a complete reversal in sentiment toward what were some of the hottest ETFs in recent years.

The currency-hedged darlings WisdomTree Japan Hedged Equity Fund (DXJ | B-63) and WisdomTree Europe Hedged Equity Fund (HEDJ | B-47) were among the least popular funds in the first five months, losing $4.2 billion and $3.8 billion, respectively. These numbers stand in stark contrast to the massive inflows both funds saw in 2015: HEDJ attracted nearly $14 billion and DXJ saw $3.7 billion last year.

What's interesting about investors' loss of appetite for these strategies is that it wasn't confined to currency-hedged ETFs. Their unhedged counterparts, the iShares MSCI Japan ETF (EWJ | B-95) and the iShares MSCI Eurozone ETF (EZU | A-84) were equally unpopular, facing net redemptions of $3.7 billion and $3.5 billion, respectively, in the same period. No one seemed to want exposure to Japan or to the eurozone, currency-hedged or not.

The outflows came as all four ETFs delivered negative performances to start the year.

Charts courtesy of StockCharts.com

These strategies, along with U.S. large-cap equity, tech stocks, China and even junk bonds, "are all classically 'risk on' positions, which are all clearly very much in 'risk off' mode," Nadig said.

Biggest Losers

The Curveball

Defense may be the best offense for most investors this year, but that doesn't mean everyone's following this playbook. In fact, leveraged and inverse products have been relatively strong in the asset-gathering game.

Inverse ETFs have been particularly hot, attracting $5.7 billion in fresh net assets since Jan. 1. The ProShares UltraShort S&P500 (SDS)—serving up inverse exposure to the S&P 500—led the charge, with net creations of $1.0 billion in five months. That's sizable considering the fund has total assets of $2.1 billion.

The Direxion Daily Gold Miners Bear 3x Shares (DUST), too, attracted some $774 million in the same period. Most of these inflows aren't sticky assets, as in long-term investment dollars; rather, they represent short-term, often single-day positions as these funds are designed to be. However, they still point to investor demand for ways to express their market views.

"We've seen strong flows into leveraged and inverse products," said Nadig. "Because anytime the market goes into defense mode, like clockwork, speculators come out of the woodwork to try and prove it wrong."

YTD 2016

Contact Cinthia Murphy at [email protected].