ETFs at Midyear: Investments Keep Pouring In

The first half of 2010 has been anything but dull for exchange-traded fund investors.

ETF assets in the U.S. decreased 0.4% during the first half of 2010 -- investors held $772 billion in 897 ETFs as of June 30, according to State Street Global Advisors. During the same period, equity markets, as measured by the S&P 500 Index, fell 8.9%.

"Despite the market's performance during the first half of 2010, ETF net inflows are ahead of last year's pace," said Tom Anderson, director of strategy and research for the Intermediary Business Group at State Street Global Advisors,in a prepared statement.

Not even the May 6 "flash crash" could shake investor confidence in ETFs, though they accounted for more than 60% of all canceled trades following the market disruption that day. Investors stuck with ETFs, and net new inflows into ETFs totaled $20.2 billion in May and June, according to State Street.

Where was the action? Fixed income continues to be the fastest area of growth: Assets increased by $21.2 billion or 21% in the six months to June 30, while the number of bond ETFs reached 105. In 2006, just six fixed-income ETFs existed, representing $20 billion assets, according to State Street. The flurry of bond activity was broad -- corporate, municipal, Treasury Inflation Protected Securities and U.S. Treasuries. The favorites were short-term bond and U.S. Treasury ETFs, which attracted more than $7 billion and $5 billion in net cash flows, respectively.

Going for the Gold, and Going Global

Amid concerns about the European debt crisis and the pace of the U.S. economic recovery, investors continued to flock to gold. Assets in gold ETFs increased by 30.2% in the first half of the year, and the popular SPDR Gold Trust (GLD) currently leads all ETFs in net cash inflows, attracting more than $7.6 billion during the first half of the year. GLD's total assets surpassed $50 billion in the second quarter -- a milestone that reflects both the increased acceptance and application of gold ETFs as a means of gaining exposure to this asset class.

Beyond gold, precious metals continue to be a focus, says Daniel Weiskopf, principle at Global ETF Strategies/Forefront Advisory. ETFS Physical Platinum Shares (PPLT), with a market cap of approximately $450 million and ETFS Physical Palladium Shares (PALL), at over $355 million were big winners, says Weiskopf.

Elsewhere, the buzz was about emerging markets. iShares MSCI Poland Investable Market Index Fund (EPOL), which was launched at the end of May, has about $50 million ($20 million more than Van Eck's Market Vectors Poland fund (PLND), which had first-mover advantage when it was launched in November of last year). Markets in Southeastern Asian countries are doing quite well this year, says King Lip, chief investment officer for Baker Avenue.

"Economies in these regions tend not to be overleveraged and they continue to see robust economic growth," says Lip. "This is in stark contrast to economies in Europe and the US which are overleveraged and seeing anemic growth." He points out stellar performers like the iShares MSCI Thailand Index (THD), up 19.5% as of July 26, and Market Vectors Indonesia Index (IDX), up 24.5%, and iShares MSCI Singapore (EWS) up 7.6%. "Investors should look to these markets and ETFs as a way to diversify their current holdings if they are overweight U.S. domestic and European stocks," he adds.

Dividends and Disappointments

Right now, investors' favorite "D" word is dividends. Thus, we're seeing an increase in Master Limited Partnerships. Companies like J.P. Morgan (JPM), ALPS Advisors, Credit Suisse (CS) and UBS (UBS), all launched ETFs that track the Alerian MLP (Master Limited Partnerships) Infrastructure Index. ($AMZ.X). These ETFs are geared not only to track this index, but also pay a dividend that is much easier to report at tax time (instead of the K-1), says Jeffrey Lyon, vice president of investments at Charles Vista.

Surely but slowly, active ETFs are gathering momentum too. "Exchange-traded products from PIMCO like STPZ, have clearly been big winners, drawing over $1 billion in assets under management," says Weiskopf.

Where though, have the disappointments been? Christian Wagner, president of Longview Capital Management points out five losers: S&P Clean Energy Index, -22.87%, MSCI Spain, -17.38%, MSCI Italy, -15.57%, MSCI France, -21.08%, MSCI Ireland, -11.90%. The corresponding ETFs: ICLN, EWP, EWI, EWQ and EIRL.

Turbulent Waters Ahead

What, then, can investors expect for the rest of 2010? More good stuff from emerging markets, says Robert Holderith, president and CEO of Emerging Global Advisors. "Brazil, India, along with China,continue to lead the global recovery and manage their stellar growth," says Holderith. Brazil's 2% investment tax and India's interest rate hikes are proof they are willing to bite the bullet when necessary to prudently manage their economies, he adds. "We look for strong fourth-quarter earnings growth and equity price appreciation in these regions over the next 12 to 24 months."

But mostly, experts say hold onto the side of the boat, because the investing waters will be choppy. Year-to-date, says Lip, there have been eight large swings in the market with an average magnitude of 11%.

"Until consumer confidence increases significantly, retail earnings will be challenged," says Wagner. "Small businesses are contracting and not expanding, so this will make the recovery tenuous." The midterm elections are also going to play a key role is shaping in the market action.

Says Lip, "The recent market recovery certainly makes the investor feel good about a possible continued recovery. But the market on paper still doesn't look quite good. Volatility will continue to be present and investors that are still feeling the pain of the last financial downturn may consider sitting this out until the market gives a better sense of where it is headed."