Lighthouse Investment Management

ETF Report

Exchange Traded Funds - US listed - February 2013

Contents
Introduction .................................................................................................................................................. 2 Flows by asset class....................................................................................................................................... 4 Flows by asset class in % of assets ................................................................................................................ 5 Non-speculative bonds: rolling 12-months flows in % of assets .................................................................. 6 Speculative bonds: rolling 12-months flows in % of assets .......................................................................... 7 US equities: rolling 12-months flows in % of assets ..................................................................................... 8 International equities: rolling 12-months flows in % of assets..................................................................... 9 International equities: rolling 12-months flows in % of assets................................................................... 10 Risk appetite: high ...................................................................................................................................... 11 Conclusions ................................................................................................................................................. 12

ETF Report - US listed - February 2013

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Introduction
Since the 'birth' of the first ETF (Exchange-Traded Fund) in 1993 their march towards success has been uninterrupted. As of February 2013, US listed ETF's contained over $1.4 trillion in assets under 'management'1. With more than $9 trillion in managed assets23, US mutual funds are still command a much larger pile. However, outflows from mutual funds investing in domestic equities have persisted over the last 6 years. Investors, discouraged by underperformance of actively managed funds, are switching to ETF's with significantly lower fees than comparable mutual funds. It is fair to assume ETF's will continue to grow rapidly and will impact market performance due to their sheer size. To get insights into investors behavior we look at flows in and out of the 20 largest ETF's, covering over 40% of all ETF assets. Looking simply at assets under management is misleading, since performance can have a significant impact on the value of assets. We therefore look at pure flow data, ignoring the impact of performance. For example: the 57% increase in assets for EEM (Emerging Markets ETF) could be entirely due to performance, or flows or a mix of both. The increase in assets of ETF's tracked from $520bn to $605bn from July 2012 to January 2013 consisted of $40bn of inflows and $45bn

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Source: IndexUniverse.com Source: Morningstar Direct US Open-end asset flows update, January 2013 3 Excluding $2.6 trillion in US Money Market Mutual Funds

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in performance.

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Flows by asset class

One way to analyze flows is to aggregate them by asset class in dollar terms. Above you see cumulative flows over the last 12 months. Observations: International equities command the largest share with roughly $20 billion inflows Domestic equities follow with around $16bn Safe bonds are next with $7bn Precious metal-related and real-estate ETF's each saw around $5bn of inflows Speculative bond ETF's achieved grew by roughly $4bn

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Flows by asset class in % of assets

An inflow of $1bn does not matter much for SPY, the 'king' of ETF's, with its $125bn assets. However, it might matter for the $5bn Russel MidCap ETF (IWR). It therefore makes sense to also look at flows relative to the asset base. Observations: Real estate shows the strongest relative inflows (admittedly represented by one ETF only) International equity ETF's enjoy higher inflows than their domestic equivalents Speculative bonds are significantly more popular than their non-speculative counterparts. Flows into precious-metal related ETF's are lagging the overall trend

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Non-speculative bonds: rolling 12-months flows in % of assets

Investor preferences change, and so do flows. Looking at rolling changes in flows can reveal interesting trends. Observations: TLT (20+ year Treasury bonds) are the least favorite, followed by TIP (Treasury inflationprotected bonds) The enthusiasm for BND (total bond market) and LQD (investment-grade corporate bonds) has recently cooled off a bit Municipal bond ETF (MUB) still shows no sign of losing momentum

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Speculative bonds: rolling 12-months flows in % of assets

Observations: The massive inflows into speculative bond ETF's seen in 2012 seem to have faded High-yield ETF (HYG) has seen consecutive outflows for the last four months Waning demand from high-yield ETF's might make it less easy for lowly rated borrowers to access capital markets or lead to stricter covenants

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US equities: rolling 12-months flows in % of assets

Observations: Nasdaq (QQQ) and Dow Jones (DIA) related ETF's have lagged overall inflows into domestic equity ETF's. This might have to do with the end of the bubble in the stock price of Apple, which is heavily weighted in Nasdaq benchmark indices. For the Dow Jones we can only speculate investors might finally realize the nonsensical nature of a price-weighted index.

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International equities: rolling 12-months flows in % of assets

Observations: In good times, investors feel confident and venture abroad in search of higher returns Increased risk appetite is evident in the brisk growth of emerging market equity ETF's (VWO, EEM), while broad international equity ETF (EFA) is lagging behind.

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International equities: rolling 12-months flows in % of assets

Observations: Interest in precious-metal related investments is, with the exception of silver, close to a freezing point Flows into the Senior Gold Miners ETF (GDX) were concentrated over two months (August and September 2011), coinciding with the all-time high in spot gold prices ($1,923/oz)

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Risk appetite: high

Here, we calculate the ratio between two sub-groups of the same asset class: speculative bond (HYG, JNK) to non-speculative bond ETF's (TLT,TIP, BND, LQD, MUB) international equity (VWO, EFA, EEM) to domestic equity ETF's (SPY, QQQ, IVV, VTI, DIA, IWR)

We used relative assets under management instead of relative flows as the time series are quite volatile. Observations: Risk appetite is at (or close to) the highest level seen since the beginning of our data.

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Conclusions
Current risk appetite is high International equity ETF's are seeing higher inflows than domestic equity ETF's in absolute dollar terms as well as relative to their asset base Emerging market equity ETF's are outpacing those investing broadly in international equities Inflows into speculative bond ETF's are cooling off significantly Interest in precious metal-related ETF's is very low A prudent or contrarian investor would use the opportunity to shift positions into more defensive ETF's

Any questions or feedback highly welcome. Alex.Gloy@LighthouseInvestmentManagement.com

Disclaimer: It should be self-evident this is for informational and educational purposes only and shall not be taken as investment advice. Nothing posted here shall constitute a solicitation, recommendation or endorsement to buy or sell any security or other financial instrument. You shouldn't be surprised that accounts managed by Lighthouse Investment Management or the author may have financial interests in any instruments mentioned in these posts. We may buy or sell at any time, might not disclose those actions and we might not necessarily disclose updated information should we discover a fault with our analysis. The author has no obligation to update any information posted here. We reserve the right to make investment decisions inconsistent with the views expressed here. We can't make any representations or warranties as to the accuracy, completeness or timeliness of the information posted. All liability for errors, omissions, misinterpretation or misuse of any information posted is excluded. +++++++++++++++++++++++++++++++++++++++ All clients have their own individual accounts held at an independent, well-known brokerage company (US) or bank (Europe). This institution executes trades, sends confirms and statements. Lighthouse Investment Management does not take custody of any client assets.

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