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What the ETF Flows Show: Risk On(ish)


The complicated relationship between investors and risk continued in October, as evidenced by exchange traded product (ETP) flows last month.  While there was significant interest in riskier fixed income assets and all things emerging markets, US equities took a hit and gold continued to be the hedge of choice.  In a market where risk-on can become risk-off in the blink of an eye, these seemingly contradictory trends seem to illustrate the environment with which investors are currently grappling.

First, the numbers.  October flows of $9.5bn brought the year-to-date global ETP flows to $192.3bn (2011’s full year total of $173.4bn was surpassed in September).   ETPs listed in Europe generated 45% of October flows, the highest ratio this year.  Europe’s flows of $4.2bn were broadly distributed across gold and a number of categories within equities and fixed income.

Investors in October maintained a degree of risk appetite, embracing both emerging market (EM) bonds and EM equities, which together drew in $8.5bn.  On the EM equity side, China and Brazil led the inflows with $2.8bn and $0.7bn respectively, perhaps bolstered by the fact that both countries have aggressively lowered interest rates in 2012.

As we wrote last week, EM bond ETPs have been one of the most interesting stories of 2012 so far.  The category, which has experienced positive monthly flows since early this year, garnered $1.9bn in October – its highest monthly total on record.  We believe this trend may continue as the prolonged low interest rate period persists and investors are forced to accept more risk in order to find yield.  In addition, the relatively positive risk/return characteristics and low historical correlations to other segments of the fixed income market should continue to make EM bonds of interest to many investors.

Also benefiting from low interest rates is investment grade corporate debt, which was the top recipient of ETP inflows within the fixed income category in October.  As Russ Koesterich recently wrote, attractive credit spreads, relatively low default risk and higher yields relative to Treasuries have made investment grade bonds one of the better fixed income bargains on a risk-adjusted basis.

However, this is where the mildly risk-on attitude seemed to end.  The US market risk rally set off by September’s central bank actions cooled in October as investors rotated out of US equity to the tune of $10.7bn.  67% of the net activity was focused in a single fund – the S&P 500 ETF Trust (SPY), which saw redemptions of $7.2bn on the back of large inflows ($10.5bn) in September.

In addition, gold ETPs built on robust flows in August and September by adding $2.5bn in October.  More than any commodity, gold is a natural beneficiary of the current monetary regime characterized by negative real interest rates.

Bonds and bond funds will decrease in value as interest rates rise.  International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume.

Gold and other precious metal prices may be highly volatile. The production and sale of precious metals by governments, central banks or other larger holders can be affected by various economic, financial, social and political factors, which may be unpredictable and may have a significant impact on the supply and prices of precious metals.

Information on SPY is provided strictly for illustrative purposes and should not be deemed an offer to sell or a solicitation of an offer to buy shares of any funds.

Dodd Kittsley, CFA, is the Head of Global ETP Market Trends Research for BlackRock.