U.S. Large-Caps’ Net Cash Inflows Top Bonds

Net cash inflows in U.S.-listed ETFs surged to $55.8 billion in the third quarter, far exceeding the average quarterly inflows of $33.8 billion seen over the last three years, according to the ETF research team at Morgan Stanley Smith Barney. With $133.4 billion for the first three quarters of the year, ETF net cash inflows are “on pace for the biggest year on record,” says Morgan Stanley. This would beat the $174.6 billion that poured into U.S.-listed ETFs in 2008.

Investors made a big switch to risk as ETFs following U.S. large-cap indices received $11.0 billion, the largest net cash inflows for the quarter, compared with $8.1 billion for fixed income ETFs. This was a big change from the previous quarter when fixed income ETFs received about $19 billion. ETFs tracking high-yield corporate bonds topped the fixed-income segment with inflows of $4.4 billion, according to Morgan Stanley.

With 20 new ETFs launched in the third quarter, and another 11 in October, the number of ETFs stands at the extremely cool total of 1,234. Total assets in the U.S. ETF market, as of Oct. 25, were $1.3 trillion, a 21% increase since the beginning of the year.

The top three funds in terms of net cash inflows were the SPDR S&P 500 ETF (SPY), with net inflows of $7.4 billion, the SPDR Gold Trust (GLD), with $4.1 billion, and the Vanguard MSCI Emerging Markets ETF (VWO), with $3.9 billion, according to Morgan Stanley. Currency ETFs experienced the largest net cash outflows for the quarter, at $71 million. For the first nine months of the year, currency ETFs have seen outflows of $2.0 million. Most of the outflows came from ETFs bullish on the U.S. dollar, while most of the inflows went into funds bullish on the euro vs. the dollar.

Blackrock continues to be the market leader with 280 U.S.-listed ETFs and $528.4 billion in assets. This accounts for a 41.7% share of the market, says Morgan Stanley, down from 48% at the end of 2008. State Street Global Advisors, with $235.8 billion in 116 ETFs holds 18.6% of the market, down from 27% at the end of 2008. Vanguard had $231.6 billion in 65 ETFs, giving it a market share of 18.3%, up from 8% at the end of 2008. Through the first three quarters of the year, Vanguard has had net cash inflows of $41.2 billion, the most of any provider, says Morgan.

FT Says ETFs Are Reaching Saturation Point

The U.S. ETF market may be getting saturated, says the Financial Times, as the appetite for new funds wanes. Last year, a record 302 exchange traded products were launched, a little less than the 389 funds that made up the entire market in 2007. At the end of 2011, there were 1,369 ETPs with more than $1 trillion in assets under management.

However, of the 190 ETFs launched in the first six months of 2011, 79% failed to reach the profitability mark of $30 million in assets under management, according to XTF, an ETF-focused research house. This was up from 62% in 2010 and less than half in 2009.  Fewer assets in the funds means less liquidity and wider bid-ask spreads.

Mel Herman, the head of XTF, says, said: “Most popular indices already have an ETF tracking them, so issuers are launching more and more niche products.”

I’ve been saying this for two year. A big difference between mutual funds and ETFs is that you don’t see many ETFs tracking the same index while each mutual fund sponsor can have their own set of index funds that track the S&P 500, the MSCI or any other popular index. The reason is twofold. Many mutual fund companies run 401(k) plans. So, they need to offer a wide range of options in the plan. Since plan participants are usually trapped and unable to buy funds outside the plan sponsor, these copy-cat index funds can build up significant assets. Also, many mutual funds are sold by investment advisors who receive a commission, or load, from the fund company. Thus, competing funds tracking the same index can build up assets as advisors direct investors which fund to go into.

Typically, the first ETF to track an index claims that market segment for itself. By the time a second fund launches, the first ETF has made a reputation and gathered a large amount of assets, making it much more liquid than any newcomer. For instance the SPDR S&P 500 (SPY), which launched in 1993, has net assets of $95.4 billion, while the iShares S&P 500 Index Fund, which launched seven years later, has only $26.2 billion.

This syndrome where the first ETF grabs all the assets and attention is called “first-mover advantage.” Since ETFs don’t have the captured audience of 401(k) plans or loads to pay to advisors, no one is there to push smaller funds, hence there are few funds tracking the same index or asset.  This means ETF sponsors need to find new indexes to track. But after a while, the indexes get so specialized they only attract a small audience. In addition, in volatile times, investors are less willing to risk investing in an offbeat concept. They want proven indexes that track broad markets. So, until investors are willing to take on more risk, unless an ETF concept is compelling, new funds will continue to struggle for assets.

Morningstar Hosts a Passive Vs. Active Debate

Morningstar this week is running a series debating the merits of passive investing vs. active investing.

Passively-managed investing is the strategy of capturing the market’s returns by holding a benchmark for a specific asset class. This is typically achieved with an index fund. Active investing attempts to earn a return better than the market benchmark. It does this by actively buying and selling stocks and bonds it thinks will outperform the benchmark.

Considering the mutual fund industry is based on actively managed investing, with a small percentage of passive funds, while 99% of the ETFs are passive investments, this debate is pretty basic to what kind of funds you want do hold in a portfolio. Building a portfolio with ETF is a tacit acceptance of the many benefits of passive over active.

Morningstar announced today that this week its analysts and strategists–including director of personal finance Christine Benz–will weigh in on active and passive investing techniques. They will clarify the state of the debate, look at ways to optimize both active and passive approaches, and offer suggestions on the best ways to combine the two. On Friday, several Morningstar experts will sit down for a live video roundtable discussion on getting the most out of active and passive strategies.

Here is the week’s lineup that can be accessed on Morningstar.com. The most relevant for ETF investors is on Wednesday, when Morningstar’s ETF team will look at how to pick the best passive funds and the hidden costs of indexing.

Monday | September 12: Clarity on the Active/Passive Divide

Hear from Morningstar’s Don Phillips, Russ Kinnel, and Christine Benz as they explore the pros and cons of using an active or a passive strategy.

Active or Passive Strategies: How to Choose?: 
Decide what attributes you value most, then go from there.

Silly Season for the Active/Passive Debate
: Here are five of the goofiest arguments for and against indexing.

Index Versus Active: What the Data Say
: Focusing on low expenses helps investors succeed, regardless of whether they take the active or passive route.

Indexing Extremists
: It’s time for the leaders of the index movement to step up and reclaim the intellectual honesty that their early supporters advocated, says Morningstar’s president of fund research Don Phillips.

The Odds Favor Index Investors: 
A low-cost index portfolio has the greatest probability for meeting long-term financial goals, says Rick Ferri.

From the Archive: What the Data Say on Active vs. Passive Funds: 
Morningstar’s John Rekenthaler on the percent of active managers who have outperformed, if active is really better in some categories, and the strongest predictors of success. (video)

Tuesday | September 13: Better Active Investing

The active investment strategy gets first treatment with Christine Benz sharing her favorite active funds and discuss how to build a portfolio of strong managers.

Wednesday | September 14: Better Passive Investing

Morningstar’s ETF team will look at how to pick the best passive funds and examine some of the hidden costs of indexing. Christine Benz will share her favorite index funds and offer five pitfalls passive investors should avoid.

Thursday | September 15: Active/Passive: Why You Don’t Have to Choose

Choosing between active and passive investments is not an all-or-nothing proposition. On Thursday, Morningstar will look at combining the best of both worlds in your portfolio.

Friday | September 16: Roundtable–Getting the Most Out of Active and Passive Strategies

Morningstar’s Christine Benz, John Rekenthaler, Scott Burns, and Michael Breen discuss the benefits and drawbacks of various active and passive strategies.

Are ETFs Too Powerful?

Mark Haines of CNBC asks Tom Lydon of ETF Trends whether ETFs are too powerful.

Most of this asks will ETFs take over for mutual funds. But then says some ETFs don’t do what they say. Again, this is a case of investors not knowing what they are buying. So, who’s fault is that?

I’m Speaking in Times Square on ETFs

I will be talking about ETFs and sigining copies of ETFs For The Long Run: What They Are, How They Work and Simple Strategies for Successful Long-Term Investing at the New York Financial Writers Drink Night on Tuesday, May 26.

The event will be held at Playwright’s Celtic Pub at 732 Eighth Avenue (between 45-46th Streets), third floor. It will run from 6-8 PM.

If you want to get a better understanding of ETFs and ask some questions, come on down.

I will explain the nuts and bolt differences and how the ETF can offer so many advantages over mutual funds and the purchase of individual stocks. I will also talk about how commodity and currency ETFs are different from stock ETFs and a little bit about the details of the leveraged and short ETFs.

Book Review of ETFs for The Long Run

Research Magazine just came out with a supplement called the Guide to ETF Investing 2009. Some great articles in there.

On page 8 of the guide is a review of my book ETFs for the Long Run. The link goes to a PDF file. The article was written by Ron DeLegge, the editor of ETFGuide.com, a great resource for ETF information. I am reprinting it here because I can’t link directly to the article.

Long-Term Thinking

Mutual funds may have enjoyed a 65-year head start, but the interest in ETF investing by individual investors and financial professionals is blossoming. Naturally, the rise of ETFs has led to a proliferation of subject material related to this still emerging investment vehicle. ETFs for the Long Run tackles this growing investment universe in a fun, readable and easy-to-comprehend manner.

The first few chapters take readers through a brief review of how ETFs came about. Nathan Most, a product developer for the Amex was instrumental in helping to launch the U.S. ETF marketplace. Most asked his development team, “Why can’t we create a warehouse receipt which would be backed by the underlying stock in the index but trade like a share of stock itself?” His question would later be answered with product prototypes that would eventually lead to the first U.S.-listed ETF in 1993, the Standard & Poor’s Depository Receipt (SPY).

Author Lawrence Carrel writes about ETFs as being a “better mousetrap.” He argues that mutual funds are inefficient from a cost standpoint: “Funds charge their shareholders for everything that goes on inside the fund, such as transaction fees, distribution charges, and transfer-agent costs.” On top of these costs, Carrel explains that there are additional charges that erode performance such as capital gain distributions. These often have the ugly habit of surprising mutual fund investors.

Timing Trouble

Remember the mutual fund timing scandal from 2003? Carrel suggests the 2003 scandal actually helped to fuel the popularity of ETFs. As you may recall, mutual funds were accused of breaking their own rules by allowing a select group of privileged investors to late-trade and market-time within their funds. On one hand, fund companies were telling investors to be long-term investors. On the other hand, these same companies were allowing hedge funds to make quick short-term profits at the expense of long-term investors. In contrast, ETFs avoided becoming tainted by the scandal because ETF investors are unaffected by the trading activity of their fellow shareholders.

ETFs for the Long Run explains the importance of building an ETF portfolio that accomplishes a logical financial mission. Carrel cites the classic 60/40 conservative portfolio which has substantially less exposure to stocks and more exposure to bonds. He suggests an equity mix using SPY, VO, IWM and EFA. For the bond position, he uses BSV, BLV, CFT and TIP. He also throws in a REIT fund (VNQ) for non-correlated market exposure.

Future Tense

Toward the end of the book, Carrel considers what the future of the ETF marketplace could become. While active ETFs have yet to make any significant impact in the business, the number of active mutual funds outnumbers that of index mutual funds. Could the same thing eventually happen with ETFs? Another area of future ETF asset growth is inside the lucrative 401(k) retirement market. Millions of 401(k) investors have no low-cost investment options or diversified choices like commodities, international bonds or REITs. Companies like Invest n Retire and WisdomTree are already aggressively pushing ETF/401(k) retirement plans. As complicated as ETF investing may sometimes seem, simplicity is often best. “The basic challenge for
the individual investor is to achieve a broadly diversified portfolio for the least amount of money,” states Carrel. This book should go a long
way to helping not just investors but top-notch financial professionals accomplish this noble objective.

PowerShares to Close 19 ETFs

In another depressing development for the ETF industry, Invesco PowerShares Capital Management today announced plans to close 19 of its ETFs on May 18.

A random sampling of phone calls to industry insiders brought reactions ranging from “This is very bad news” to “It’s about time.”

“After carefully evaluating numerous factors including shareholder considerations, length of time on the market, asset levels and the potential for future growth, we proposed closing certain portfolios that have not gained sufficient acceptance with investors,” said Bruce Bond, president and CEO of Invesco PowerShares, in a written statement.

In the wake of the huge run up of 2006-2007, many industry insiders and industry watchers predicted a consolidation of funds. In didn’t take long for the process to start. Just two months into 2008 Claymore Securities shut down 11 ETFs. Since, then many independent ETF firms have eliminated funds, with some firms closing shop completely. However, PowerShares is definitely the largest ETF company to shut down funds and it’s shocking to see it joining this crew.

With 135 ETFs holding $25.8 billion in assets under management as of March 31, PowerShares was one of the four main ETF companies, along with State Street Global Advisors, iShares and Vanguard Group. According to the company, the affected funds represent less than 1% of PowerShares’ total assets.

Obviously, the industry made a decision in 2006 and 2007 to throw a lot of portfolio ideas against the wall to see what stuck. Some were offbeat, but interesting concepts. Some were just stupid. But, when investors feel flush they are willing to take a chance on interesting ideas. Of course, most people now eye investment products with suspicion and aren’t willing to trust Wall Street further than they can throw it.

Part of the problem is the overall economy and market conditions. Most investors are still shell shocked from seeing how the market’s crash decimated their nest eggs. They’re currently debating whether to pull their money out of the market completely or leave what’s left alone and hope for some bounceback. That’s assuming they still have a job. As more people lose their jobs, or worry about such, they are more likely to liquidate their investments than make new deposits. And the few that are willing to make new deposits are looking for the safest, most stable funds. Some of these ETFs probably could have survived in a more accepting market environment. But today investors sure don’t have any desire or patience to experiment with an offbeat portfolio idea like the PowerShares Dynamic Hardware & Consumer Electronics Portfolio (PHW), one of the funds due to close.

Here is the list of funds to close

* PowerShares Dynamic Aggressive Growth Portfolio (PGZ)
* PowerShares Dynamic Asia Pacific Portfolio (PUA)
*PowerShares Dynamic Deep Value Portfolio (PVM)
* PowerShares Dynamic Europe Portfolio (PEH)
* PowerShares FTSE RAFI Asia Pacific ex-Japan Small-Mid Portfolio (PDQ)
* PowerShares FTSE RAFI Basic Materials Sector Portfolio (PRFM)
* PowerShares FTSE RAFI Consumer Goods Sector Portfolio (PRFG)
* PowerShares FTSE RAFI Consumer Services Sector Portfolio (PRFS)
* PowerShares FTSE RAFI Energy Sector Portfolio (PRFE)
* PowerShares FTSE RAFI Europe Small-Mid Portfolio (PWD)
* PowerShares FTSE RAFI Financials Sector Portfolio (PRFF)
* PowerShares FTSE RAFI Health Care Sector Portfolio (PRFH)
* PowerShares FTSE RAFI Industrials Sector Portfolio (PRFN)
* PowerShares FTSE RAFI International Real Estate Portfolio (PRY)
* PowerShares FTSE RAFI Telecommunications & Technology Sector Portfolio (PRFQ)
* PowerShares FTSE RAFI Utilities Sector Portfolio (PRFU)
* PowerShares High Growth Rate Dividend Achievers Portfolio (PHJ)
* PowerShares International Listed Private Equity Portfolio (PFP)

Personally, I’ll be sad to see the retirement of the ticker symbols PDQ, which I always thought of as Pretty Damn Quick, and PUA, the abbreviation for Pick-Up Artist.

Next week, the funds will begin the process of liquidating their respective portfolios. According to the press release, this process will cause each fund’s holdings to deviate from the securities included in its underlying index and each fund to increase its cash holdings, which may lead to increased tracking error. Shareholders may sell their holdings prior to May 19. Shareholders of record on the close of business May 18 will receive cash equal to the amount of the net asset value of their shares as of May 22, which will include any capital gains and dividends, in the cash portion of their brokerage accounts.

Stewart Pummels Cramer and It’s My Fault

Cramer, I’m sorry, man. I didn’t mean to bring a whole media circus upon your head. And now some guy named Stewart is involved and making a mockery of what you do and your network’s credibility. This has really gotten out of hand.

The whole thing started a month ago when I pretty much said Jim Cramer, the host of CNBC’s Mad Money program, didn’t know what the hell he was talking about with respect to ETFs. In particular, Cramer was calling for the SEC to ban the ProShares UltraShort Financials ETF (SKF). He said this was a dangerous vehicle for investors. I said Cramer was out of line and that people should read the prospectus before buying something like this. Then I, well, I wasn’t very nice and pointed out he told people to hold Bear Stearns just days before it went out of business.

IndexUniverse.com picked up on this and decided to interview me about my views on Cramer and SKF. I tried to be nice, but basically said Cramer was wrong. Well, from there it just picked up steam. I was watching The Daily Show with Jon Stewart on Monday, which is my wont to do, and lo and behold, he has CNBC’s financial news commentary in his crosshairs of satire. Stewart pretty much lambasted the entire CNBC network for not telling the American people we were heading into a crisis and for sucking up to the CEOs that caused this crisis. Cramer took offense and started biting back. Originally started as an attack on CNBC commentator Rick Santelli, Cramer became the face of the debate as he became more vocal about Stewart’s attack. Stewart continued for the next three days, culminating with Cramer coming onto the Daily Show. The interview nearly lasted for the whole show. Stewart pulled the cartoon trick of ripping out Cramer’s heart and eating it in front of him before letting him die.

It wasn’t very funny and it wasn’t really satire. But it was intense and vicious. Stewart was unrelenting in his criticism of CNBC. He blamed the network for failing to inform investors and instead acting as cheerleaders for Wall Street. All the country’s anger at Wall Street came through Stewart in an accusation that was compelling the way a big car accident is compelling. And Jon was right, the media, with a few notable exceptions, did cheer this on.

The problem Stewart said was the “gap between what CNBC advertises itself as and what it is.” The sad thing is most people know that CNBC is a cheerleader for the market. One just needs to look at the way they chastised Congress for not passing the TARP fast enough in September and their refusal to look deeper at, let alone attack, Treasury Secretary Henry Paulson’s blatant attempt at a power grab with now government oversight.

Stewart was brilliant. The upsetting thing for me was that he, a satirist, commentator and comedian, was asking harder hitting questions than most of the mainstream media, of which I am a member, has over the past 10 years. Essentially, is showed that most of the financial media hadn’t learned anything from the cheerleading that led to the Internet bubble of 1999.

“I know you want to make finance entertaining, but finance isn’t a … game,” said Steward. “You think it’s a sin of omission, but it’s a sin of commission. … You knew what the banks were doing and you touted it for months. So to say it’s a crazy once in a lifetime tsunami is disingenuous at best and criminal at best.”

Surprisingly, unlike many of the commentators out there on both the left and right, Stewart is very polite with those he doesn’t agree with. He never screams at guests he doesn’t agree with and never interrupts them. Still, he can be brutal and vicious.
I give Cramer a lot of credit for taking on Stewart on Jon’s home court. Stewart is like a football team that never loses at home. And he uses the old “60 Minutes” trick of pulling out videos of people contradicting themselves. Tim Russert was a master of this and one of the few in the mainstream media to use it.

I can’t decide what I think of Cramer’s performance. A lot of people say he should have been as stubborn and feisty as he is on his show and defended CNBC more. Maybe he realized it was indefensible and maybe CNBC realized this was a way for the network to acknowledge they screwed up and to make a mea culpa to the public. Since Cramer has no problem apologizing for his mistakes, and since he is one of the network’s biggest personalities, he seemed a perfect choice to become the point man on this.

Cause in the end, as Stewart asked, “Whose side are you on?”

All in all it was incredible television, compelling, entertaining, enlightening, educational and as bloody as a talk show can get from two men sitting at a desk wearing ties.

This is only the pinnacle of why many people get their news from The Daily Show. While a lot of the show can be sophomoric, it is also one of the most intelligent shows on TV. Especially because it is one of the only shows on TV that talks to authors of serious books on topics of national and international importance. It’s a comedy show? Who else on TV talks about books besides Oprah and Brian Lamb on Cspan? And Oprah doesn’t deal with nonfiction too much. Sure plenty of people interview authors, but hardly ever for 8 minutes about the subject of the book.

So, Jon, or whoever on your staff who reads this blog, thanks. And if you are looking for another book, check out ETFs for the Long Run.

This Kid is Gonna Have Nightmares Tonight

Checkout this commercial talking about how you don’t have to worry about your financial future if you keep your investments with AIG. HA!. This kid wakes up in the middle of the night scared about his parents taking care of finances. They say, “Don’t Worry, buddy. We have AIG.” In light of what went on with AIG and the stock market in the wake of the Federal government bailout, this kid is gonna have nightmares tonight.

ETFs in 401(k) Plans

A June survey conducted by State Street Global Advisors and Knowledge@Wharton determined that financial advisors think the biggest potential growth area for the exchange-traded fund industry is in 401(k) plans. Of the survey’s 840 respondents, 43% said that 401(k)s would be the biggest area of growth for the ETF industry going forward, compared with 27% for actively managed ETFs and 20% for unified managed accounts.

Ironically, this perspective was soundly rebutted in a July 2008 article in Journal of Indexes. The article, “Why ETFs And 401(k)s Will Never Match” (by David Blanchett and Gregory Kasten), outlined a variety of reasons why ETFs may never gain a large foothold in the 401(k) industry. Among the reasons listed were transaction costs, including the bid/ask spread and the brokerage commission associated with every purchase and sale of ETF shares. Another disadvantage noted was the inability to buy fractional shares of ETFs. The fact that the tax advantage ETFs offer in taxable accounts disappears in a tax-deferred plan such as a 401(k) was another highlighted drawback.

It’s been nearly two and a half years since I first reported that the industry is devoting resources to the idea of incorporating ETFs into the 401(k) platform. It seems like a perfect time to evaluate the current state of ETFs in defined contribution plans in general, and in 401(k)s specifically.

This story was originally published on Index Universe. For the full article click here.