By William Patalon III
Money Morning/The Money Map Report
Last year - at the height of a global financial crisis that tipped stocks into a freefall - investors still added $176 billion to exchange-traded funds, the hot investment class better known as ETFs.
So far this year - as investors yanked $49 billion out of conventional mutual funds - investors poured $35 billion into ETFs, said Simfund MF, a fund-tracking database produced by a recent report by Strategic Insight.
Investors are attracted to ETFs because they combine the best features of individual stocks with those of mutual funds. As portfolios, ETFs offer the diversification of a fund. But they trade on exchanges like stocks, giving them the liquidity of that individual security.
What's more, ETFs come in countless flavors: They are focused or theme-oriented portfolios that enable investors to participate in the latest trends or invest in the hottest markets.
As an example, consider the global commodities shopping spree that China has been on for the past several years - a trend that Money Morning has highlighted as a long-term profit play that readers need to keep in mind.
In a column written back in April, noted ETF expert Gary A. Gordon said that investors were looking to capitalize on that trend - and were looking at ETFs as the way to do so.
"I'm not surprised by the sheer volume of questions that I get about commodity ETFs," Gordon said. "China's buying up everything from common use metals to rare earth metals. It follows that lots of folks wish to buy what China buys."
While the $600 billion-plus invested in U.S. ETFs is admittedly dwarfed by the $9.3 trillion managed in non-ETF mutual funds, exchange-traded funds have been the investment industry's hottest product since they were first introduced in 1993.
And analysts expect that trend to continue. As the afore-mentioned statistics show, ETFs have been slower to catch new investor capital this year than last - a fact analysts say is due to reductions in investor nerve and shortages of available cash, both the result of the worst U.S. recession in decades.
Although ETFs may be down, they're certainly not out. In fact, Strategic Insight projects ETF assets will hit $1 trillion in 2011 - an increase of nearly 70% from current levels.
The longer stocks continue their current surge -- or at least remain stable - the hungrier investors will get for ETFs, a top ETF-industry executive told Reuters.
"If we do see better capital markets, we believe that the growth to the structure itself is in its very early innings," Fran Kinniry, principal of Investment Strategy Group at The Vanguard Group Inc., which has about $60 billion in 39 ETFs, told the news service.
Loren Fox, senior research analyst at Strategic Insight Senior Research Analyst Loren Fox says that ETFs aren't supplanting conventional mutual funds, but instead are capturing money that would have otherwise been dedicated to individual stocks.
That's in large part due to the perception that ETFs are a "diversified alternative" to a single-stock play, enabling the investor to make a bet on a sector (banks), an asset class (gold), or an investment theme (alternative energy). At a point in time when "risk" is something to be avoided at virtually any cost, ETFs take on an added allure, said Scott Burns, an ETF analyst for Morningstar Inc. (Nasdaq: MORN) in Chicago.
"I may think banks are undervalued and want to invest in them, but I don't know which one has a bomb in the car and which one is a goldmine," Burns told Reuters.
Indeed, specialized ETFs have brought in the largest amount of investor capital in the year's first seven months. The top three (and the total inflows) so far this year have been:
- Gold ($13 billion-plus).
- Natural resources ($8.8 billion).
- Government bonds (Nearly $8.8 billion).
For Money Morning readers, the ability to more easily invest in markets beyond U.S. borders may be the key advantage that ETFs offer. This capability hasn't been lost on investors in general, says Gordon, the ETF expert.
Indeed, 12 years ago, there were only 21 ETFs that invested in foreign markets. And most of those weren't all that exciting, focusing large-cap, developed regions or on single countries in Western Europe.
Today, there are 174 foreign ETFs trading on U.S. securities exchanges. They focus on foreign economic sectors, specific emerging economies, small-cap foreign stocks, and even foreign bonds, Gordon said.
"What's the reason for the enormous demand for international ETFs, particularly emerging market ETFs?" Gordon asked. "For one thing, there is close-to-unanimous agreement that China, India and parts of Latin America have better economic growth prospects than developed economies. And stronger economic growth often leads to larger capital appreciation in one's stock portfolio."
There's even the profit prospects emanating from the financial crisis to consider.
"I do believe that emerging countries have the increased potential to 'decouple' from the developed world going forward," Gordon said. And while many overseas markets have been stung by the financial crisis, those smaller markets are alluring since they figure to be "exceptionally resilient to global stimulus."
[Editor's Note: In a related story that appears elsewhere in today's issue of Money Morning, Contributing Editor Shah Gilani details key unfolding developments related to exchange-traded funds. To access that story directly, please click here.]
News and Related Story Links:
Real Demand Behind The Explosive Growth of International ETFs.
ETF growth slows, but bright future still forecast.
ETF Expert Gary A. Gordon:
Web Site Bio.
Money Morning Special Investment Report:
What Companies Are Profiting From China's Commodities Crusade?
About the Author
Before he moved into the investment-research business in 2005, William (Bill) Patalon III spent 22 years as an award-winning financial reporter, columnist, and editor. Today he is the Executive Editor and Senior Research Analyst for Money Morning at Money Map Press. With his latest project, Private Briefing, Bill takes you "behind the scenes" of his established investment news website for a closer look at the action. Members get all the expert analysis and exclusive scoops he can't publish... and some of the most valuable picks that turn up in Bill's closed-door sessions with editors and experts.