Equity ETF investors kept the pedal to the metal in the second quarter

Equity ETFs rise for an eighth consecutive quarter, though it wasn't all smooth sailing

Jul 22, 2014 @ 7:00 am

By Tom Roseen

Despite the old adage of “sell in May and go away,” investors kept the pedal to the metal in second quarter of 2014, pushing the average equity exchange-traded fund's (ETF) three-month return to 4.71%, with equity ETFs posting their eighth consecutive quarter of plus-side returns. Q2 was not all smooth sailing, though. Sectarian violence in Iraq set investors back on their heels and sent prices of both oil and gold higher as President Obama ordered 300 members of the U.S. special-operations forces to the country. Investors became concerned that persistently rising oil prices would impact economic growth.

Even with ongoing geopolitical concerns between Russia and Ukraine, market pundits' calling for a near-term correction, and the Federal Reserve's continued taper countdown, a solid May jobs report (the U.S. economy added some 217,000 jobs, outpacing the analyst-forecasted 210,000) and interest rate cuts by the European Central Bank (ECB) toward the beginning of June rallied the U.S. market to new highs and sent the Stoxx Europe 600 to its highest level in six years.

Increased M&A news, a good May industrial production-and-capacity-utilization report, a booming new-home-sales report, and better than expected China retail sales kept investors in the game despite soaring oil prices. Toward June month-end, dovish comments by the Fed helped catapult the S&P 500 to its 22nd record close for the year and the NASDAQ to its strongest finish in 14 years.

ETF investors (authorized participants, or APs) were net purchasers of ETF assets for the quarter (to the tune of $34.9 billion), injecting a net $30.0 billion into equity ETFs, while continuing to pad the coffers of taxable fixed income ETFs (+$4.2 billion) and municipal debt ETFs (+$0.7 billion). In contrast to Q1 2014, when APs favored domestic (+$6.1 billion) over nondomestic (+$0.8 billion) issues, for Q2 they appeared to prefer nondomestic equity ETFs over domestic equity ETFs, injecting $16.2 billion versus $13.8 billion, respectively—both handsome inflows for the quarter. Nonetheless, APs showed a rising predilection for emerging-market funds (+$9.0 billion) over developed-market funds (+$7.2 billion) during the quarter, perhaps as a result of the former's strong Q2 returns.

Strong performance from some prior-quarter world equity laggards, along with a strong repeat performance from India Region ETFs, helped propel Lipper's World Equity Funds macro-classification (+5.33%) to the top of the ETF charts for the quarter, followed by Sector Equity Funds (+4.74%), U.S. Diversified Equity (USDE) Funds (+4.13%), and Mixed-Asset Funds (+3.68%).The World Equity Funds macro-group benefitted from news that India's pro-business Bharatiya Janata Party handily beat the ruling Congress Party. In addition, ECB President Mario Draghi spearheaded a cut in interest rates and turned the deposit rate for banks negative to encourage economic growth and boost inflation, and China's retail sales data beat forecasts. The India Region ETF classification (+24.70%) posted the strongest Q2 return of the world equity group (and of all equity ETF classifications), followed by Latin American ETFs (+7.00%) and Japanese ETFs (+6.23%). The three top-performing individual equity ETFs in the universe for Q2 were housed in Lipper's India Region Funds classification. At the top of the charts was Market Vectors India Small-Cap Index ETF (SCIF), returning a spectacular 43.40% for Q2. Following SCIF were EGShares India Small Cap ETF (SCIN), posting a 36.51% return, and iShares MSCI India Small-Cap ETF (SMIN), adding 32.67% to its prior quarter-end value.

The Sector Equity ETFs macro-group (+4.74%) housed three of the four top-performing classifications in the equity ETF universe for the quarter. At the top of the list for the first quarter was the Precious Metals Equity Funds classification, returning 11.72% for the quarter. The classification benefitted from a flight to safety in response to the growing turmoil in Iraq. Near-month gold prices leapt 6.08% in June and advanced 2.99% for the quarter. Sectarian violence in Iraq and geopolitical concerns in Libya, Nigeria, and Iran sent oil prices higher as investors anticipated related global supply issues, which pushed energy-related and natural resources issues to the head of the class, with Energy MLP Funds (+10.37%), Natural Resources Funds (+10.00%), Global Natural Resources Funds (+7.22%), and Utility Funds (+6.94%) all showing strong relative performance.

With corn futures at five-month lows after the U.S. Department of Agriculture reported stocks of the commodity were up 39% from June 1, 2013, and with price weakness reported in soybeans and wheat, it wasn't too surprising to see Commodities Agriculture Funds (-7.31%) posting the only negative quarterly return of the equity ETF classifications. Among the cellar dwellers for the quarter were Teucrium Wheat Fund (WEAT), posting the second worst quarterly return (-16.98%) of all individual ETFs (however, in comparison, handily outpacing ProShares VIX Short-Term Futures ETF (VIXY, -32.60%), Teucrium Corn Fund (CORN), losing 14.68% for the quarter, and Teucrium Agricultural Fund (TAGS), declining 8.90% for Q2.

Tom Roseen is head of research services for Lipper Inc.

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