Equity ETFs declined for 1st quarter in nine

In a summer filled with geopolitical uncertainty, the Federal Reserve tapering its bond-purchasing programs and hinting of changes in interest rate policies, and slowing economic growth from China, investors still managed to push the major indexes to new heights — although only at the margin — as U.S. economic reports showed continued growth and second-quarter earnings season revealed upside surprises.

For the full third quarter, equity funds posted their first negative quarterly return in nine quarters, with the average equity exchange-traded fund (ex-short bias, leverage and exchange-traded notes) three-month return declining 3.65% as investors contemplated an increase in market volatility last month and began taking some hard-won profits off the table.

INVESTORS’ RESOLVE

In September, investors showed amazing resolve in the face of enough geopolitical risk to bring about the oft-called-for but so far elusive 10% technical correction. Warnings of imminent attacks on Western targets by Islamic State jihadists, increasing tensions in Russia/Ukraine, Syria’s civil war and Hong Kong’s recent democratic protests, while being closely watched, had yet to produce wholesale sell-offs in the market.

Many investors initially fretted at the beginning of September about the lower-than-expected August jobs report, along with news of the European Central Bank’s aggressive easing measures and hints of plans to buy asset-backed securities. These were accompanied by consensus-beating University of Michigan/Thomson Reuters consumer-sentiment readings, renewed commitment by the Fed to facilitate the economic recovery, and Scotland’s vote to remain part of the U.K., all of which kept investors in the game but still on guard.

ETF investors (authorized participants) were net purchasers of ETF assets for the quarter (to the tune of $42.6 billion), injecting a net $37.9 billion into equity ETFs, while continuing to pad the coffers of taxable fixed- income ETFs (+$3.8 billion) and municipal debt ETFs (+$0.8 billion). By contrast to the second quarter, when authorized participants favored non-domestic (+$16.2 billion) over domestic (+$13.8 billion) issues, they appeared to prefer domestic equity ETFs, injecting $22.6 billion versus $15.3 billion, respectively — both relatively strong inflows, considering the increased uncertainty. Authorized participants showed a preference for emerging-markets ETFs (+$9.6 billion) and international developed-markets ETFs (+$7.2 billion) during the quarter, perhaps because of the relative outperformance of China region ETFs (+3.99%, the top-performing Lipper equity ETF classification for the quarter) and their recent aversion to European region ETFs (-7.83%).

Tom Roseen is head of research services for Lipper.