The first half of 2013 has been quite a ride — in both the stock and bond markets — and fund flows have been largely accurate in depicting the best and worst performing asset classes.
The biggest story by far has been the recent unprecedented rise in interest rates, which sent bond prices tumbling from April highs. TrimTabs reported an estimated $80 billion was yanked from bond ETFs and mutual funds in the month of June alone. That number dwarfs the $42 billion in bond fund redemptions that occurred in October 2008 during the collapse of Lehman Brothers.
It also signals that investors are becoming increasingly skittish with the prospect of tapering from the Federal Reserve. The result: risk aversion, especially in options such as the iShares TIPS Bond Fund (TIP) and the iShares Investment Grade Corporate Bond Fund (LQD). According to Index Universe, these funds have experienced over $9 billion in outflows since the beginning of the year — redemptions due in large part to the interest rate sensitivity of the underlying bonds in these ETFs.
Conversely, the same fund flow data confirms that bond ETFs with lower average durations and less sensitivity to interest rates have gained assets. The PowerShares Senior Loan Portfolio (BKLN) and Vanguard Short Term Bond ETF (BSV) are two of the top ETFs for new assets in 2013, with new additions of over $3 billion each. Both of these funds have held up well despite the steady stream of selling throughout the bond sector.
Another area of the market that has seen tremendous inflows this year are Japan ETFs. The WisdomTree Japan Currency Hedge ETF (DXJ) and the iShares MSCI Japan ETF (EWJ) have increased their asset bases by a combined $13 billion.
Investors that chose DXJ this year have been rewarded with gains of over 25%, which bests the 16% return of EWJ over the same time period. It seems the currency hedging component of DXJ has added a measurable impact to the total return of the ETF when compared to a straight equity index strategy. In fact, the currency hedging story has been so successful this year that WisdomTree recently launched similar strategies for Japan small-cap stocks, European stocks and U.K. stocks.
Other notable asset flows in the first six month of the year include the SPDR Gold Shares (GLD) which has shed an astounding $18 billion in assets along with a price decline of over 25%. In addition, the iShares MSCI Emerging Markets ETF (EEM) has declined over 12% and posted outflows of $8 billion.
Of course, one thing I think we can all agree on is that the next six months will most likely not look anything like the last six months. Personally, I believe we will see a return of stability in interest rates which may reverse the trend of bond fund redemptions.
In my experience, the largest redemptions and lowest sentiment typically occur near market a bottom which is why I believe the selling in bonds is overdone. The same can be said for gold prices which may be due for a short-term bounce considering the pounding that they have taken this year.
In addition, I would not be surprised to see a more profound correction in stocks during the next six months. While the timing and depth of the correction are unknown, the key will be navigating this volatility with an eye towards risk management and the ability to take advantage of new opportunities with dry powder.
Some of my favorite areas of the market to buy on a pullback include dividend-paying stocks, regional banks and minimum volatility ETFs.
David Fabian is the Chief Operations Officer and Managing Partner of Fabian Capital Management. To get more investor insights from Fabian Capital, visit their blog here or click here to download their latest special report The Strategic Approach to Income Investing.