10/05/16   Behind the September ETF Flows

In the next week or so, you will likely see reports indicating that $3.6 billion flowed into Real Estate ETFs in September. However, that figure is misleading, because actual net inflows into the underlying REITs was only about $0.6 billion. The other $3.0 billion is the result of an accounting gimmick.

On September 16, major index and ETF providers implemented structural changes to align themselves with the recent change to the Global Securities Classification Standard (“GICS”), which promoted Real Estate to sector status by extracting it from the Financials sector. The change did not create any new REITs or add REITs to the GICS system. Instead, it merely pulled the existing equity REITs from the Financials bucket and placed them in their own Real Estate bucket.

Given this scenario, one would expect the combined assets of all Financials and Real Estate ETFs to have similar levels on August 31 and September 30. There is an expectation for a reduction of assets in Financials ETFs due to the extraction of the REITs, but those same assets were transferred into Real Estate ETFs and should offset this. Granted, there are also market valuation changes and differences in industry-level asset flows that come into play, and it turns out that market declines were September’s largest contributors.

On August 31, there was $34.5 billion allocated to Financials ETFs and $65.8 billion in Real Estate ETFs, for a combined total of $100.3 billion. During September, assets in Financials declined by $5.0 billion, and Real Estate ETFs increased $2.3 billion, resulting in a combined loss of $2.7 billion. Market setbacks account for about $2.5 billion of the decline, suggesting about $0.2 billion of net outflows.

One obvious peculiarity in the September flows that I noticed is the asset-flow accounting methodology applied to the Financial Select Sector SPDR (XLF) when it spun off its REIT holdings. It accomplished this by issuing a special dividend consisting of shares of the Real Estate Select Sector SPDR (XLRE). Although about $3 billion in assets came out of XLF in this manner, none of it was logged as an outflow. Instead, the nearly 665 million shares of XLF saw the value of their shares reduced by $4.44 each. Since the share count wasn’t reduced, there were technically no outflows as a direct result of this stock dividend.

The same $3 billion that came out of XLF went directly into XLRE. However, XLRE reported it as an inflow because it had to create additional shares that were issued as dividends. Even though there was not any change in the combined assets as a result of this dividend, the industry flow reports show about $3 billion of new inflows that didn’t really occur.

The September “reported” asset flows are $0.87 billion in outflows for Financials ETFs and $3.65 billion of inflows for Real Estate ETFs, resulting in a net inflow of $2.78 billion. However, by properly adjusting for the $3 billion that moved from XLF to XLRE, the net inflow turns into a net outflow of $0.22 billion.

Total assets across the entire U.S. ETF and ETN industry increased 0.7% to $2.4 trillion in September. Total inflows were reported as $17.8 billion, but due to the special dividend anomaly discussed above, the adjusted figure is about $14.8 billion. The year-to-date inflow figure now stands at $165 billion.

There were massive dislocations in the sector rankings over the past week. I have commented numerous times over the years about two sectors swapping positions. edgecharts-2016-10-05Typically, this involves two closely ranked categories, resulting in each moving one or two positions in opposite directions. Over the past week, Energy and Utilities swapped positions. However, it was not a mere one or two position change. Instead, each made a huge nine-position move. The distance of this position swap is the largest I have ever seen, and it is just one position short of the theoretical maximum. Energy zoomed from last place to second, swapping places with Utilities as it plunged from second place all the way to the bottom. What happened? The rise in Energy can be attributed to the run-up in oil prices resulting from OPEC’s decision to reduce production limits. Meanwhile, the recent tailspin for the Utilities sector commenced a few days before the crude-oil rally got underway, so it is not entirely attributable to higher costs. Instead, the reason seems to be the ongoing investor nervousness regarding the prospect of higher interest rates. Technology was unaffected by the relative-strength realignment and held its top-ranked position for a ninth week. Industrials and Financials moved a step higher, while Consumer Discretionary and Materials climbed two. Health Care, Telecom, and Real Estate dropped in the rankings, and they flipped from green to red in the process. Real Estate plunged from third to 10th in a decline that eclipsed all but Utilities.

The four smallest-capitalization categories put additional distance between themselves and the others. Micro-Cap is on the top for a fifth week and has a clear advantage over the three Small-Cap segments that are now in a virtual tie for second place. The seven other larger-capitalization categories are tightly bunched in a near-tie for fifth place or last place, depending on your perspective. Value has a slight edge over Growth at all capitalization levels, but it is not enough to warrant any action at this time.

China lost momentum this week, but it still has a commanding lead over the other global categories. Latin America jumped from fifth to third, earning itself the title of “most improved” this week. Emerging Markets and Pacific ex-Japan held steady, while Japan slid three places lower. Little changed in the lower half of the rankings, although the spread in momentum scores has narrowed. The U.S. markets seem to be holding up, but they do not look all that wonderful when compared to the rest of the world. The U.S. slipped a notch in the relative-strength rankings, and it is now in a virtual tie with the U.K. and Canada for last place.

The charts above depict both the relative strength and absolute strength of various market sectors, styles, and geographic locations on an intermediate-term basis. Each grouping is sorted (top to bottom) by relative strength. The magnitude of the displayed RSM value is a measure of absolute strength, which is our proprietary method of measuring and reporting the intermediate-term strength as an annualized value.


“ETF flow trend does not have any predictive value, but is a signpost of where we are.”

—Nicholas Colas, chief market strategist at Convergex


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