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ETF Flows Hint at Rise in Overseas Investing: SSgA

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Exchange-traded funds overall are on track for another strong year, says David Mazza, head of research for SPDR ETFs and State Street Global Advisors Funds Research Team.

“We continue to see the ETF industry grow robustly across, effectively, the entire landscape,” Mazza said during a visit to ThinkAdvisor’s New York office. “Equities and fixed income products both … have taken in sizable assets year-to-date.”

According to SSgA and SPDR’s 2015 Midyear ETF & Investment Outlook report, of which Mazza is an author, net inflows of ETFs have hit $72.5 billion so far, pushing overall industry assets under management to $2.12 trillion across 1,496 funds.

Worldwide, assets invested in globally listed exchange-traded funds and products set a new record of $3.02 trillion in May, according to ETFGI’s preliminary monthly global insight report.

And a recent report from Goldman Sachs predicts ETF assets will hit $6 trillion by 2020.

“[The Goldman report] seems like a big number but based on the speed at which the industry is growing might actually be conservative,” Mazza said.

Mazza also pointed to a recent study from the Financial Planning Association that showed ETFs have become the preferred investment vehicle among advisors.

“[T]he economy, while a bit shaky and mixed, is trending in the right direction, and people are beginning to have more confidence, but they’re looking toward ETFs increasingly as the preferred vehicle to express those opinions,” he said.

In the interview, Mazza talked about some of the trends he sees in the 2015 Mid-Year ETF & Investment Outlook report and recapped what recent ETF flows hint about how investors are positioned for the second half of 2015.

International Equities

The most noticeable trend in the midyear outlook is that investors are choosing international equities over U.S. equities, Mazza said.

The report finds that investors are looking beyond U.S. borders for opportunities and more attractive valuations in international markets, which may may also reflect lower-than-expected recent U.S. economic growth.

“People have looked overseas for that valuation opportunity, for that boost in sentiment in the fact that the dollar continues to look like the strongest currency and will be potentially for some time,“ Mazza told ThinkAdvisor.

According to the report, investors clearly turned to Europe early this year on expectations of European Central Bank (ECB) easing, although investors continue to closely monitor the tenuous situation in Greece.

“Because of the ECB’s actions and the weakness of the euro in particular, it drove investors to say, ‘OK … while long-term Europe might continue to face some structural challenges, now might be the time to diversify away from the U.S.’” Mazza said. “Purely index-based exposure might not necessarily give you the gains in the U.S. that people become accustomed to.”

Sector Investing

In addition to investors looking overseas for opportunities, they’re also reassessing their domestic exposure.  Another trend Mazza has found in the midyear outlook is the growth of sector investing in the U.S.

“Advisors are now taking a cue from the institutional community who have done sector investing for some time and saying, ‘Well I understand that the market for sort-of single-stock investing still remains — it’s hard. It’s risky because then you’re basically placing all your bets on one particular company,’” Mazza said.

Instead, investors can get access to a sector or an industry. Mazza gave homebuilders stock as an example — where once the environment for homebuilders stock have been challenged, now household formations have increased and so have new home sales.

“So, people that are looking to take advantage of that can add or tilt their portfolio toward these types of stocks in an ETF at a very low cost and get diversification not just of one homebuilding company but 50 of them,” Mazza said.

The outlook report finds there could be even more scattering among sector performance as the economy strengthens and the recovery matures, rather than “a rising tide lifting all boats.”

The report states, “There have been multiple sector rotations over the past year with different sectors taking the leadership baton, which is normal as a recovery lengthens.”

Energy Sector

Up until the last months and weeks, energy had been by far the most popular sector, Mazza said.

“Which is surprising to a lot of folks because 2014 as everybody knows was not an easy ride for those stocks,” he added.

The report finds that inflows in the energy sector early this year may have been strongly driven by creation-to-lend activity as short interest spiked.

“People actually were beginning to buy before oil prices rebounded,” Mazza told ThinkAdvisor. “I wouldn’t even call it getting lucky. They studied it, they looked for where the opportunity was … so, a lot of money moved into the energy space to start the year. Because energy stocks up until recently have done fairly well, that was a great trade for those investors.” The energy sector has taken in $6.49 million in assets year-to-date, according to the report.

More recently though, according to the report, investors have shown signs of bottom fishing in energy-focused funds after the dramatic sell-off in oil as short interest has fallen and flows continue to increase,” the report states.

Financial Sector

If rates begin rising, the financial sector and banks in particular have positive exposures to changing interest rates, according to the report.

“As we’re beginning to see in the last month, from a flow perspective, and continuing into this month, people are beginning to look at financials for the first time in a while,” Mazza told ThinkAdvisor. “Financial stocks obviously do well historically in a rising rate environment but they also, in today’s market environment because they’ve been ignored by the investor community, are another area that have some favorable valuations.”

The report suggests that allocating to these exposures in the financial sector and banks may allow U.S. equity investors to position their portfolios for rising rates.

What’s most interesting to Mazza is the smaller type of financials, like the regional banks.

“They do very, very well in an improving U.S. economy,” Mazza said. “They also do well when we begin to see mortgage lending and consumer loans increase. That’s really their bread and butter, you know they’re not capital markets participants.”

And as consumer discretionary increases, he added that people begin to be more confident and take out loans to buy more cars or boats or do home improvements.

— Check out Investors Boost Cash on Threats of Rate Hike, Grexit on ThinkAdvisor.