Wall Street Daily

Hot ETF Trends to Avoid in 2015

Though it may be hard to do, we need to shift our attention away from the twisted wreckage within the energy sector for a second.

That’s because, as 2014 winds to an end, investors need to make a plan for 2015. And in order to formulate a strategy, we need to reflect on the past year.

Thus, I’ve taken a look back to see where the “hot money” was flowing. If we want to poach the investing herd in 2015, then we’ll have to identify the most popular trades.

Analyzing exchange-traded fund (ETF) flows is a great way to do this and can help us avoid overly crowded trades going forward.

Here are some of the hottest ETF trends in 2014:

1. The Year of the S&P 500

It’s certainly been a tough year for active managers, and the fund flows echo this difficult stock-picking environment.

Year to date, three of the top seven ETFs with the largest fund inflows are S&P 500 Index tracking funds: the iShares Core S&P 500 (IVV), Vanguard S&P 500 (VOO), and SPDR S&P 500 (SPY).

Cumulatively, inflows for these funds total nearly $26 billion this year, slightly lower than last year’s $29 billion.

2. Euro Hedged Equity Is All the Rage

Everyone hates the euro. So naturally, two of the fastest growing ETFs in 2014 provide exposure to European equities but hedge the exposure to the euro.

Introduced in October 2013, the Deutsche X-trackers MSCI Europe Hedged Equity (DBEU) grew rapidly in 2014, going from under $10 million in assets to nearly $700 million today.

The WisdomTree Europe Hedged Equity ETF (HEDJ) actually experienced the ninth-largest fund inflow of all ETFs in 2014, totaling $4.4 billion.

The popularity of these euro-hedged funds is reminiscent of the gravitational pull of the WisdomTree Japan Hedged Equity Fund (DXJ) in 2013. Year to date, the DXJ has slightly underperformed the S&P 500, but with dramatically larger drawdowns and higher volatility.

3. REITs Getting Bloated

Real estate investment trusts (REITs) have been a very popular choice in 2014, as many investors are reaching for yield.

The Vanguard REIT (VNQ) has experienced the 10th-largest inflow of any ETF. Also, the Schwab U.S. REIT (SCHH) saw strong inflows relative to its smaller size.

As I’ve said before, most of the largest REITs, which these ETFs will have the highest exposure to, are expensive.

Here’s a sector that you definitely want to go active with, since there are smaller REITs with cheap valuations.

4. Transports on Fire

Airlines, railroads, and shipping companies are big beneficiaries from cheaper oil, since gasoline, diesel, and jet fuel are major inputs for these transportation companies.

However, the transport stocks were already making headway before the price of oil started to collapse this summer.

The iShares Dow Jones Transportation Average ETF (IYT) has seen over $1 billion in inflows this year.

The SPDR S&P Transportation ETF (XTN), which has a healthy 27% allocation to commercial airlines, is one of the fastest growing ETFs in 2014. Its assets have ballooned from around $70 million to over $500 million.

This transports trade is quickly becoming a “no lose” proposition for investors… at least in their own minds.

5. Peak MLPs

The iPath S&P MLP ETN (IMLP) – although technically not an ETF – has displayed perhaps the second most impressive rise, after DBEU. Assets for IMLP have risen from around $50 million to upwards of $750 million.

These inflows were surely ill-timed, but the master limited partnership (MLP) craze is a longer-term phenomenon.

Fund assets for the JPMorgan Alerian MLP ETF (AMJ), which was created in 2009, peaked at around $6.8 billion in September 2014.

Naturally, with the price of oil cratering, someone has already yelled fire in this crowded theater.

And as I showed earlier this week, many MLPs have questionable payout sustainability.

Bottom line: As long as there are markets, there will always be hot money flows.

As we cautioned with the iShares iBoxx High Yield Corporate Bond ETF (HYG) and the PowerShares Senior Loan Portfolio (BKLN) earlier this year, significant and sustained fund inflows tend to indicate unfavorable risk-reward relationships.

Safe (and high-yield) investing,

Alan Gula, CFA