TuesdayJuly 12, 2016www.bloombergbriefs.com

Vanguard Dominates Inflows With $140B Cash HaulBY ERIC BALCHUNAS, BLOOMBERG INTELLIGENCE ANALYST

Vanguard is making attracting cash look easy.The firm took in $140 billion in new money in the first half of the year, as many other

issuers and investment vehicles struggled to tread water amid market turmoil.Vanguard's flows are spread between its exchange-traded funds and active mutual

funds, with the lion's share going into its low-cost index products, some of which are now the world's largest funds. The rise of Vanguard's almost-free investing model has essentially sapped billions of dollars of potential revenue from Wall Street.

Vanguard's exchange-traded funds have taken in $38 billion in new cash this year. While about a quarter of the firmwide haul of $140 billion, it's easily the most of any ETF issuer in what has been a tough year for flows due to shaky market conditions.

Vanguard maintains a sizable 2016 lead over chief rival , whose iShares BlackRocktook in $27 billion in the period. BlackRock received slightly more cash than Vanguard in the past two years.

Vanguard's ETF flows have been accompanied by an increase in volume. The firm's products average about $4 billion in daily trading, up from just over $1 billion a day five years ago.

In some cases, Vanguard ETFs are becoming the most liquid in a category. The day after the Brexit vote, the led all European-focused Vanguard FTSE Europe ETF VGKETFs, with $1.3 billion of shares exchanged.

Vanguard's rise represents a transfer of wealth away from financial middlemen and toward investors' accounts via low fees and limited trading. Vanguard's asset-weighted fee is 0.13 percent vs. averages of 0.27 percent for ETFs, 0.72 percent for actively managed mutual funds and 1.8 percent for hedge funds.

In dollar terms, for every $3 trillion in assets, hedge funds take in $54 billion in fee revenue, while active mutual funds receive $22 billion and ETFs $8 billion. Vanguard, by comparison, collects just under $4 billion.

NEWS

Vanguard Dwarfs Entire Fund Industry in 2016 Flows

Source: Bloomberg, Vanguard, Hedge Fund Research and Investment Company InstituteFlows through June, except hedge funds through MarchETFs and mutual fund flows are ex-Vanguard

Top Performing, U.S. Listed

Top Performing, Europe

Source: Bloomberg. Data to July 11 close from a month before. Funds over $50 million AUM and unleveraged only.

Top Performing, Leveraged

Source: Bloomberg. Based on screen of entire universeof leveraged ETFs, to July 11.

July 12, 2016 Bloomberg Brief ETFs 2

NEWS

BY ELENA POPINA, BLOOMBERG NEWSTo see just how different the outlook for Chinese equities is between U.S. and local

investors, take a look at the trend in exchange-traded fund flows.Traders pulled $1.7 billion from U.S.-traded ETFs focused on China’s mainland and

offshore shares this year as of June 27, data compiled by Bloomberg show. Similar funds available on Chinese exchanges grew by about $1.7 billion during the same period.

The divergence comes as MSCI Inc.’s decision last month not to include A shares in its global benchmark indexes gives international investors one more reason to avoid some of the world’s worst-performing stocks. On the mainland and in Hong Kong, sentiment is more upbeat as some traders anticipate that government measures to boost growth and make the market more transparent are leading to improvements.

“Sentiment has gotten more bearish among U.S. investors on China,” , Stephen Tusenior analyst at , said by phone. “U.S. investors appear to Moody’s Investors Servicebe predominantly focused on the level of corporate debt combined with the slowdown in growth. These issues are also a concern of Chinese investors, but it’s balanced to a degree by a more sanguine view on the long-term, five- to 10-year growth outlook and potential positives from reform and restructuring.”

Chinese ETF Flows Showing a Split in Sentiment

While last month’s vote in the U.K. to pull out of the European Union touched off a tumultuous two days in global markets and the price of China-focused ETFs tumbled, neither those in the U.S. or in China and Hong Kong posted big fund flows. Investors are probably still assessing the potential long-term impact of the move on global markets before deciding whether to add or withdraw money, said

, a director of Mohit BajajETF trading solutions at

in WallachBeth CapitalNew York.

Fidelity Investments is cutting fees for 27 index mutual funds and exchange traded funds in a bid to attract more assets into passive strategies.

The reductions will save current investors about $20 million annually, and bring the average expense ratio for the funds to 10.2 basis points from 11.6 basis points, Boston-based Fidelity said in a June 28 statement. Two of the funds will have an expense ratio of as low as 1.5 cents per $100 invested, depending on the share class, when the changes go into effect on July 1.

— Taylor Hall and Charles Stein, Bloomberg

News

Fidelity Cuts Fees for 27 Index Funds

Citadel Securities hired Cory Laing from . to run Goldman Sachs Group Incsales for exchange-traded funds, the latest high-profile addition at the trading firm. Laing spent about 16 years at Goldman Sachs, according to his LinkedIn profile, most recently running the bank’s ETF sales. His sales team at Citadel Securities aims to persuade brokers to send more of their clients’ ETF trades to Citadel Securities.The company, part of billionaire Ken Griffin’s Citadel LLC, plays a significant role in U.S. stock trading — a related asset class — and now trails only NYSE Group, Nasdaq Inc. and Bats Global Markets Inc. in terms of how much volume it handles.

— Annie Massa, Bloomberg News

Citadel Securities Hires Goldman Sachs’s Laing    

 Bank ETFs Post Worst Outflows of Year in Brexit AftermathBY WENDY SOONG, BLOOMBERG NEWS

Investors dumped exchange-traded funds tracking banking stocks amid increased uncertainty following the U.K.’s vote to leave the European Union. During the week ending July 1, U.S.-listed ETFs tracking lenders had their biggest outflows of the year. For the broader financial sector, they reached $2 billion — one-third of the total withdrawals among all equity funds in the nation.

$5 Trillion Rout in China Stocks in '15

A lack of transparency in China’s stock market contributed to a $5 trillion rout in domestic shares last year, bringing an end to the country’s longest-ever bull market. Mainland stocks have struggled to recover since then, with the Shanghai Composite posting the second-worst decline among the world’s ten biggest equity markets. — Elena Popina

Calculated using U.S.-listed equity ETFs.

July 12, 2016 Bloomberg Brief ETFs 3

 

TOOLKIT

July 12, 2016 Bloomberg Brief ETFs 4

TOOLKITPros Are Using ETFs to Replace Futures and Swaps, Says Cohen of iShares

Sophisticated investors are increasingly using ETFs where they would have once used an instrument like a future or a swap, said Samara

, ’s U.Cohen BlackRockS. head of iShares Capital Markets in New

York. Cohen explained the trend in an interview with Bloomberg's Yakob Peterseil on July 5.

What is it?

"There were a few people buying an S&P 500 ETF for their core exposure, but there were multiples of those people using futures to do the same thing. Just getting exposure to that market previously required that you needed to be in a futures contract, and futures contracts need to be rolled quarterly. So being able to access those exposures on exchange, which doesn't require bank intermediation, allows people to execute on complex strategies with more transparent instruments, and also of course instruments that don't have counterparty credit risk."

Who's doing it?

"The user base is anyone who trades a bond, a single equity, a swap or a future. [They're] learning how to use an ETF because there are times in the life cycle of all four of those things that the ETF probably offers better economics."

Which iShares ETFs?

" is definitely used as a financial HYGinstrument. There are several of our equity funds that are, as well. Our single country funds, our emerging market bond fund , our long-dated treasury fund EMB

. With relatively liquid underlyers, like TLTS&P 500 stocks, the Russell 2000, we've seen a big uptake in the ETF as the preferred delta-one instrument to the futures and the swaps. It's definitely not just a function of less-liquid underlyers."

Why now?

"A lot of futures users want the ability to get in and get out very quickly, so not only the AUM of the fund matters, but the on-exchange volumes that happen every day. So I think there was a growth trajectory that had to be reached, at which point

ETFs really became a competitive instrument — and a complementary instrument — to futures and swaps."

What does it mean for AUM?

"Overall, if there are more two-way flows, it increases the utility [of the ETF], which is why I think directionally it will be positive for AUM. But short-term, there should be more AUM volatility. And as a function of that, having robust platforms for primary activity becomes ever-increasingly important."

What's next?

"Our next year is about our next generation of products as we think about this user and their needs, especially in fixed income. I think there are certain fixed-income derivatives markets, especially single-name CDS, where if you read the statistics, notionals are down 80 percent from the pre-financial crisis highs. And so the ability of the exchange-traded product market to somehow provide an avenue for those exposures I think is a place where we'll be putting pen to paper over the next year plus."

 

Q&A

July 12, 2016 Bloomberg Brief ETFs 5

Q&ALow-Fee ETFs Can Be a Form of Alpha, Says Beachhead Capital's Beer

> Hedged equity strategy has around $50 million in AUM> "Big push" to come up with next generation of liquid alternative productsInterviewed by Yakob Peterseil, Bloomberg Briefs

Andrew Beer, Managing Partner at Beachhead Capital Management

 Q: Your Equity Hedge Dynamic Beta Strategy uses six ETFs linked to broad-based indexes to try and outperform hedge funds. How do you beat hedge funds using just six ETFs?A: The equity hedge is really simple in that it's designed to deliver equity-like performance over time but with bond-like risk. What the research shows is that hedge funds make most of their money over time from asset allocation decisions, more so than from security selection. So if we can get the asset allocation decisions right, we can get most of the returns.

Q:What makes ETFs useful for hedge fund replication?A: We see this big push across the industry to come up with a next generation of liquid alternative products that learn from the mistakes and failings of what we call the first generation of liquid alternative products. One thing is the fees are very high. The expense ratio for those products is often above 250 basis points. We think ultimately the products should look a lot more like traditional asset management products and be 100 bps or less.

Q: Why should investors be looking to "liquid alternatives" now?A: A lot of people think 'ok, we're in the 8th year of a bull market, equity valuations are quite high, bonds aren't really going to provide the diversification that they would if rates were 6 percent and not one percent.' And so they're looking for alternatives that they can add to clients' portfolios.

Q: How does the strategy actually work?A: We analyze portfolios of hedge funds and we determine what major markets they're exposed to and in what weights, and we invest directly in those markets.

 

We rebalance it once a month because we get new information in on hedge funds.

Q: Which ETFs do you use?A: Our core product that we've been running for about four years uses primarily iShares ETFs, but we've also created one that uses primarily First Trust ETFs.

Q: Why did you choose iShares?A: We went for the largest and most liquid ETF in any of the categories, and when we did it initially, iShares happened to meet most of those criteria.

Q: You don't use inverse or leverage ETFs though. Why not?A: We don't like the way they're designed. If you use an inverse ETF and want to have that position for 3 months, you're going to lose money in almost all circumstances.

Q: Can't an investor get similar exposure to such strategies via a smart beta or factor ETF?A: Our risk profile is usually a lot lower than those strategies. I expect those kinds of strategies will continue to take in a lot of assets, but I also expect a lot of investors will be disappointed with the outcome. We've seen this with a lot of new factor-based strategies where somebody identifies something that has effectively been outperforming and then more and more money floods into it and it

subsequently does not outperform the way they'd hoped.

Q: Isn't that true of hedge funds, too?A: We looked at using hedge funds that have only performed well. What you find is that like a lot of things, they do well until you invest, and then they do like everybody else. So what we decided was the most stable outcome was to have these big managers. In our basic long-only product, we use the 40 largest equity hedge funds that are in a hedge fund database.

Q: Is bigger necessarily better?A: The reason we use those is that they are big, stable funds that are very well known to the institutional investment community. We want to have an 80 percent-plus correlation to what those guys do over time.

Q: You say you can outperform the hedge fund strategies you're tracking. How?A: Replication outperforms because if you think of a hedge fund portfolio that has been earning 6 percent for its investors, it was probably earning 10 percent before the 2-and-20 fee structure. So if you aim for the 10 percent with a replication strategy and you get 8 of the 10, and you charge 100bps in fees, you’re still going to be at 7 percent, not six. We have an expression: "fee reduction is the purest form of alpha."

At a Glance

AGE:CAREER:

48Has been at Beachhead for nine years; previously worked at Baupost Group LLC hedge fund

EDUCATION: Harvard Business School, MBA; Harvard University, A.B. in European history

READING: Magnifico: The Brilliant Life and Violent Times of Lorenzo de' Medici by Miles Unger

ARE HIGH-YIELD BOND ETFS....JUNK?

July 12, 2016 Bloomberg Brief ETFs 6

ARE HIGH-YIELD BOND ETFS....JUNK?

The Case Against Junk-Bond ETFs Where Managers Rout IndexesBY EMMA ORR, BLOOMBERG NEWS

Tired of your stock manager? No problem, buy an exchange-traded fund that tracks the S&P 500. But if you’re sick of your junk-bond manager, good luck finding an ETF that can beat him.

Since 2007, more than 80 percent of active high-yield managers tracked by Bloomberg posted better returns than either ’s $15.9 billion BlackRock Inc.iShares iBoxx $ High Yield Corporate

or ’s Bond ETF HYG State Street Corp.$11.3 billion SPDR Barclays High Yield

, the two biggest of their Bond ETF JNKkind. In stocks, fewer than 25 percent of managers beat indexes over the same time frame.

Why active managers do better in junk is a pressing question for investors who’ve poured $61 billion into bond ETFs in 2016. One reason is scarcity: unlike stocks, where there’s an ETF for every style, the high-yield market offers far fewer options. Another is the challenge of building indexes in fixed income that provide enough liquidity to keep ETFs afloat.

Junk-bond ETFs are “a terrible vehicle to accumulate wealth over time,” said

, director of high-Gershon Distenfeldyield at , AllianceBernstein Holding LPwhich oversees $35 billion. “The facts are the facts.”

Distenfeld, who’s the manager of several active credit funds, is an outspoken critic of passive junk-bond investments. But he has data to back up his claims: Since the beginning of 2008, more than 90 percent of active high-yield managers tracked by Morningstar Inc.have posted better returns than the average junk-bond ETF, while in equities just 20 percent of active managers win. BlackRock notes that over the past five years its ETF has outperformed roughly half of all active funds in all share classes.

Nobody is saying the challenges of bond ETFs automatically make them an inferior investment. If junk bonds rise, owning high-yield debt will make you money regardless of the wrapper, and not everyone who owns a junk ETF is looking

to beat active managers. According to BlackRock, the percentage of active managers beating their ETF is lower when all mutual fund share classes are considered and their security has had long stretches of outperformance.

“If you don’t like it, don’t buy it,” said , head of U.S. credit Oleg Melentyev

strategy at . “Nobody’Deutsche Bank AGs forcing you.”

People are buying, nevertheless. On June 24 alone, as Brexit angst swamped markets, investors directed $291 million into BlackRock’s junk ETF, more than any of the investment giant’s other ETFs, data

Junk-bond ETFs are “a terrible vehicle to accumulate wealth over time. The facts

are the facts.”

compiled by Bloomberg show.“An ETF sort of acts like an exchange

for bonds now, because over the counter is less desirable,” said , Eric Balchunasa Bloomberg Intelligence analyst. “So now you have bonds trading in a stock-like wrapper. No shocker, it’s a huge hit.”

This year, the Lord Abbett High-Yield Fund is returning 8.1 percent, beating both ETFs but trailing its benchmark, the BofA Merrill Lynch U.S. High-Yield Constrained Index. The Federated Institutional High-Yield Bond Fund, which uses the Barclays U.S. High-Yield Unhedged USD Index as its benchmark, is also outperforming the ETFs with 8.7 percent returns and losing to its benchmark.

As is often true with bonds, liquidity, or the ease with which something can be bought and sold, is a central

consideration in junk ETFs. The things that let you trade ETFs like stocks in real time require rapid-fire buying and selling of the underlying assets, processes that get harder the less liquid those assets are. As a result, the big junk ETFs track collections of very liquid bonds — and those aren’t always the best-performing ones.

Losing to active managers should be viewed as the price you pay for an ETF’s ease of use, according to Melentyev. While a sophisticated stock investor has a host of alternatives for gaining passive exposure such as futures or simply buying all the stocks individually, that’s not true in credit. The need to own bonds that can be bought and sold quickly can hurt ETF returns while still being a convenience worth paying for, he said.

“What an ETF does in credit is more than just delivering you passive performance. It actually delivers you the ability to trade an illiquid market in a relatively liquid fashion,” he said. “Nothing comes free in this world, so that ability that ETF delivers to you comes at a cost.”

Pitting active managers against exchange-traded funds is a “false comparison” because of the different makeup of their portfolios, according to

, a strategist at BlackRock, Steve Laipplywhich oversees the largest junk ETF. The Lord Abbett High Yield Fund, one of the largest actively managed junk funds, has almost 6 percent in equities, for example.

Junk ETFs also provide a way of insuring against performance swings among active managers, said Dave

, a State Street ETF strategist. Mazza“They have some of the widest spread between those that do well and those that do poorly,” he said. “So an ETF can really help hedge those bets.”

“They’re meant for professional investors,” said Distenfeld. “But for a strategic investor to say, I’m going to put five percent of my portfolio in high-yield and I’m going to buy these ETFs — the numbers don’t lie, they’re not a good solution for core high-yield strategic investment.”

— with assistance from James Seyffart

July 12, 2016 Bloomberg Brief ETFs 7

   

 

FLOW DATA COMPILED BY GOSIA WASZAK AND WILL GRIFFITHS, BLOOMBERG ANALYTICS

July 12, 2016 Bloomberg Brief ETFs 8

FLOW DATA COMPILED BY GOSIA WASZAK AND WILL GRIFFITHS, BLOOMBERG ANALYTICS

The tables show the flows into and out of ETFs in the 30 days to July 10, according to data compiled by Bloomberg. The graphic in the tables show the high, low,

average and current monthly flows during the past 12 months. The orange dots illustrate where the latest monthly flows are in comparison with the mean flows,

the purple dots. The ends of the bars represent the minimum and maximum monthly flows for the year. The Z-score provides the number of standard deviations

the latest monthly flows are above or below the mean.

 Bloomberg Brief: ETFsJennifer Rossa

Bloomberg Brief

Managing Editor

jrossa@bloomberg.net  

Yakob Peterseil

Bloomberg Brief Editor

ypeterseil@bloomberg.net

Paul Smith

Bloomberg Brief Editor

psmith152@bloomberg.net

Johnna Ayres

Marketing & Partnership

Director

jayres1@bloomberg.net  

Christopher Konowitz

Advertising

ckonowitz@bloomberg.net

Interested in learning more

about the Bloomberg terminal?

Request a free demo .here

© 2016 Bloomberg LP. All rights reserved. This newsletter and its contents may not be forwarded or redistributed without the prior consent of Bloomberg. Please

contact our reprints group listed left for more information.  

 

Ten Largest Absolute Net Inflows

Ten Largest Absolute Net Outflows