ETF flows data of late continue to tell the story of an economy where investors are increasingly embracing growing excitement for value and growth opportunities in equity space. According to Morningstar data, estimated net flows into European equity ETFs grew from EUR 1.32 billion in the second quarter of 2010 to EUR 4.04 billion in the third quarter, while net flows into European fixed income ETFs dropped from EUR 3.69 billion in Q2 to EUR 0.43 billion in Q3. Data for the month of October showed flows into equity ETFs estimated at EUR 4.57 billion--the highest monthly figure so far in 2010 and surpassing the outcome for the whole of the third quarter. Meanwhile, flows into fixed income ETFs in October 2010 were estimated at EUR 0.25 billion, representing a 45% monthly drop from September.
Even investors seeking the safety of bonds are also increasingly vying for some decent measure of return. Capital preservation with no consideration for yield is no longer the mainstream trade it once was. Yields of the safe-haven AAA-rated government bonds have been trading at historical lows for some considerable time now, while chances to see them pushing north look rather slim at present. As a result, investors seeking to extract some yield while retaining a theoretically reasonable margin of capital protection have little option but to look beyond the realm of AAA developed government-tracking ETFs. The question is where?
Some investors may have been considering the high-yielding alternative of non-AAA Eurozone government bonds. But with sovereign risk-aversion again making big headlines (e.g. Ireland and Portugal) and Germany pushing for the approval of a Eurozone sovereign rescue mechanism including haircuts on principal, taking on non-AAA Eurozone government risk may prove a step too far for a yield-seeking but safety-conscious investor. Besides, those seeking to access the non-AAA Eurozone government bond market via ETFs would find that choices are limited to Amundi’s Ex-AAA Government Bond EuroMTS ETF. This ETF was launched in mid-June 2010 to tap into potential demand for Eurozone peripheral debt in the wake of the approval of the Eurozone Stabilisation Fund. The take-up has been lacking, with assets under management around the EUR 20 million mark as we write. By comparison, the iShares Markit iBoxx Euro High Yield ETF, offering exposure to non-investment grade rated European corporate bonds, has attracted around EUR 200 million of assets since its launch in September 2010.
These comparative take-up figures do make interesting reading, but the fact is that both the Eurozone peripheral and High Yield ETFs mentioned remain outliers within the broad European ETF market. Recent flows data show that yield-seeking investors have mostly focused on the more predictable investment-grade corporate and emerging market fixed income ETFs. According to Morningstar data, estimated net flows into EUR-denominated corporate bond ETFs stood at EUR 0.32 billion in the third quarter of 2010, up from EUR 0.26 billion in the second quarter, while net flows into global emerging market bonds were calculated at EUR 0.16 billion in Q3 and EUR 0.22 billion in Q2. Meanwhile, net flows into EUR-denominated sovereigns dropped to EUR 0.15 billion in Q3 from EUR 1.86 billion in Q2. Alternative growth measures (e.g. total net assets year-to-date growth rates) paint a similar story.
It is not difficult to understand why. According to our calculations (based on data collected on November 15) the yield spread between the broad German and Eurozone government bond indices has averaged 75 basis points so far in 2010. Investors favouring EUR-denominated corporate bonds vs. Germany sovereigns would have been in for an average pick-up of 120 basis points, while emerging market government bonds yielded an additional 280 basis points. At the top of the “yield pick-up” table, we have EUR High Yield, delivering an average spread of close to 500 basis points vs. the broad Germany sovereign index.
Of all the alternatives to EUR-denominated sovereigns, the asset class that has experienced the highest growth in relative terms has been emerging market government debt. This is unsurprising when considering that most emerging market economies--particularly Asian and Latin American--have weathered the global crisis much better than their developed counterparts. The hefty current account surpluses accumulated in the years prior to the global financial crisis have allowed most emerging market governments to avoid the slippery slope of higher borrowing while putting comprehensive stimulus packages in place during the worst phases of the downturn. As a result, their creditworthiness has increased, with some emerging market government bonds now yielding significantly less than those of troubled developed economies such as Greece, Ireland or Portugal, which are now seen by some as unworthy holders of the prized “developed” accolade.
With the Eurozone again suffering from peripheral tremors, chances are that yields of the ultimate safe-haven assets (i.e. Germany government bonds) may either trend further south, or at least show a fairly high resistance to head upwards for a protracted period. As such, investors wanting to squeeze yield out of fixed income ETFs, but wary of excessive volatility in the Eurozone government bond market, will likely continue directing their attention to corporate, emerging market and High Yield ETFs going forward.
