The Money’s Really Flowing

by Mitchell Clark, B. Comm.

It doesn’t seem like there’s much news that can stop this stock market. Even with a shaky start to the week, the broader market climbed back, as institutional investors keep buying.

According to data provided by the National Stock Exchange, which is a niche exchange operating out of Jersey City and Chicago, exchange-traded funds (ETFs) and exchange-traded notes (ETNs) experienced substantial net inflow in May, growing some $17.0 billion from April. According to the data, the total net inflow into U.S.-listed exchange-traded funds so far in 2009 was some $30.0 billion, with long international equity ETFs garnering the most attention.

This explains why one of my favorite ETFs, the iShares FTSE/Xinhua China 25 (NYSE/FXI), is doing so great in this market. In fact, ever since I first began writing about this ETF in this column in mid-February, it has appreciated over 50% to its current level of around $38.00 per share. This is a strong performance for a large-cap fund and it illustrates the degree to which institutional investors have decided to participate in this market. Since the March low, this ETF has basically gone straight up, while offering a dividend yield of just under three percent.

I like ETF investing and so do a lot of institutional investors. The entry and exit costs are cheap, the fund fees are cheap, and ETFs allow you as an investor to express a view in the marketplace without having to use all the money in your portfolio. So, if you want a little exposure to China or perhaps some gold, but you aren’t sure which individual stocks to own, then you can easily express this view by buying shares in a related ETF. Lots of institutional investors do this. Even pension and endowment funds take on large positions in ETFs when they think there’s a good opportunity.

In the case of iShares, which was started by Barclays Global Investors, 2008 was the second strongest year for ETF inflow after 2007. Last year, the firm secured $56.0 billion in new ETF assets after garnering a record $58.0 billion in 2007. Forty-four percent of U.S. iShares net inflow came from institutional investors, with the remainder coming from individual investors and financial advisors. At the end of 2008, there was a total of a quarter trillion dollars invested in the iShares ETF family, and the numbers show huge net inflow coming at the expense of traditionally managed mutual funds.

The other great thing about ETFs is that, for the most part, they are very transparent. Every day you know the exact closing price and you know upfront the percentage management fee to run the fund and your broker’s commission to buy or sell. There aren’t any fees that are hidden or front- or back-end loads, otherwise known as sales charges. I never understood why a brokerage firm or a mutual fund felt like it had a right to charge a sales fee just so you can have the privilege of giving them your money. Those fees have always been rip-offs for individual investors.

Last year, the top iShares ETF in terms of inflow was the iShares Russell 2000. The seventh largest ETF in terms of inflow was my favorite, the iShares FTSE/Xinhua China 25 (NYSE/FXI).

I’m all for buying and selling stocks in a speculative portfolio, but in terms of building a few core positions as an investment, I think you can’t beat a well-known ETF.