XLU Utilities Select Sector

In total, the first quarter of 2012 was a great year for the ETF industry. Issuers saw 85 new products hit the market—while 16 were delisted—and net inflows reached nearly $56 billion in the time period. This surge in interest, as well as the strong performance of the market, led total ETF assets to hit the $1.2 trillion mark heading into Q2.

Yet while the time period was pretty solid overall, a few funds saw declining levels of interest heading into the second quarter. Of the relatively few funds that saw outflows in terms of assets under management in the first quarter, just three managed to see levels decline by more than one billion dollars in the time period (read Three ETFs With Incredible Diversification).

Surprisingly, these three have little in common suggesting that declining interest isn’t concentrated in one sector of the market. Instead, investors seem to have a broad falling out with several segments across the global economy including an individual country, a U.S. sector, and even a broad regional product too.

Furthermore, all three have gained more than $1.5 billion in assets over the past three year period suggesting that investors aren’t exactly fed up with these ETFs, just that some may be seeking better opportunities elsewhere. No matter the reason, these billion dollar outflows are still pretty astounding given the broad market strength, especially considering they all focus in on stocks.

Below, we highlight these three mega losers from the first quarter and give our thoughts behind why we think these funds have seen such a hard time despite an overall positive investing environment:

Select Sector SPDR Utilities Fund (XLU)     -$1.1 billion in outflows

The easiest outflows to explain on this list came from State Street’s XLU. The product is highly defensive in nature and is usually thought of as a good play in bear markets thanks to its high yield and relatively recession proof business structure.

While these traits can be huge positives, they can be to a fund’s determent during a bull run like the one we saw in the first quarter. During this time period, XLU lost about 2.6% while the S&P 500 added more than 12% in comparison. This produced an incredible gap between the two products and was undoubtedly one of the main culprits for the slump in assets in the fund (see charts of XLU here).

Interestingly, the lost of the $1.1 billion in assets looks to cost State Street roughly $1.98 million in revenues on an annual basis, based on the expense ratio of 18 basis points.

Instead of this fund, it appears from a U.S. sector perspective products in the financial and energy spaces were extremely popular. XLE added almost $950 million for the energy space while the financial sector, as represented by XLF, put on about $800 million in assets for the quarter.

iShares MSCI Brazil Index Fund (EWZ) -$1.35 billion in outflows

The biggest loser in Q1 from an individual market perspective—as well as the second biggest overall—was iShares’ EWZ. The product lost about $1.35 billion in the time period and has actually seen outflows of about $1.8 billion over the past 52 weeks.

Part of the reason for this could be growing worry over the Brazilian market, especially in the face of inflation and uncertain commodity prices. Additionally, the country’s government seems uncommitted to stopping inflation as some policy makers are looking to loosen rates in order to further stimulate demand across the country.

Beyond this, some investors may just be getting sick of the heavily concentrated nature of EWZ, especially when compared to other products targeting the nation. In fact, EWZ puts close to 60% of its assets in three sectors including 16.7% in Petrobras and 11.6% in Vale.

The loss looks to be even more hurtful to iShares’ bottom line; based on the 59 basis point expense ratio, the loss in the first quarter looks to cost the company roughly $7.97 million in revenues over the course of a full year (see more on funds on the Zacks ETF home page).

Instead of EWZ, it appears as though investors have been more partial to ETFs targeting Russia, China, and developed markets in Europe such as Germany. In terms of other South American funds, all the other products tracking Brazil saw inflows—albeit modest—while Chile led the way in terms of country specific inflows in Latin America.

iShares MSCI EAFE ETF (EFA) -$2.43 billion in outflows

By far the biggest loser in terms of AUM in the first quarter was iShares’ EFA. The fund tracks a broad swath of countries with the heaviest weights going to companies based in Japan, the UK, and Switzerland. The product saw outflows of nearly $2.5 billion in the quarter although AUM is still quite robust coming in at just over $38 billion overall (see The Trend Is Your Friend With These Three ETFs).

Part of the reason for the big losses in AUM could be due to increased worries over several developed markets in the European region, especially large markets such as Spain and France. In fact, outflows were up to about $1.2 billion March alone and totaled close to half a billion the final week of the period. This could signal that investors are finally fed up with these low growth markets and that investors are cycling into higher growth sectors instead for the second quarter.

While this may be a compelling reason for the outflows, a far more likely reason is the rise of a key competitor, the Vanguard MSCI EAFE ETF (VEA). This Vanguard fund tracks the exact same index as its iShares counterpart but does so at a fraction of the price, charging investors just 12 basis points a year in fees compared to 0.35% for EFA (read Five Cheaper ETFs You Probably Overlooked).

This product has seen inflows of $1.16 billion so far in 2012 and close to $2.8 billion over the past 52 weeks suggesting that this fund has taken up the slack in EFA for the most recent quarter. Given this, it appears as though investors may not be too dismayed with the performance of the EAFE region and that instead they are flowing towards lower cost products for similar exposure.

This shift hasn’t been good news for iShares though, as the loss of $2.43 billion in assets looks to translate to lower revenues of about $8.5 million for the company over the course of the year.

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