Equity ETFs post third straight year of plus-side returns

In the fall, cautious investors were bombarded with mixed news, ranging from continued eurozone weakness and new cases of Ebola in the U.S., to a major slump in oil prices. But better-than-expected U.S. economic news and fresh interventions by global central banks in the fourth quarter pushed local indexes to new records, albeit at the margins. For fourth-quarter 2014, equity ETFs posted their ninth quarter in 10 of plus-side returns, with the average equity exchange-traded fund's three-month return at just 0.01% as investors embraced reports that the U.S. economy had outpaced growth in most other developed nations and thus shied away from global markets. Investors began selectively focusing on interest-related, out-of-favor and relatively safer domestic equity issues. Investors were kept in the game by reports that the Chinese and European central banks were laying the groundwork for quantitative easing and asset purchases, strong U.S. employment statistics and the Fed's commitment to be “patient” before raising interest rates. In 2014, the average equity ETF (+3.11%) was in positive territory for the third consecutive year, although the average was pulled down by Lipper's world equity ETFs macroclassification (-2.46%).

Equity ETFs ranked by quarterly returns

As of Dec. 31. Excludes leveraged and inverse funds, and exchange-traded notes. *Most recently reported net prospectus expense ratio. N/A=Not available Source: Lipper, a Thomson Reuters company

(More: BlackRock attracts record flow in 4Q amid ETF demand, Pimco turmoil) In December, investors witnessed increased market volatility. After initially cheering a surprisingly strong November jobs report (the U.S. economy added 321,000 jobs that month — the biggest gain since early 2012 and beating consensus estimates by 86,000) and a 0.4% rise in hourly wages, investors began to fear the Federal Reserve would raise interest rates faster than expected. In addition, the Commerce Department had reported in October that factory orders were on the decline. The U.S. markets experienced a sharp pullback in mid-December, when the International Energy Agency again cut its global crude oil demand forecast. That led to concerns the global economy might succumb to deflation, which could lead to a global recession or even depression. During the week ended Dec. 12, the S&P 500 took one of its largest one-week losses since September 2011, falling 3.5% over the week. Investors shrugged off the consensus-beating University of Michigan/Thomson Reuters consumer-sentiment readings, focusing instead on the decline in December wholesale prices. That played on concerns the U.S. economy's growth rate might be unsustainable.

Newly-launched equity ETFs, ranked by average daily volume during Q4 2014

As of Dec. 31. Excludes leveraged and inverse funds, and exchange-traded notes. *Most recently reported net prospectus expense ratio. Source: Lipper, a Thomson Reuters company

Despite the late-month collapse of the ruble, the wild fluctuations in oil prices and an unexpectedly hawkish statement by the Federal Open Market Committee, the equity market rallied in relief that the Fed was not being even more hawkish. In a Santa Claus-like rally, investors pushed the Dow Jones Industrial Average and the S&P 500 to their 38th and 52nd record closes of the year, respectively, during the Christmas-shortened trading week. The Dow closed above the 18,000 mark for the first time. The U.S. stock market closed the good year on a down note, however, with the Dow witnessing a triple-digit loss on the last trading day of the year and chalking up its first monthly loss (-0.03%) in three. ETF investors (authorized participants, or APs) were net purchasers for the quarter, injecting $88.6 billion into equity ETFs while being net purchasers of taxable fixed-income ETFs (+$19.5 billion) and municipal debt ETFs (+$1 billion).

Equity ETFs with the largest inflows

As of Dec. 31. Excludes leveraged and inverse funds, and exchange-traded notes. *Most recently reported net prospectus expense ratio. Source: Lipper, a Thomson Reuters company

Similar to third-quarter 2014, when APs favored domestic (+$17.3 billion) over nondomestic (+$11.7 billion) issues, they injected $85.6 billion into domestic equity ETFs in the fourth quarter, versus only $3 billion for nondomestic. Despite the relatively strong returns by China region ETFs (+10.10%), APs shunned emerging market ETFs (-$2 billion) and European region ETFs (-$5.3 billion) on fears of a decline in global growth. They focused on the perceived safety of large domestic, out-of-favor and interest-paying issues, with large-cap ETFs attracting $53.0 billion. The four top-performing individual equity ETFs in the fourth quarter were housed in Lipper's China region ETFs classification. At the top of the charts was PowerShares China A-Share Portfolio (CHNA), returning an eye-popping 59.88%. Following that were Deutsche X-trackers Harvest CSI 300 China A-Shares ETF (ASHR), posting a 42.10% return; Market Vectors ChinaAMC A-Share ETF (PEK), 41.64%; and KraneShares Bosera MSCI China A Share ETF (KBA), 35.31%. Still, the China region ETFs classification was not the top performer of the equity universe in the final quarter of the year. That claim went to real estate ETFs, which gained 12.94%, followed closely by health/biotechnology's rise of 10.36%. For the first quarter in four, Lipper's U.S. diversified equity ETFs macroclassification (+5.13%) jumped to the top of the leader board, outpacing the other three broad equity groupings: mixed-asset ETFs (+0.62%) took the runner-up position, followed by sector equity ETFs (-2.41%) and world equity ETFs (-3.79%). While world equity posted the worst macroclassification performance in the fourth quarter, natural resources and commodity-related ETF classifications posted the poorest returns in the equity ETF universe.

Equity ETFs with the largest outflows

As of Dec. 31. Excludes leveraged and inverse funds, and exchange-traded notes. *Most recently reported net prospectus expense ratio. Source: Lipper, a Thomson Reuters company

With the U.S. dollar on its recent tear, and the oversupply of oil and lower demand making headlines, it was little wonder that dollar-priced commodities were pummeled during the quarter. Commodities energy ETFs lost 29.93% and became the basement dweller. The classification housed the four worst-performing individual ETFs. Natural resources, which fell 17.09%, and commodities general funds, down 16.03%, were the next-poorest-performing classifications. At the bottom of the equity ETF universe was PowerShares DB Oil Fund (DBO), declining 42.62%. It was bettered marginally by United States Oil Fund LP [USO, -41.26%), United States Brent Oil Fund LP (BNO, -40.64%) and United States Gasoline Fund LP (UGA, -37.69%).

One-year anniversary equity ETFs

As of Dec. 31. Excludes leveraged and inverse funds, and exchange-traded notes. *Most recently reported net prospectus expense ratio. Source: Lipper, a Thomson Reuters company

Tom Roseen is head of research services at Lipper Inc.