Right from get-go in 2012, investors were shaking off a long spell of market anxiety, becoming more willing to venture into equities and add more risk to their portfolios, according to Scott Burns, director of ETF research at Morningstar. The reason was performance - the firm's aggressive allocation category, for instance, was up a solid 8% through Jan. 31. Its bank loan group was also higher, up 8%, and the China region group rose 7.4%.

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"When you look at underlying returns, we definitely saw more investor movement into equities and money flowing out of fixed income," Burns says. "It reversed a pretty significant trend that had been ongoing since 2009."

The performance also looked strong from State Street Global Advisors' point of view. Its SPDR S&P Homebuilders (XHB) fund was up about 41% from Oct. 1, 2011, through the end of January; the SPDR S&P Regional Banking (KRE) fund rose 34.4%; and the SPDR S&P Transportation ETF (XTN) was up 29% over the same period.

Basically, investors had a clearer understanding of how the underlying industries of those ETFs worked, and were able to tamp down some of their previous anxieties, Burns says. It also helped that the Europe Union got a handle on how to begin solving the Greek debt quandary.

"At one point the world was able to write off Greece, and the entire southern portion of Europe was supposed to be in default," Burns says. "That is off the table now."

There were hardly any negative numbers in the lot, but where they declined, they made significant dips. Morningstar's world allocation category plunged 27.55%, and the volatility group was down 15.5%.

In terms of net asset flows, fixed-income funds led the field, taking in about $23 billion, according to State Street Global. The flow of assets highlighted tremendous liquidity in the market, says Kevin Quigg, global head of ETF strategy and consulting for State Street Global Advisors.

"More users are going into the fixed-income market," Quigg says. "ETFs … have become so prevalent and large, you see institutions using the same exposure vehicles that financial advisors are using."

ETFs organized by market cap size, from largeto small-caps, took in about $16 billion. Dividendpaying funds had about $11 billion in net inflows, according to State Street data.

 

FUN WITH FIXED-INCOME ETFs

Looking ahead, exciting times might be ahead for fixed-income ETFs, driven by potential policy changes and market forces. PIMCO launched an ETF version of its market-dominating PIMCO Total Return Fund on March 1, in a widely anticipated industry event. "What we seem to be reading and seeing is that there are more options to follow in that space," Quigg says.

Also, President Obama has floated a proposal to cap the value of tax-exempt interest at 28%, a move that would ultimately apply to interest on all municipal bonds, even if they have been outstanding for years. If enacted, it might hurt some municipalities' ability to borrow and reverse a conventional investing practice that has played a crucial role in clients' retirement planning portfolios.

"The success of Build America Bonds has emboldened the Obama administration," Burns says. "They've said: 'We can get funding without giving a tax break to rich people.'"

 

 

Donna Mitchell is a senior editor of Financial Planning.