Advisors and investors alike continue to turn to ETFs as portfolio building blocks, with the category attracting $73billion in new money in the second quarter, according to Morningstar data.

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The instruments also offer a clear vantage point on some of the market's seismic shifts resulting from the massive negative return in gold and the rise in interest rates in May and June. "Despite the carnage in the bond market, ... the S&P 500 has held up remarkably well," says Morningstar ETF analyst Michael Rawson.

Indeed, the oldest and most popular of the large blend funds, SPDR S&P 500 (SPY), returned 2.9% for the quarter and gained more than $1 billion in cash flows. An index fund with core equity holdings and assets that exceed $133 billion, SPY also had a one-year return of 20.4% and a three-year return of 18.3%. Other large blend funds also performed well for the three- and six-month periods: iShares Core S&P 500 (IVV) registered a 2.9% return for the quarter and 13.8% YTD, while Vanguard Total Stock Market (VTI) generated a 2.8% return for the past three months and 14.1% year to date.

Over the same period, money flowed out of bond funds, as the 10-year rate hit 2.59%. "It was sort of a knee-jerk reaction to the Fed," Rawson says. "Intermediate term bond funds had outflows. ... Vanguard Total Bond Market ETF (BND) had a -2.4% return [for the second quarter] and lost $483 million in assets; iShares iBoxx $ Invest Grade Corp Bond (LQD) lost 4.4% and had outflows of $3 billion."



Investors also soured on emerging market stocks, with Vanguard FTSE Emerging Markets ETF (VWO) retreating 8.4% for the year; it lost $3.7 billion from redemptions.

With emerging markets out of favor, investors have been turning to frontier markets; iShares MSCI Frontier 100 (FM) - which invests in such markets as Argentina, Estonia, Kazahkhstan, Lebanon and Mauritius - gained 7.6% for the same period. While these frontier market ETFs are touted as having more growth potential than their emerging markets counterparts, they are also less liquid, Morningstar has noted in its ETF Investor newsletter.

Gold has also lost its glitter, accounting for most of the bottom-performing equity ETFs, as measured by one-year return. The biggest loser was Global X Gold Explorers (GLDX), off 42.12% for the 3-month period and 56.53% YTD. "I think the strengthening U.S. economy has hurt the argument that a weak U.S. economy could lead to a debasement of the U.S. dollar and stronger gold prices," Rawson says.



Among industry categories, Heather Brilliant, Morningstar's global director of equity and credit research, says technology is overvalued while basic materials funds are below fair value. "We think that valuations look somewhat attractive in basic materials, [but] we're also concerned that second-quarter earnings could be not great," Brilliant says.

Longer term, she is cautiously bullish on health care, although she views it as at or slightly above fair value. "On the margin, we're starting to see increasingly high cash levels on the balance sheets," she says. Health care ETFs were up 4.66% for the past three months and 19.6% year to date.



Laton McCartney is a New York writer who has contributed to Money Management Executive and Information Management.

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