How ETFs fared in the first quarter

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This report was first written for BMO InvestorLine.

ETF Commentary

As the first quarter of 2010 came to an end investors continued to turn their attention toward exchange-traded fund (ETF) products. With fund companies' expanded marketing campaigns and continued product releases, it was not surprising that a large amount of assets continued to flow into this popular product group. Institutional and retail investors alike seemed to appreciate their ability to not only gain exposure to more obscure and less accessible sections of the global market, but to do so with ease and flexibility.

Looking at the Canadian ETF market, we still saw a relatively small offering compared to that available in the U.S, but the number of local products continued to rise on a consistent basis. In the first quarter alone the Canadian ETF market added 37 offerings to the line-up. The U.S. ETF market, introducing 54 more products to the market, also continued to expand. Looking at the aggregate numbers (Table 1), we can see there was approximately $33.3-billion of assets in Canadian ETFs and about $816.4-billion allocated to U.S. offerings.

Canadian ETFs

Looking at the average first quarter returns of Canadian ETFs by Canadian Investment Funds Standards Committee's category (Table 2), we see that Japanese Equity ETFs, posting a positive return of 8.1 per cent, led the group with an impressive turnaround from the previous quarter. The majority of these gains were realized in March as the yen slipped and momentum built in Tokyo stocks.

Financial Services Equity ETFs (+7.3 per cent) and U.S. Equity ETFs (+6.5 per cent) took the second and third spots as investors anticipated continued gains in the Canadian banking system and as U.S. equity indices pushed toward their 18-month highs. Overall, 18 of the 24 CIFSC classifications posting quarterly returns ended the period in positive territory.

At the bottom end of the ETF group Natural Resources ETFs (-6.6 per cent) posted the worst quarterly performance on average on continued weakness in the natural gas sector. The Precious Metals Equity group was also toward the bottom of the pack, reversing its course from the previous three periods and falling just in the red with a negative return of 0.3 per cent on average. Canadian Short-Term Fixed Income ETFs (-0.6 per cent) dipped into negative territory for the first time in four quarters as short-term government bond yields were pushed higher toward the end of the quarter.

U.S. ETFs

The quarterly performance numbers for U.S. ETFs showed some similarities to those of their Canadian brethren. Looking at the ten top returns for Q1 2010 (Table 3), Diversified Leverage ETFs, with a return of 11.7 per cent, led all classifications. (ETFs within this group use a sustained level of leverage to help magnify the returns of a specific index.) The top performing ETFs in this group tracked small- and mid-cap U.S. indices whose unleveraged returns alone were strong for the quarter. Financial Services ETFs (+9.8 per cent) and Small-Cap Value ETFs (+8.9 per cent) filled the second and third positions. Consumer Services ETFs also showed a strong quarterly gain of 8.0 per cent.

At the southern end of the group (Table 4) Dedicated Short-Bias ETFs (-12.7 per cent) once again claimed the last spot as the overall U.S. market gained strength. Global Natural Resources ETFs (-8.1 per cent) was dragged down by weak performance in the alternative energy sector, while natural gas- and agriculture-based ETFs helped push the Commodities group down 6.4 per cent.

Special to The Globe and Mail

Jeff Tjornehoj is Research Manager - U.S. and Canada, and Matthew Lemieux is Research Analyst with Lipper, a Thomson Reuters company