A look back at the ETF trading markets from last week…
Last week domestic equities continued to watch the Fed for any indication on the timing of the next rate hike. Fed Governor Lael Brainard was the last to speak before the Federal Open Market Committee pre-meeting quiet period took effect, hinting that there was a higher likelihood of a rate hike in December than this month. (CNBC, 12Sep2016) International Equity markets remained under pressure as selling carried over from the previous week as well as uncertainty as to whether or not the Bank of Japan will move rates into negative territory instead of expanding stimulus. Further weighing on international sentiment was Deutsche Bank receiving a $14 billion fine from the US Department of Justice to settle claims over its issuance of residential mortgage-backed securities in the lead-up to the 2008 financial crisis.
The VIX was active throughout the week but ended lower. Notably, US equities had gone 43 sessions without a move greater than 1% close to close, with the previous Friday (9/9/16), Monday (9/12/16), and Tuesday (9/13/16) breaking that pattern. In the commodities space, Crude Oil finished weaker after the International Energy Agency said that they expected the oil glut to last longer than expected. Gold weakened while the US Dollar strengthened this week. It is our opinion that the trajectory of interest rates remains a dominant theme in the market place.
ETF and US Composite volumes increased, assisted by quadruple witching and index rebalancing on Friday. Quadruple witching refers to the expiration date of stock index futures, stock index options, stock options and single stock futures, which typically results in elevated trading. Alternative strategies saw the biggest increase in volumes, led by these categories of funds: Volatility, Inverse Equity, and Leveraged Equity strategies. All of these categories saw nearly identical buy and sell side activity, with Managed Futures seeing the most selling.
The US Equity category, historically the most traded category, was the second most traded category this week with volume on the exchanges being split between buying and selling. The Large Blend and Large Growth categories saw the largest increases in volume. International Equity saw volumes increase, largely on the back of Foreign Large Blend strategies that comprise developed markets (hedged and unhedged) strategies. We believe Europe Stock strategies struggled due to negative international sentiment while Foreign Large Value saw an overall volume increase 30%. Finally, the Taxable Bond category experienced an increase in volume with investors’ strength in the Nontraditional Bond, Short Government, and Bank Loan strategies.
For FlexShares, demand by investors was strongest in the International Equity category - lead by IQDF and the US Equity category – lead by QDEF and QDYN. The Taxable Bond category experienced the most sell side activity focused on RAVI. Among the Sector Equity categories, GUNR saw both buying and selling activity while NFRA and GQRE continue to spark investor interest. We believe this underscores the demand for broad-based risk-management strategies as the potential for volatility goes higher.
Futures are contracts that trade on an auction market in which participants buy and sell commodity and futures contracts for delivery on a specified future date.
An option is a financial derivative that represents a contract sold by one party (the option writer) to another party (the option holder). The contract offers the buyer the right, but not the obligation, to buy (call) or sell (put) a security or other financial asset at an agreed-upon price (the strike price) during a certain period of time or on a specific date (exercise date).
ADV (Average Daily Volume) is the number of shares a security is traded each day averaged over some length of time.
Bloomberg Index definitions
Standard and Poor's 500 Index is a capitalization-weighted index of 500 stocks. The index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. The index was developed with a base level of 10 for the 1941-43 base period.
Russell 2000 Index is comprised of the smallest 2000 companies in the Russell 3000 Index, representing approximately 8% of the Russell 3000 total market capitalization. The index was developed with a base value of 135.00 as of December 31, 1986.
MSCI EAFE Index is a free-float weighted equity index. The index was developed with a base value of 100 as of December 31, 1969. The MSCI EAFE region covers countries in Europe, Australasia, Israel, and the Far East.
MSCI EM (Emerging Markets) Index is a free-float weighted equity index that captures large and mid-cap representation across Emerging Markets (EM) countries. The index covers approximately 85% of the free float-adjusted market capitalization in each country.
Bloomberg Barclays US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market. The index includes Treasuries, government-related and corporate securities, MBS (agency fixed-rate and hybrid ARM pass-throughs), ABS and CMBS (agency and non-agency).
Bloomberg Commodity Index is calculated on an excess return basis and reflects commodity futures price movements. The index rebalances annually weighted 2/3 by trading volume and 1/3 by world production and weight-caps are applied at the commodity, sector and group level for diversification. Roll period typically occurs from 6th-10th business day based on the roll schedule.
WTI is the price of crude oil light, commonly referred to as "oil" in the Western world. West Texas Intermediate (WTI) crude oil is the underlying commodity of the New York Mercantile Exchange's oil futures contracts and is utilized as an oil benchmark.
Gold is quoted at a price of 1 troy ounce of .999 percent fine gold deliverable now. This means you can usually purchase one ounce of gold bullion at this price plus the dealer's premium.
US 10-Yr Yield index indicates the yield of the US Treasury bond market with a maturity of 10 years. The rates are comprised of generic United States government bill/note/bond indices.
U.S. Dollar Index indicates the general international value of the US dollar. The index does this by averaging the exchange rates between the US dollar and other major world currencies.
Bloomberg Barclays TIPS 1-10 year index measures the performance of the US Treasury Inflation Protected Securities (TIPS) market with maturities ranging between 1 and 10 years.
The Chicago Board Options Exchange Volatility Index (VIX) reflects a market estimate of future volatility, based on the weighted average of the implied volatilities for a wide range of strikes. 1st & 2nd month expirations are used until 8 days from expiration, then the 2nd and 3rd are used.
Investors cannot invest directly in an index.
Morningstar Category definitions
Diversified Emerging Markets: Diversified emerging-markets portfolios tend to divide their assets among 20 or more nations, although they tend to focus on the emerging markets of Asia and Latin America rather than on those of the Middle East, Africa, or Europe. These portfolios invest predominantly in emerging market equities, but some funds also invest in both equities and fixed income investments from emerging markets.
Equity Precious Metals: Precious-metals portfolios focus on mining stocks, though some do own small amounts of gold bullion. Most portfolios concentrate on gold-mining stocks, but some have significant exposure to silver-, platinum-, and base-metal-mining stocks as well. Precious-metals companies are typically based in North America, Australia, or South Africa.
Volatility: Volatility strategies trade volatility as an asset class. Directional volatility strategies aim to profit from the trend in the implied volatility embedded in derivatives referencing other asset classes. Volatility arbitrage seeks to profit from the implied volatility discrepancies between related securities.
Large Blend: Large-blend portfolios are fairly representative of the overall US stock market in size, growth rates and price. Stocks in the top 70% of the capitalization of the US equity market are defined as large cap. The blend style is assigned to portfolios where neither growth nor value characteristics predominate. These portfolios tend to invest across the spectrum of US industries, and owing to their broad exposure, the portfolios' returns are often similar to those of the S&P 500 Index.
Trading – Leveraged Equity: These funds seek to generate returns equal to a fixed multiple of the short-term returns of an equity index. The compounding of short-term returns results in performance that does not correspond to those of investing in the index with external leverage. For example, a fund attempting to achieve 2 times the returns of a given index on a daily basis is unlikely to deliver anything like 2 times the index’s returns over periods longer than one day. Many of these funds seek to generate a multiple of the daily or weekly return of the reference index. Trading funds are not considered suitable for a long-term investor and are designed to be used by active traders.
Trading – Inverse Equity: These funds seek to generate returns equal to an inverse fixed multiple of short-term returns of an equity index. The compounding of short-term returns results in performance that does not correspond to those of investing in the index with external leverage. For example, a fund attempting to achieve negative 2 times the returns of a given index on a daily basis is unlikely to deliver anything like negative 2 times the index’s returns over periods longer than one day. Many of these funds seek to generate a multiple typically negative 1 to negative 3 times the daily or weekly return of the reference index. Trading funds are not considered suitable for a long-term investor and are designed to be used by active traders.
Commodities Energy: Energy portfolios invest in oil (crude, heating, and gas), natural gas, coal, kerosene, diesel fuel, and propane. Investment can be made directly in physical assets or commodity-linked derivative instruments.
Financial: Financial portfolios seek capital appreciation by investing primarily in equity securities of U.S. or non-U.S. financial-services companies, including banks, brokerage firms, insurance companies, and consumer credit providers.
Miscellaneous Region: Miscellaneous Region stock portfolios invest in countries or smaller regions that do not have their own category. They typically have a narrow geographical range.
Equity Energy: Equity energy portfolios invest primarily in equity securities of U.S. or non-U.S. companies who conduct business primarily in energy-related industries. This includes and is not limited to companies in alternative energy, coal, exploration, oil and gas services, pipelines, natural gas services, and refineries.
Before investing, carefully consider the FlexShares investment objectives, risks, charges and expenses. This and other information is in the prospectus, a copy of which may be obtained by visiting www.flexshares.com. Read the prospectus carefully before you invest. Foreside Fund Services, LLC, distributor.
An investment in FlexShares is subject to numerous risks, including possible loss of principal. Fund returns may not match the return of the respective indexes. The Funds are subject to the following principal risks: asset class; commodity; concentration; counterparty; currency; derivatives; dividend; emerging markets; equity securities; fluctuation of yield; foreign securities; geographic; income; industry concentration; inflation-protected securities; infrastructure-related companies; interest rate / maturity risk; issuer; large cap; management; market; market trading; mid cap stock; MLP; momentum; natural resources; new funds; non-diversification; passive investment; privatization; small cap stock; tracking error; value investing; and volatility risk. A full description of risks is in the prospectus.