Bond ETFs Get a Boost

Equity exchange-traded funds took a hit in May, but the mass exodus was offset by investors' rush to safety, increasing the demand for more defensive funds.

Money poured into fixed income ETFs last month as inflows totaled $7.5 billion in U.S. bond funds.

Europe’s inability to deal with its debt crisis is worrying investors, triggering a flight to the safety of U.S. Treasurys. The yield on two-year Treasurys are currently sitting at 0.27%, a stark contrast to its 10 year average of 2.48%.

And the old mantra of  “sell in May and go away” proved to be true. The Dow ended down 6.21%, snapping a seven-month win streak and posting the largest monthly point and percentage drops in two years.

May’s most popular ETF was the Vanguard Total Bond Market ETF Fund (NYSE:BND).  The fund, which tracks the Barclays Capital Aggregate Float-Adjusted Bond Index, attracted $1.23 billion according to the Index Universe. Bonds are the backbone of the fund, including corporate, mortgage-backed securities and Treasurys.

The second most popular fund was iShares Barclays 1-3 Year Treasury Bond (NYSE:SHY), attracting $1.15 billion. SHY ended the volatile month in the green, up 0.02% in May.

The riskier bets which started the year strong were among the month’s worst performers. The iShares MSCI Emerging Markets (NYSE:EEM) experienced outflows of $1.54 billion. SPDR Barclays Capital High Yield Bond was not far behind as investors withdrew $1.17B over the 4-week period.

So far in June, the trend among ETFs is similar to last month. Investors are taking a “risk-off” approach, opting for bonds over equities.  The Vanguard Short-Term Bond (NYSE:BSV) has attracted $445.44 million while inflows into iShares Barclays Aggregate Bond (NYSE:AGG) total $245.26 million.

Earlier this year, investors were flocking to risky high-yield or “junk” bonds, but threats of a possible Greek exit from the euro and Spanish bank failures is hitting the sector, and investors can’t seem to get rid of the holdings fast enough. High-yield bond ETFs posted global outflows of $1.3 billion, the first exodus in six months.

PowerShares Fundamental High Yield Corporate Bond Portfolio (NYSE:PHB) saw its biggest one-day outflow of cash in its history this week. PHB, an exchange-traded fund managed by Invesco PowerShares, invests in high-yield corporate bonds. Outflows total $53.23 million since June 1st, according to Index Universe.

So will investors continue the risk-adverse approach to investing in the coming months? If President Obama or Federal Reserve Chairman Ben Bernanke’s statements on the economy are any indication, the market looks to be heading toward a volatile couple of months. Both President Obama and Ben Bernanke reiterated Europe’s threat to the U.S. economy and the urgent need to resolve the region’s financial crisis, offering little reassurance to skeptical investors.