Exchange-traded funds were en vogue in February.
So much so, that both ETFs backed by equities and fixed-income securities saw inflows as investors piggybacked on the stellar performance of global equity indexes that were up double digits for the year and the S&P 500 index enjoying its best start since 1987.
Matthew Bartolini, head of SPDR Americas Research at State Street Global Advisors, said that it appeared that ETF investors are embracing the broad rally and putting their cash back to work. In his February US ETF Flash Flows report, he noted that fixed income ETFs broke a three-month streak of more than $10 billion of inflows in February, as investors rotated out of the safety of short-term government funds.
Concurrently, equity funds, which had been beaten up of late, reversed course taking in over $15 billion of inflows during the month. Bartolini told Traders Magazine that this marks the first time since October 2018 that equity ETFs attracted more inflows than their fixed income counterparts.
For now, the noticeable gains have turned broad-based flows positive, as investors have looked for somebody to love (namely ETFfs), Bartolini began. But the hammer might fall on this rally given the confluence of macro uncertainties and still sluggish global growth. Not to mention, given how supersonic the rebound has become (20% of S&P 500 stocks are considered overboughtv right now) investors may start to question whether this rally is real life or just fantasy, potentially leading these double digit gains to bite the dust. This underscores why we remain constructive on defensive equities that trade at inexpensive valuations but have quality balance sheets. We also favor defensive short duration bond strategies with lower volatility that generate income similar to broad aggregate exposures, given how flat the yield curve has become.
On the equity side of the ledger, after posting outflows of almost $18 billion in January, equity funds reversed course taking in over $15 billion of inflows in February. This marks the first time since October 2018 that stocks beat bonds from a fund flow perspective. However, even with the $15 billion this month, equity funds remain in the red for 2019.
The negative net number is largely a result from the cyclicality (tax rebalancing) that impacts January flow figures, Bartolini explained. Stretching the timeframe out to three months shows positive flows for equities. So, no one is kicking mud in the stocks face. While fixed income ETFs narrowly missed their third straight month of more than $10 billion of inflows, they are still outpacing equity ETFs this year and on a three-month basis, even though equity ETFs have $2.2 trillion more assets than fixed income funds. Right now, fixed income ETFs have taken in 3.7% of their start-of-year assets and are poised once again to pick up market share this year relative to equities within the ETF industry, as investors continue gravitating towards ETFs to express a wide array of views on the bond market.
In parsing down equities, while US-focused equity ETFs may have taken in the most flows for the month of February, the real standout was emerging markets (EM) taking in over $4 billion. That $4 billion represents 2.4% of start-of-month assets, a figure that far outpaces the 0.7% for US-focused funds. Bartolini said the year-to-date statistic is even more impressive, as EM has taken in 7.5% of its start-of-year assets – the highest in the geographical category.
As for fixed-income, SSGA reported most fixed income segments received inflows during the month, with the exception of two different categories – Government and Convertibles. Bartolini said the former is evidence of the renewed risk-taking expressed by investors, while the latter is likely idiosyncratic driven given how concentrated the convertible ETF offerings are.
From a markets perspective, the flows into fixed income ETFs represent three trends, he began. First, Increasing portfolio risk tolerance as markets have rebounded, but with a lower volatility profile. As a result of the higher coupon, EM debt and high yield offer equity-like returns but with lower volatility. Second, seeking areas for income generation as Treasury yields have fallen, evidenced by mortgages already taking in 18.7% of their start-of-year assets. Mortgages, by nature, have no spread risk but yield 73 basis points more than Treasuries. Lastly, ongoing use of the structure to construct portfolios and being active with fixed income, either by tailoring portfolios with indexed based exposures or outsourcing segments to the numerous active fixed income mandates that have been launched over the years.