Flow & Tell with iShares | February 2023

ETF FLOWS IN FEBRUARY: SIX MORE WEEKS OF WINTERY PERFORMANCE

January delivered unexpectedly strong market performance after a volatile 2022, but the bear market rally has since lost steam. February brought stronger-than-forecasted economic data, elevated yields, and stubborn inflation - a triple macro whammy that, in our view, solidified expectations for the Federal Reserve to hold interest rates in restrictive territory. Tight monetary policy dampened both equity and bond market performance in tandem, potentially contributing to muted ETF flows across asset classes.

Investors appeared to seek safety in February, flocking to short-duration Treasuries in lieu of equity risk. In the equity arena, emerging market flows slowed on the back of renewed strength in the US dollar, but preference for international flavor remained.

THEMES OF THE MONTH

Flows, you’re on mute

Select ETF sectors garnered inflows despite poor broad market market performance, but flows were modest compared to January.

Bonds (mostly) have more fun

A slew of uncertainty from inflation to geopolitics pushed investors to prefer short duration, but high yielding exposures, with short-dated Treasuries emerging as the allocation of choice.

EM flows slow

January delivered EM optimism as a reopened China provided global tailwinds. Flows stalled in February as hawkish monetary policy expectations led a USD rally.

FEBRUARY ETF FLOWS

February ETF heat map

February ETF flows compared with index performance

Scatter plot showing the relationship between index performance and ETF sub-asset class flows for February 2023.

Source: BlackRock, Bloomberg, chart by iShares Investment Strategy. As of February 28, 2023. Flows normalized by AUM as of January 31, 2022.

 

Index performance is for illustrative purposes only. Index performance does not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.

 

Index performance is measured by the following indexes: EM  Equity: MSCI Emerging Markets IMI Index; Gold: ICE LBMA Gold Price Index; U.S. Treasury: ICE BofA 10-Year U.S. Treasury Index; Communication Services: S&P 500 GICS Level 1 Communication Services Sector Index; Utilities: S&P 500 GICS Level 1 Utilities Sector Index; HY Credit: iBoxx USD High Yield Index; Commodities: S&P GSCI Index; Information Technology: S&P 500 GICS Level 1 Information Technology Sector Index; Consumer Staples: S&P 500 GICS Level 1 Consumer Staples Sector Index; Health Care: S&P 500 GICS Level 1 Health Care Sector Index; Financials: S&P 500 GICS Level 1 Financials Sector Index; Industrials: S&P 500 GICS Level 1 Industrials Sectors Index; Energy: S&P 500 GICS Level 1 Energy Sectors Index. Coloring is based on quadrants: quadrant I: green; quadrant II: yellow; quadrant III: pink; quadrant IV: purple.

Chart description: Scatter plot showing the relationship between index performance and ETF sub-asset class flows for February 2023. Chart shows some sectors, like Energy and Health Care, see both negative index performance and outflows in January. On other hand, DM ex-U.S.  Equities and Small- & Mid-Cap sectors saw both positive ETF flows and index performance.


FLOWS YOU'RE ON MUTE

ETFs attracted little love in February as the Bloomberg U.S. Agg clocked its worst month since September and all three major equity U.S. indices sank to finish the month in the red (and not the good, Valentine’s Day hue).1 U.S. listed ETFs added a modest $8.3 billion across all asset classes, a 79% drop from January’s total flows, and an 89% plunge from the previous February’s inflows.2 On an absolute basis, it was the smallest monthly change in total assets since the pandemic.3

Despite the muted activity, February’s poor market performance did not translate to outflows even amid fears of higher for longer interest rates thanks to surprisingly strong economic data that solidified hawkish monetary policy expectations. Ten of the S&P 500’s eleven sectors closed the month with losses as broad-based declines pulled the index lower.4 Equity sector ETFs were unsurprisingly the laggards of the month, contributing $3.9 billion of outflows in aggregate. Bonds slumped lower in tandem, in an unwelcome throwback to 2022, badly battered as U.S. Treasury yields climbed to 3-month highs.5 Still, flows did not follow performance: ETFs collected modest inflows even as the market reversed course from January’s unexpectedly (and perhaps unjustifiably) strong performance. Equity funds added $6.0 billion alongside $2.8 billion into fixed income ETFs.6

Muted flows across asset classes in February

Bar chart depicting equity and fixed income ETF flows, as well as average flows for both assets.

Source: BlackRock, Bloomberg, Markit, chart by iShares Investment Strategy. ETF groupings determined by BlackRock, Markit. Average monthly flows are averaged from January 31, 2021 to February 28, 2023. As of February 28, 2023.

Chart description: Bar chart depicting equity and fixed income ETF flows, as well as average flows for both assets. The chart shows a sharp drop in flows for both equities and fixed income, with inflows well below averages for both.


BONDS (MOSTLY) HAVE MORE FUN

Recent fund flows have shown a pronounced rotation from domestic equities into fixed income, which held true even as the pace of money in motion slowed in February. Higher inflation data and stronger economic indicators prompted a reset in rates and widening of credit spreads. Investors responded by allocating to Treasury ETFs, primarily at the front-end of the curve. SHV (iShares Short Treasury Bond ETF) was the top ETF asset gatherer in February, adding $4.5bn for its largest monthly inflow on record.7

But fixed income flows in February told another story as well. Examining just which funds suffered outflows and which captured inflows likely reveals divergent preferences between fast money traders and longer-term investors.

In total, fixed income ETFs netted $2bn in February, a far cry from the more than $20bn added in January.8 Under the hood, however, the bulk of outflows were concentrated in a small handful of funds. Flagship credit funds LQD (iShares iBoxx $ Investment Grade Corporate Bond ETF) and HYG (iShares iBoxx $ High Yield Corporate Bond ETF), both among the most highly traded funds in their asset class, each experienced outflows of more than $5bn — reflective of both the prevailing risk-off sentiment as well as their use as popular hedging vehicles among institutional investors.

Inflows, on the other hand, were spread across a larger number of funds and a wider range of exposures. Funds more often associated with longer term holding periods had banner months. That divergence — sharp outflows from trading vehicles coupled with strong inflows to asset allocation ones — may simply suggest a difference in investment horizon, where long term investors see opportunity to lock in higher yields, while high frequency traders fret about near term volatility. The commonality? Both investor types used ETFs to help position their portfolios.

Flows to short-dated Treasuries increase amid hot economic data

Bar chart depicting ETF Treasury flows across durations in the month of February.

Source: BlackRock, Bloomberg, Markit, chart by iShares Investment Strategy. ‘ETF flows’ the total net flows over the course of February 2023. February 28, 2023. ETF groupings determined by BlackRock, Markit.

 

Past performance does not guarantee future results.

Chart Description: Bar chart depicting ETF Treasury flows across durations in the month of February. The chart shows an increase in short term allocations in the latter half of the month as economic data increases interest rate expectations.


EM FLOWS SLOW

After a supportive start of the year for emerging market (EM) exposures, 2023's macroeconomic picture quickly soured after stronger than expected inflation and labor market data raised Fed Funds expectations. EM ETFs have been a popular choice for many investors looking to diversify their portfolios as the U.S. dollar weakened from a peak in September. In January, EM ETFs added $11.7 billion while investors priced in higher possibilities of a Fed rate cut at the end of the year and inflation expectations decreased.9

Fast forward to February and surprisingly strong Consumer Price Index data for January, which rose 0.5% month-over-month, and a red-hot payrolls report drastically changed investors’ Fed policy expectations.10 U.S. Treasury yields surged in February and investors priced in a higher terminal rate, contributing to a rally in the dollar. As the dollar strengthened, flows into EM exposures in February turned net negative with EM ETFs seeing $981 million of outflows.11 That marked a sharp reversal — EM ETFs have gathered assets for each of the last four months as the dollar declined.

One thing is clear: flows have been closely tied to the dollar. We could continue to see outflows from EM ETFs as the strong dollar makes international exposures less attractive. But we believe any potential weakness in the dollar could make EMs an enticing option again.

Reversal: investors shy away from emerging markets

Line and Bar chart showing U.S. Dollar spot index and weekly flow into EM ETFs from July 2022 to the end of February 2023.

Source: BlackRock, Bloomberg. As of March 1, 2023. Chart by iShares Investment Strategy. USD Spot Index represented by DXY Currency. Emerging Market ETFs categorized by Markit.

 

Index performance is for illustrative purposes only. Index performance does not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.

Chart description: Line and Bar chart showing U.S. Dollar spot index and weekly flow into EM ETFs from July 2022 to the end of February 2023. As the dollar weakened from a peak in September, inflows into EM ETFs turned strongly positive. In the last month as the USD strengthened again from a 10 month low, investors turned away from EM with EM ETFs experiencing outflows every week in February.


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Kristy Akullian

Kristy Akullian

Senior member of the iShares Investment Strategy team

Jon Angel

Investment Strategy

Contributor

Faye Witherall

Investment Strategy

Contributor