Flow & Tell with iShares | January 2023

January ETF heat map

January ETF flows compared with index performance

China’s swift reopening after three years of strict zero-Covid controls spurred emerging market (EM) optimism in January, propelling standout flows as investors reallocated overseas. Several favorable inflation reports and a peaking U.S. dollar also added tailwinds to reverse last year’s volatility-induced slide.

Emerging market equities captured $8.9 billion in inflows in January, accounting for over 44% of net equity inflows on the year (compared to under 8% in 2022).² EM sovereign debt ETF flows followed a similar trajectory, fetching $2.2 billion in January — its largest month of inflows since 2018.³ These strong flows underscore a sentiment shift in the new year after 2022’s poor performance on the heels of tightening monetary policy and a surging USD, prompting investors to up their allocations from last year’s underweight positioning in a return to benchmark. Further, strong flows to single country funds point to tactical positioning in precision products, suggesting strong demand from both strategic allocators and fast money traders.

Emerging markets were not the only exposures feeling the reopening love — investors also turned to global strategies to tap tailwinds from easing Covid restrictions. January delivered $7.4 billion in inflows to developed markets ex-U.S. equities, its most positive month since January 2022.⁴ Certain commodities also notched inflows as the world’s largest raw material consumer returned online: natural gas and metal ETFs both touted positive flows in January.⁵

While last year’s nearly $200 billion in fixed income ETFs inflows set a record, 2023 is also off to a hot start.⁶ The strong consensus view that investors should top up their fixed income allocations at attractive yields translated to $23.2 billion in net inflows in January.⁷ Investment grade corporate credit ETFs sat atop the fixed income table, gathering $9.1 billion in net assets as investors look to deploy capital towards opportunities within the asset class.⁸

But what stands out about fixed income ETF flows this year is the preference for liquidity, regardless of exposure. While there are 582 fixed income ETFs listed in the U.S., the top 10 asset-gatherers in January represented nearly half of average daily trading volumes. The preference for liquidity was more consistent than preference for exposure, as we saw demand for emerging market debt, investment grade and high yield corporate credit, mortgage-back securities, broad-market debt, and U.S. treasury ETFs. This trend is favored by institutional investors, who often gravitate toward best-in-class liquidity to deliver nimble and tactical plays. In other words, investors see numerous opportunities within bonds and are turning towards the liquidity of ETFs as they make their portfolio allocation decisions.

In the ETF landscape, we often ask ourselves whether flows precede or follow performance. Where it gets interesting is when flows and performance aren’t the perfect match. For instance, despite the S&P 500 ending 18% lower in 2022, U.S.-focused equity ETFs added $314.5 billion.⁹ On the other hand, the start of 2023 saw U.S. equity ETFs shed $657 million in January, despite strong performance as markets rallied to finish the month in the green.¹⁰ This puzzling flow-performance dichotomy can in part be traced to a popular ETF use case: tax loss harvesting, a strategy utilized in down years as investors sell assets in the red to lock in losses, and reinvest proceeds elsewhere. Large outflows from U.S. equities in January were partially a byproduct of large inflows in December, as tax-related trades were mechanically unwound.

Within fixed income, investors poured into U.S. Treasury ETFs across the duration spectrum in 2022 even though performance for the year was negative across the curve. More distinctly, long-term U.S. Treasury ETFs added $22.6 billion in assets despite the long end of the curve not offering much in the relationship, falling over 30% on the year.¹¹ But that link looks to have righted itself to start the new year: performance year-to-date is positive, and investors continue to add to long-term U.S. Treasury ETFs to the tune of $2.4 billion (the most across duration buckets).¹²