Flow & Tell with iShares | March 2023

March ETF heat map

March ETF flows compared with index performance

In March, markets grappled with regional bank failures, mixed economic data, and undeterred central banks that continued to hike rates. These developments triggered big shifts in global yield curves and the highest level of bond market volatility since the Global Financial Crisis.²

Amid this uncertainty, investors used ETFs to quickly adjust their allocations, with a clear preference for higher quality bonds. Top-rated U.S. Treasury ETFs added more than $24 billion — setting a record for monthly flows — while credit-risky corporate and high yield bond ETFs suffered redemptions.

Within the U.S. Treasury category, two themes are evident. First, ETFs focused on T-bills and other short term government bonds were popular choices, presumably acting as a landing spot for assets leaving bank deposits. While these ETFs do not feature FDIC guarantees like other savings vehicles, they may provide additional income. As an example, SGOV (iShares 0-3 Month Treasury Bond ETF) posted its largest monthly inflow on record ($2.2 billion) as investors targeted attractive yields at the front end of the curve.

At the same time, the Treasury ETF flows data also shows an appetite for longer maturity exposures. Those bonds are traditionally associated with a “flight to quality” trade and generally outperformed their shorter-term counterparts in March as rates declined in March. IEF (iShares 7-10 Year Treasury Bond ETF) was the top asset gathering bond ETF in March, adding $6 billion. Its longer duration cousin TLT (iShares 20+ Year Treasury Bond ETF) was also among the top recipients as investors rushed to build potential recession hedges into their portfolios.

March’s FOMC meeting coupled a 0.25% hike with a dovish message on growth, inflation, and unemployment — a marriage that brought a ceiling in sight for federal funds rates. Investment allocations diverged on this new rate expectation: one camp traded on soft landing expectations, while recession-wary bears turned defensive.

Notably, some investors who believe the Fed will engineer a soft landing flocked to growth as favored allocations, many of which were funded by an exodus from value exposures. Historically, growth equities have fared better as interest rates fall, as looser monetary policy provides cheaper sources for funding future growth. Value-style exposures, on the other hand, can struggle and relatively underperform when rates decline. March’s rate reset pushed cumulative growth net inflows into positive territory on the year, as U.S.-listed growth ETFs began March with net outflows of $4.3 billion but reversed to close the month.

While the higher-for-longer trade fell out of favor over the month, we remain focused on still-sticky inflation. Many investors who maintain conviction in the elevated rate regime, as well as those bracing for recession, turned to quality factor ETFs. Quality ETFs netted $13 billion of net inflows YTD, as their defensive fundamentals (low financial leverage, stable year-over-year earnings) attracted investors concerned about the macroeconomic uncertainty ahead.

As a non-producing asset, there is often a tradeoff between gold and interest rates. As rates rose dramatically in 2022, and real rates turned positive very quickly, gold looked relatively less attractive as a store of value compared to high-quality fixed income, which offered both a flight to safety and attractive yields. However, as the Federal Reserve nears the end of their rate-hiking cycle, gold prices may have found support in the stabilization of real rates and a potential peak in the U.S. dollar.

March brought a slew of conditions usually favorable to gold. Investor fear skyrocketed, as bank failures captured headlines. Correlations between traditional asset classes like stocks and bonds turned positive, meaning investors had little place to hide. It’s no surprise, then, that investors turned to gold as a relative ‘safe-haven’ and an important source of diversification during a period of unusually volatility: over $800 million flowed into gold ETFs since the beginning of March.