Flow & Tell with iShares | Oct 2021

October ETF heat map

October ETF flows compared with index performance

Professional investors increasingly build whole portfolios using ETFs, and when some of the largest managers reshuffle their holdings, it can register in ETF flows. BlackRock model ETF portfolios with more than $158 billion in global assets under management were among those who rebalanced in October, resulting in some standout flows to several ETFs.² Reflationary themes were in focus, but with an eye to moderately reducing some risk in stocks and searching for yield within fixed income.

The iShares Fallen Angels ETF (FALN) had its largest month of net inflows since inception, adding $1.2 billion in net assets during October.³ The outsized October flows add to an already remarkable trajectory: growing from a $400 million fund at the end of 2020 to more than $4 billion fund at the end of October.⁴ “Fallen angels” are bonds that were issued with an investment grade rating but were subsequently downgraded to “speculative,” or high yield-rated grade. Higher economic growth rates could benefit these recently downgraded issuers — many of which fell victim to last year’s pandemic-related slowdown. Indeed, we think improving business conditions could cause some fallen angels to be upgraded to investment grade status.

Certain BlackRock model ETF portfolios seeking to mitigate equity and inflation risks through quality exposures also added to the iShares TIPS ETF (TIP) and iShares MSCI USA Min Vol Factor ETF (USMV), and pulled back from tech-heavy sector allocations and investment grade corporate bonds that might struggle in a rising interest rate environment.

Covid-era fallen angel upgrade cycle on similar path of previous fallen angel upgrade cycles

Investors zeroed in on earnings season during the second half of October, shifting gears from the broader macro trends that dominated headlines during the summer months. As a result, U.S.-domiciled sector ETFs saw a sizable pickup in activity and accounted for nearly 40% of October flows versus an average of just 16% year-to-date.⁵

More than 70% of the S&P 500 companies reported third-quarter earnings in October and many companies topped analyst forecasts, a positive trend that renewed optimism around the U.S. equity market.⁶ In both flows and performance, the recent focus has been on finding the sectors that are best positioned to weather cross-currents such as inflation and broken supply chains. Financials exemplify the trend, with October ETF inflows totaling $2.4 billion.⁷ A strong earnings cycle benefitted the sector, as did a relative insensitivity to supply chain woes and rising interest rates.

We advocate for a barbell approach combining value and quality: a strong U.S. consumer continues to drive the economic recovery — benefiting cyclical, value-oriented companies — while hedging with quality exposures may help guard against pass-through inflation and volatility as the economic rebound continues to power new record highs.

Sector ETFs driving flow activity

Supply chain bottlenecks are hitting equity market sectors in different ways, from surging energy costs and widespread semiconductor shortages to a persistent shortage of workers to perform key jobs, such as drive trucks. As the reverberations from the pandemic continue, sectors with the highest operating margins (operating income/total revenues) are also seeing the largest flows. We attribute this connection to the ability of high-margin sectors to weather delays and cost pressures better than low-margin sectors.

Information technology has been in the spotlight as relatively low operational costs and an increasingly virtual world insulate it from the volatility of the physical world. However, it’s not just about technology, as real estate sector ETFs accumulating $3.6 billion in inflows over the past two months.⁸ Increased housing demand, labor shortages, and costly raw materials has hit both sides of the supply and demand equation, providing a tailwind for the sector headed into year-end. For more information about how to help protect your portfolio from supply chain disruptions, please see our latest commentary on global supply chain issues.

Operating margins and ETF flows