Displaying items by tag: inflows

In March, inflows into active ETFs reached a new monthly record of $26 billion. It’s somewhat counterintuitive given the strong performance of global equity markets, which tend to favor flows into passive funds. 

For the first quarter, total inflows into active ETFs reached $64 billion, a new quarterly record. YTD, 32% of ETF inflows have been into active ETFs, despite accounting for only 7% of total ETF assets. Based on the current pace, active ETF inflows should exceed $200 billion this year, a more than 50% increase from last year’s record of $130 billion.

A key factor behind the growth of active ETFs is a desire to reduce exposure to mega cap tech stocks, which account for an increasingly large share of popular market-cap, weighted indices. And this has only been exacerbated in Q1, with these stocks tacking on double-digit gains. 

Additionally, there are concerns that financial markets could get choppier given uncertainty around monetary policy and the economy. This is leading many market watchers to believe that we are shifting to a new market environment, which should favor lagging stocks and stock-picking strategies over passively holding indices. According to Noah Damsky of Marina Wealth Advisors, “We think a more active approach is appropriate as we anticipate more choppy markets with upcoming rate cuts by the Fed. We’re making active tilts in our portfolio to laggards such as health care, and over time we anticipate increasing exposure to utilities as rate cuts draw nearer.”

Finsum: Inflows into active ETFs reached new records in March and the first quarter. Active ETFs account for only 7% of total assets. So, it’s impressive and telling that 32% of ETF inflows were into active ETFs in Q1.  

Recent economic data and tea leaves from Fed officials have resulted in more challenging conditions for fixed income. Essentially, there is much less certainty about the timing and direction of the Fed’s next move as economic data and inflation have been more robust than expected. 

According to Michael Arone, chief investment strategist at State Street, this presents an opportunity with high-yield bonds given that yields are at attractive levels while a strong economy indicates that defaults will remain low. So far this year, high-yield bonds have outperformed with a slight positive return, while the iShares Core US Aggregate Bond ETF (AGG) and Vanguard Total Bond Market ETF (BND) are down YTD.

This is a contrarian trade as high-yield bond ETFs have had $387 million of outflows YTD, while fixed income ETFs have had $2.8 billion of net inflows YTD. It’s also a way for fixed income investors to bet that the US economy continues to defy skeptics and avoid a recession despite the Fed’s aggressive rate hikes. 

Currently, high-yield bonds have an average spread of 338 basis points vs Treasuries. Many of the most popular high-yield ETFs have effective durations between 3 and 4 years which means there is less rate risk. Spreads have remained relatively tight and could widen in the event of the economy slowing. 

Finsum: High-yield ETFs are offering an interesting opportunity given attractive yields. This segment of the fixed income market also is benefiting from recently strong economic data which indicates that default rates will remain low.

Passive fixed income inflows have accelerated in recent years, yet the category still trails passive equity strategies in terms of market share and adoption. Over the last decade, passive equity funds have become the dominant way in which investors get exposure to equities. Currently, passive equity funds account for 45% of global funds, while fixed income accounts for 24%. In terms of the global market, passive equity funds account for 19%, while passive fixed income comprises just 2%.

S&P Dow Jones Indices anticipates that we will see increased adoption of passive fixed income strategies over the next decade, similar to how passive took over the equity landscape. Already, inflows and market share of passive fixed income strategies are growing at a faster rate than equities. 

It should be noted that bond index funds in ETF form didn’t arrive until 2002, while equity ETFs launched in 199 and there are a limited number of fixed income benchmarks relative to equities. It’s also more difficult to replicate a bond index given that they tend to have thousands of securities, higher trading costs, more turnover, and require higher levels of oversight given maturation dates, defaults, credit rating changes, and new issues. Overall, it requires about 10 times more trades to track a fixed income benchmark than an equity benchmark. 

Finsum: Passive fixed income flows have accelerated in the last couple of years due to attractive yields. Here’s why some see the category exploding over the next decade, similar to passive equities, and what’s held it back.

Two ever-present risks for fixed income investors are credit risk and interest rate risk. Rising interest and default rates diminish the value of bonds and have to be considered especially with corporate bonds. 

However, some ETF issuers now offer corporate bond ETFs with less credit and interest rate risk such as the WisdomTree U.S. Short Term Corporate Bond Fund (SFIG). It currently offers a 4.76% yield and invests primarily in short-term, corporate debt with an effective duration of 2.47 years. It’s notable that SFIG can offer such generous yields despite investing in high-quality debt with over 44% of holdings rated AA or A. 

Another potential catalyst for SFIG is when the Fed cut rates later this year. Currently, there are trillions on the sidelines in money market funds and some of this would migrate to funds with higher yields like SFIG.

According to BNP Paribas, another reason to be bullish on investment-grade corporate bonds is due to lower issuance and structurally, higher inflows. It sees less of a case for capital appreciation given the flat yield curve and recent rally, but it believes that yields at these levels are sufficiently attractive.

Finsum: Corporate bond investors have to be mindful of credit and interest rate risk. Investors can mitigate these factors with an ETF that invests in high-quality, short-term corporate debt.

Entering the year, there was considerable optimism that the Fed could begin cutting rates as soon as March. However, the February FOMC meeting, recent inflation data, and the January jobs report have made it clear that the status quo of a data-dependent Fed, prevails. It’s clear that the Fed’s next move is to cut, but timing is the mystery.

This state of affairs means that the window for bond investors, seeking value, remains open. While recent developments have been bearish for bonds, investors have a chance to take advantage of higher yields if they are willing to live through near-term volatility. This is especially if they believe the Fed will cut rates later this year which will lift the whole asset class higher. 

According to Bloomberg, “The US economy is testing bond traders’ faith that the Federal Reserve will deliver a series of interest-rate cuts this year.” Investors can buy the dip with a broad bond fund like the Vanguard Total Bond Market Index Fund ETF, or they can search for more yield by taking on more credit risk with the Vanguard Short-Term Corporate Bond Index Fund ETF. Both have low expense ratios at 0.04% and 0.03%, respectively, and have dividend yields of 3.2%.  

Finsum: Bonds are experiencing a bout of weakness due to uncertainty about the timing and extent of the Fed’s rate cuts. Here’s why investors should consider buying the dip.