European fixed income investors sought to safeguard their portfolios in 2022 with ETF flows showing a clear preference for higher-quality investments, according to data from Invesco.
Paul Syms, Head of EMEA Fixed Income ETF Product Management at Invesco.
ETFs providing exposure to US Treasuries experienced the most robust demand by some margin, gathering 20.0 billion in net new assets (or 61% of total fixed income ETF net inflows) over the year.
Euro- and US dollar-denominated investment-grade credit came in second and third with $8.4bn and $7.8bn net inflows, respectively, while European government bonds were in fourth place, pulling in $6.5bn net new assets.
In total, developed market government bond ETFs accounted for almost 89% ($29bn) of the asset class’s total demand over the year.
Flows were sharply different within more speculative segments of the fixed income landscape. Chinese bond ETFs dominated outflows (-$11.3bn) as yields fell below those on developed market government bonds.
Inflation-linked bond ETFs also had a poor year, shedding -$5.1bn, as central banks tightened policy, as did lower-quality credit with high yield bond ETFs experiencing net outflows of -$2.6bn.
Inverse ETFs – those betting on rising yields – also saw significant outflows as the rise in yields generated positive returns.
Commenting on these flow trends, Paul Syms, Head of EMEA ETF Fixed Income Product Management at Invesco, said: “This is largely unsurprising as previous flows into lower-rated bonds were largely driven by the extremely low yields offered by developed market government and investment-grade bonds, particularly since the pandemic.
“However, following central banks tightening policy, these higher-quality, more liquid fixed income asset classes now offer sufficient yield to attract demand once more.”
Source: Invesco.
Looking ahead to fixed income’s outlook in 2023, Syms highlights three areas that investors may wish to keep an eye on: global inflation, the potential for recession in the US, and opportunities in lower-rated debt.
Syms notes that central bank policy is likely to continue being dictated by high levels of inflation but there is a fine line between tightening policy enough to bring inflation under control and tightening too much and driving the economy into recession with central banks having to decide when to enact a policy pivot following aggressive rate hikes in 2022.
While spreads for euro and sterling-denominated credit remain wide even after the recent bounce, Syms points out that US dollar-denominated credit spreads are close to longer-term averages and could be vulnerable if the Fed is unable to generate a “soft landing” for the economy.