December ETF flows: The end of easy layups

Dec 31st, 2019 | By | Category: ETF and Index News

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By Matthew J. Bartolini, Head of SPDR Americas Research, State Street Global Advisors.

Matthew J Bartolini, Head of SPDR Americas Research

Matthew J Bartolini, Head of SPDR Americas Research.

2019 was a very good year for almost everything. After a weak 2018 performance set a favorable starting point for both stocks and bonds, easing monetary policy actions helped produce the best annual returns in a decade for the standard 60/40 portfolio.

Over 75% of global stocks had positive returns, and 97% of the bonds in the Bloomberg Barclays US Aggregate Bond Index registered a gain in 2019.

Finding positive returns in 2019 was like making an easy layup, giving investors plenty of opportunities to run up the score.

Asset class ETF flows: Active funds poised to come off the bench

After averaging $12.9 billion a month and taking in a record $26 billion in June alone, fixed income flows were the star player in 2019. Flows alone accounted for a 24% expansion in the asset base for bond ETFs. The strength in flows stemmed partly from market-related reasons (income in a low-rate world) and partly from secular forces.

By contrast, even the eye-popping $81 billion of inflows to equity ETFs in November and December wasn’t enough to pull full-year flows back to prior-year levels for that asset class. In fact, 2019 produced the lowest annual equity fund flows of the past five years. Investors appear to be responding by scouring the globe for improved prospects. Inflows have increased outside the US, especially among emerging market ETFs.

Source: SSGA.

Active funds took in $26 billion in 2019, largely driven by fixed income strategies, which account for 79% of active ETF assets. On a relative basis, those flows represent 34% growth for active funds in 2019. Passive strategies netted $307 billion of inflows, which represented just a 9% increase in that category’s assets.

Two factors suggest relative growth in active fixed income ETFs will continue:

  • More funds will have identifiable track records. At the moment, only 48 of the 113 active fixed income strategies have at least a three-year track record.
  • Active fixed income strategies may provide more benefit to investors in 2020, given their ability to balance the macro and micro risks in the current environment while targeting a yield on par with historical levels.

Sector ETF flows: Losing streak extends to second consecutive year

Sector flows were challenged throughout 2019 and came in net negative for the year at -$4.2 billion. This is the second year in a row in which sector flows were negative—the first time that has ever happened.

The outflows were led by Financials and Health Care. But the $4 billion of net outflows by sectors cannot be hung on just two segments—six of the 11 sectors had outflows in 2019.

Source: SSGA.

The negative trend for Health Care and Financials will likely abate, given the reduced headline risk and strong fundaments for Health Care and the anomalous nature of the outflows in Financials over the past two years, which reversed the equally anomalous inflows after the 2016 election.

Furthermore, given current valuations, broad-based returns are likely to be lower. As a result, investors are likely to seek alpha opportunities, which sectors have historically offered due to their high dispersion across a low number of securities.

Finally, while the 2019 full-year trend was negative, the three-month trend is positive. In fact, the rolling three-month figure not only finally broke past the bottom 10th percentile—it broke the zero bound and the historical median as well.

Unlike other equity areas, sector flows do not experience as much seasonality, so this trend may herald stronger performance in 2020.

Source: SSGA.

Fixed income ETF flows: High-yield mounts a comeback

Fixed income flows were positive across every sector for every time period mentioned below. Investors turned toward traditionally interest-sensitive sectors as they sought to benefit from duration-induced price appreciation in a low interest rate environment.

Source: SSGA.

Investors’ need for higher levels of income generation pushed high-yield bond ETFs to a record $18 billion of inflow, following their worst-ever year of outflows in 2018. A combination of strong flows and double-digit market returns produced record high-yield bond ETF assets of $56 billion at the end of the period.

Source: SSGA.

For 2020, however, it is unlikely that we will see this type of sizable flow activity again, as many of the flows were a derivative of broader US Treasury yields falling so quickly in 2019. And bond yield trends and interest into high yield have historically shown a correlation, as shown above.

Can the winning streak continue?

It seems unlikely that 2020 will put up the same gaudy numbers we saw in 2019. Last year’s strong returns have stretched equity valuations and compressed bond yields, which historically have led to lower future returns. Beyond valuations, capital markets’ ability to continue to run up the score in 2020 will depend heavily on how they react to the first 100 days. That period will produce a lot of policy and political stress that the markets will have to digest as either news or noise.

After a great run in 2019, we would caution investors who may be attempting to squeeze out those last few points of return or incremental yield. It may not be worth the risk.

(The views expressed here are those of the author and do not necessarily reflect those of ETF Strategy.)

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