Strong ETF Inflows Reflect Buying Under Blue Skies
Electric Light Orchestra’s joyful hit Mr. Blue Sky was written when, following two weeks of rain, their lead singer finally saw the Swiss Alps glistening under bright blue skies and happily thought, “Hey there, Mr. Blue Sky.”
Widely recognized as one of the happiest anthems of all time, the song’s sunny disposition was shared by the market this past month and quarter. Global stocks rallied 3% in March, their fifth month in a row with gains, and are now up 7.8% through the first three months of the year while notching 10 new all-time highs.1
This is the best first quarter (Q1) for global equities since 2019, and second-best Q1 in the past decade.2 And the first three months of the year typically don’t display a Mr. Blue Sky mood. The average Q1 return over the past 30 years is just +1.15% — the second-worst out of the four quarters.3
As ETF flows reveal, buying behavior had a similar Mr. Blue Sky tint this quarter.
ETFs Take in More than $200 Billion in Q1
ETFs’ $103 billion in March inflows is the fourth-highest monthly total ever. And those strong flows pushed Q1 flows to $203 billion, 57% greater than the typical Q1 (Figure 1).
With such a strong start to the year, even if ETFs amass just their average inflows for the next three quarters, 2024’s total could surpass $620 billion. That would be the second most all-time, and more than likely push total assets under management well past $9 trillion (currently at a record $8.8 trillion) — as long as market returns remain buoyant.
Active ETFs are playing a large part in this above-trend pace.
- Active ETFs took in a record $26 billion in March, fueled by record inflows in both equities (+$16 billion) and fixed income (+$7 billion).
- This is the eighth month in a row where active ETFs have added more than $10 billion and their 48th month in a row with inflows.
- Year to date, active ETFs have taken in $64 billion, a record start to any year.
And if active ETFs sustain this momentum from the past nine months (averaging $16 billion a month), 2024’s total active ETF inflow could be $208 billion — far surpassing 2023’s record $130 billion.
That projection is not farfetched. As of right now, active ETFs account for 32% of all ETF inflows — their highest rate ever (Figure 2) and off a 7% share of assets. If the projection of $620 billion for all ETFs holds, and the active share capture remains consistent, that would mean $200 billion into active ETFs this year.
Equities Get $85 Billion More than Bonds in Q1
Equities took in $85 billion more than bonds over the past three months. That differential is above the 80th percentile — where it’s been all year.
Within equities, US stocks led on both notional and relative terms last month. Their $65 billion in inflows is far more than any other geographical region, and that notional figure represents 1.19% of US equity funds’ start-of-month assets.
In the US, there was a preference for cyclical sectors (+$4 billion) while defense sectors posted their record 10th consecutive month with outflows. From a style perspective, investors continue to buy growth, with a record 14th month in a row with inflows. And growth’s nearly $12 billion of inflows in March ranks second-most all-time, while the $25 billion over the prior three-months ranks first all-time.
Figure 3: Geographical Flows Favor the US
| In Millions ($) | March | Year to Date | Trailing 12 Mth | Year to Date (% of AUM) | Current AUM |
|---|---|---|---|---|---|
| U.S. | 64,507 | 110,317 | 414,081 | 2.17% | 5,654,388 |
| Global | 1,819 | 1,902 | 5,712 | 0.99% | 202,100 |
| International-Developed | 5,325 | 12,021 | 50,543 | 1.76% | 728,624 |
| International-Emerging Markets | 1,798 | 4,256 | 11,087 | 1.76% | 251,808 |
| International-Region | 750 | 2,240 | -3,027 | 2.95% | 82,246 |
| International-Single Country | 552 | 3,525 | 10,708 | 3.34% | 113,072 |
| Currency Hedged | 2,358 | 4,122 | 7,202 | 23.54% | 23,933 |
Source: Bloomberg Finance, L.P., State Street Global Advisors, as of March 31, 2024. Top two/bottom two categories per period are highlighted. Past performance is not a reliable indicator of future performance.
Outside the US, while net international inflows are not overwhelming, international sub-category flows do show some discrete positioning trends:
- International-developed ex-US funds took in $5 billion in March, their record 45th consecutive month with inflows.
- Currency-hedged ETFs witnessed $2.3 billion of inflows in March, or 11% of their start-of-month assets, right as the US dollar strengthened versus prominent currencies like the Japanese yen.
- Emerging market ETFs had $1.8 billion of inflows in March, but 110% of those flows were into emerging market ETFs that exclude China (+$1.9 billion of net inflows) as investors are shying away from that country.
- China-focused ETFs had $925 million of outflows in March, restraining the broader single-country sector and the $1 billion into India and $400 million into Japan.
Bond Buyers Prefer Credit over Defense
Aggregate bond ETFs, driven by active funds (48% of all aggregate inflows versus an asset market share of 23%), had the greatest inflows in March and year to date. The emergence of active ETFs amid ongoing rate volatility is likely to continue to support the broader aggregate bond category.
Credit-related sectors like investment-grade corporate bonds continued to receive outsized interest as high yield bond ETFs had outflows. Yet, the similarly subjective credit exposed bank loan & collateralized load obligations (CLO) category saw $1.8 billion of inflows in March — and now has $4 billion in inflows on the year.
For investment-grade corporates, the $3 billion in March raised the trailing three-month total to $13.5 billion. This ranks in the 99th percentile and eighth all-time, as the potential carry from investment-grade corporate bond yields remains attractive, even as spreads remain quite tight.
With such a noticeable interest in risk-on credit, defensive ultra-short duration government bond ETFs had $2 billion of outflows — leading the broader short-term government bond category to a fifth month in a row with outflows, totaling $21 billion.
This run on assets is also one month shy of a record streak of outflows. Yet, with reinvestment risk on the horizon and investors seeking to put the mountain of cash built up over the past year to work, outflows from those ultra-short maturity and defensive sectors are likely to continue. A trend to watch for April flows.
Figure 4: Credit-sectors Take in Over $4 Billion in March
| In Millions ($) | March | Year to Date | Trailing 12 Mth | Year to Date (% of AUM) | Current AUM |
|---|---|---|---|---|---|
| Aggregate | 9,645 | 24,257 | 81,268 | 4.89% | 515,752 |
| Government | 2,303 | 7,470 | 68,010 | 1.96% | 382,403 |
| Short Term | 54 | -5,518 | 9,814 | -2.70% | 199,013 |
| Intermediate | 1,539 | 9,079 | 22,589 | 9.28% | 97,855 |
| Long Term (>10 yr) | 711 | 3,908 | 35,607 | 4.59% | 85,535 |
| Inflation Protected | -1,372 | -2,059 | -15,514 | -3.38% | 58,821 |
| Mortgage Backed | 1,179 | 1,759 | 10,924 | 2.86% | 62,450 |
| IG Corporate | 3,243 | 13,509 | 27,051 | 5.50% | 257,860 |
| High Yield Corp. | -299 | 1,537 | 16,435 | 2.11% | 74,647 |
| Bank Loans and CLOs | 1,842 | 4,391 | 10,105 | 21.22% | 25,053 |
| EM Bond | -805 | -2,013 | -1,074 | -6.76% | 27,672 |
| Preferred | 539 | 939 | 1,850 | 2.75% | 36,152 |
| Convertible | 68 | 177 | 303 | 3.28% | 5,658 |
| Municipal | 1,209 | 713 | 17,149 | 0.58% | 123,666 |
Source: Bloomberg Finance, L.P., State Street Global Advisors, as of March 31, 2024. Top two/bottom two categories per period are highlighted. Past performance is not a reliable indicator of future performance.
What to Expect Next: April Showers or More Blue Sky?
Supportive fundamental and economic data sparked the good vibrations leading to Mr. Market’s Mr. Blue Sky mindset in Q1.4 Heading into Q2, strong momentum for these trends could help the Mr. Blue Sky sentiment continue.
While upbeat, Electric Light Orchestra’s Mr. Blue Sky does ponder what happens when he goes away, and the feel-good vibes stop. “But soon comes Mr. Night creepin’ over, now his hand is on your shoulder.” And that’s the big question: When will the sun set on this market’s version of Mr. Blue Sky — and who/what will play the role of Mr. Night?
The Federal Reserve (the Fed) is most likely to be the Mr. Night that flips this market’s mixtape to the B-side and plays Led Zeppelin’s Fool in the Rain. Perhaps by delaying rate cuts beyond July, leading to a smaller window to alter policies before election-related narratives complicate things. Or perhaps with how it ends its quantitative tightening (QT) program that could remove too much liquidity from the system. Back in 2019, the Fed waited too long, and the market’s mood soured and volatility rose.
Filmmakers frequently use Mr. Blue Sky to brighten the mood. If the market’s mood does deteriorate from an appearance by Mr. Night, even as fundamentals and economic data remain healthy, playing a few Mr. Blue Sky-esque chords with asset allocation decisions could help you do the same for portfolios by:
- Focusing on quality and value in equities, alongside an emphasis on consumer sectors like homebuilders that have benefitted from the recent economic resilience.
- Using active bond managers to target credit opportunities while navigating ongoing rate volatility amid shifting policy moods.
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