March ETF Flows: The Only Certainty Is “I Don’t Know”

The societal and economic impacts of the unprecedented global coronavirus pandemic sent markets reeling in March. Global equities fell into their first technical bear market in over a decade, and volatility spiked. Risk-off behavior, along with policy actions, pushed Treasury bill yields into negative territory.

There have been other crises, but this one is different. The catalyst has been one of humanitarian drivers—not structural or geopolitical. Our collective health has been impaired, and social behaviors have been upended around the world. The timing of when things may return to “normal” remains uncertain, and the path back from this crisis will be unlike any other.

Asset class exchange traded funds flows: Gold funds posted near-record inflows as investors de-risked

With markets in turmoil and uncertainty high last month, investors broadly de-risked while also seeking market hedges. Fund flows are representative of these trends, with only a few categories registering meaningful inflows. The broad-based de-risking led to fixed income outflows, with bond ETFs experiencing their first monthly outflows since October 2018 and their worst month on record. Equities counterintuitively finished the month with net inflows, as investors sought out liquid, market-hedging vehicles to express directional views. This was quite noticeable among the most liquid ETFs, where shares were created and then lent out to investors seeking to express a negative directional view¹ via short positions.

Gold funds posted $2.8 billion of inflows in March—pushing their quarterly inflows to $6 billion, the fourth highest level ever. Gold inflows over the rolling 12-month period, at $15.4 billion, are now at the second highest level ever—narrowly outpacing Brexit-related inflows. Only 2009 saw slightly higher inflows over a rolling 12-month period, as shown below.

Overall flow trends in March reflect investors using ETFs to make real-time asset allocation decisions and access liquidity, leading to record increases in trading volumes across a multitude of market segments. Amid the current market volatility, secular forces that have driven ETF industry growth have been put on pause. After accumulating inflows in 58 out of the last 60 months, active funds endured $6 billion of outflows last month. Similarly, after inflows in 48 out of the last 50 months, smart beta funds had $7 billion of outflows in March. Low-cost ETFs—the darling of the industry—had outflows of $4 billion last month, largely driven by the outflows in fixed income. For perspective, over the last twelve months, low-cost ETFs have averaged $20 billion of inflows a month. March was a noticeable reversal. ESG funds had inflows, but it’s still early days there.

Geographic ETF flows: US equity funds saw inflows while non-US focused ETFs had outflows

Geographic flows paint an interesting but mixed picture. US equity funds posted inflows, while non-US focused ETFs had outflows. Inflows into US funds were predominantly driven by more liquid ETFs being utilized for a variety of market purposes—including the long-to-lend transactions described above and option-related activity. This is evident in an uptick in ETF tethered-option volumes.² Outflows in non-US focused market exposures reflected broad-based de-risking.

Breaking out the flow patterns in a time series by US versus the rest of the world more clearly illustrates these trends. As shown below, once volatility spiked in late February, both segments saw outflows. However, once the market became more volatile, and the demand for hedging vehicles increased, US exposures decoupled and saw inflows. Toward the end of the month, as the most severe downside pressures somewhat abated following certain policy actions, the demand for market hedges slowed—leading to a few dips for US exposures.

Fixed income ETF flows: A deluge of outflows with inflows only for government and high yield

Fixed income ETFs have never seen a deluge of outflows like they did in March. Only two sectors had inflows—and they were on different ends of the risk spectrum. Government ETFs had the most inflows, while high yield also saw inflows. The government flows were somewhat consistent, but predominantly led by short-term exposures. High yield flows were a bit more erratic, however.

Up until the last week of the month, high yield saw outflows. Following stimulus actions, and with high yield spreads over 1,000 basis points,³ it appears tactical investors rotated back into the market. Both investment grade and high yield corporate ETFs saw a wave of selling as the markets turned volatile. But buyers of both credit types returned, once policy measures aimed at stabilizing the investment grade market were announced on March 23. See the chart below. During the last five days of the month, $3 billion was deposited into high yield and a slightly lower amount was redeemed from government funds.

Maturity ETF flows: Record inflows for ultra-short and short-term government bonds

Ultra-short and short-term government bond ETFs saw their most inflows ever for a 30-day period. Inflows picked up pace once key technical indicators (such as 200-day moving averages) used by traditional trend-following equity strategies were breached, triggering a defensive shift. The inflows, however, also reversed a bit when the market did. The chart below depicts the noticeable risk-off behavior from tactical investors last month.

Think discipline and diversification

The path back from this crisis will be unlike any other, even if the $7 trillion fiscal and monetary policy plans feel similar to past crisis rescue packages.⁴ These policies are intended to bridge the gap, while our adherence to social distancing and shelter-in-place measures—along with the heroic efforts of our brave medical professionals—seek to flatten the COVID-19 curve.

When will everything go back to the way it was? The answer is a phrase I have used more often in the past month than ever before: “I don’t know.” In these same conversations, I typically stress having humility; respect for those who are risking their lives so we can live ours; and discipline to adhere to the advice of medical professionals, so we can get back to something that resembles normalcy.

Discipline applies to investing too. Portfolios need discipline and proper diversification. This volatility is not over—data has yet to reveal the full extent of the impact on the economy. We have bounced nearly 20% off of bear market lows⁵ (in almost a bear market rally). Yet since 1926, when the S&P 500® Index has endured a 20% or more rally in a bear market, it has still taken an average of 641 days⁶ for a recovery to pre-bear market levels—and the path has not been linear.

History can provide some context about what a recovery could look like. In 1918, one quarter of the world’s population was infected with the Spanish flu, leading to a death toll of between 17 and 50 million people.⁷ The next decade brought the Roaring 20’s when we built great big things, made massive technological advancements, cured diseases, and created great art.⁸

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