March Flash Flows: A Lot of Crooked Numbers

With rates rising, bonds posted their worst quarterly return (-6%) since 1980. Stocks didn’t do any better: even after the March rally, Q1 returns were -5%. ETFs, however, continue to take in assets, side-stepping the current market volatility, as fund flows in March were the third-most ever, totaling $93 billion.

In baseball, the phrase “a crooked number” refers to a number other than zero or one being scored. When a team scores two or more runs in an inning, it is said that they have “hung a crooked number” on the scoreboard — and the pitcher.

This isn’t a good thing if you are that pitcher, or fan of the team. A few innings in a row with crooked numbers going up on the scoreboard and the pitcher hits the showers early and fans might head for the exit.

Global capital markets definitely had a crooked number hung on them this quarter. Global equities fell 14% through the first 9 weeks of the quarter, only to rally in the past three weeks — trimming the decline for the quarter to -5.3%.¹

Stocks fell the same amount as bonds in the quarter. Yet, given bonds shouldn’t have such severe declines, it felt like bond portfolios had the same type of crooked number hung on them as the Washington Nationals did in the eighth inning of a recent spring training game. The Nats gave up 15 runs in that one inning.

Nevertheless, flow totals illustrate that investors remain undeterred and continue to allocate capital at elevated rates. Yet, there were areas where there was more conviction than others — a by-product of our uncertain market environment.

Another $90 Billion Here, Another $90 Billion There

Fund flows in March were the third-most ever, totaling $93 billion. This is now the fifth time in the last two years where flows have been above the $90 billion mark. The flows in March were also 50% of the overall $195 billion first quarter flows.

The most conviction was expressed within equities, and namely US equities. Equity funds took in 70% of all flows in March, with US exposures taking in 88% of all equity flows. The latter is well above the market share of assets, as US funds only comprise 78% equity assets. Inexplicably, emerging market (EM) funds posted the second-most flows (+$6 billion) last month out of any geographic region — and their sixth-most all time. The flows on the quarter were also the second-most as a percent of start-of-year assets.

Now, given the fungibility and flexibility of the ETF structure, some of these flows could be tied to short positions as well as bearish option trades — a reason why flows analysis needs to be multi-dimensional. And we have seen short interest rise on the segment in 2022 as the market has fallen and remained under pressure given the Russia-Ukraine War as well as the downbeat performance from China (-14.2%).

While those equity figures are sizable, there were other areas that went parabolic. With volatility elevated, inflation rising, and commodities posting their best quarter since 1990,² broad-commodity and gold ETFs each took in their third-most ever for a month (+$2 and +$6 billion, respectively).

For broad-commodity exposures, as shown below, this pushed their trailing three - month fund flow total to its highest ever. Gold, while not at all-time highs, has its trailing three-month flow figures sitting at their eighth highest. Given the inflation and volatility dynamics present in the market, these figures are likely to remain elevated.

Sector Flows both Defensive and Cyclical

Sector funds, in the aggregate, posted inflows of $1 billion in March. Yet, for the quarter sector funds amassed $16 billion as investors sought to make discrete allocations within this disperse return environment.

For the quarter, it was a mixture of defensive/secular growth posturing combined with a specific inflation sensitive cyclical focus.

Both trends make sense. With volatility rising on the month, defensive markets like Utilities, Consumer Staples, and Health Care segments all had inflows. And with energy stocks rallying 40% on the quarter,³ their largest quarterly return ever, Energy sector flows were over $4 billion. But it was not without volatility, as there were periods in March where monthly flows were negative. Nevertheless, sentiment has been positive toward this sector.

Floating over Fixed within Bonds

Bond funds had inflows last month, led by broad-based government bond funds and Inflation-Protected bond strategies. The latter is intuitive, as Treasury Inflation-Protected Securities (TIPS) outperformed nominals by 2.3% on the quarter,⁴ given the elevated inflation dynamics and increasing inflation expectations present in the marketplace.

High income seekers continued allocating to the floating rate bank loan market. The $781 million of inflows in March marks the 18th month in a row this sector has had inflows. Over this timeframe, loan funds have taken in $14 billion.

With rate hikes on the horizon, loans will likely continue to be sought after. Their more relative defensive properties compared to fixed rate high yield (loans fell 10 basis points in Q1 compared to 480 basis points for high yield) may also continue to support interest in the space.⁵ The latter is evidenced by more than $12 billion being redeemed from fixed rate high yield.

The $12 billion redeemed out of high yield bond ETFs is the worst for a quarter ever, and the worst for any three-month period as well. As shown below, this surpasses the outflows witnessed in during the pandemic and the financial crisis.

The negativity is likely a function of tight valuations (spreads are in the bottom 11^th percentile) combined with more attractive options with the loan space, given the latter’s floating rate coupon and duration effects dragging high yield returns down by 432 percentage points.⁶

Navigating Crooked Numbers on the Scoreboard

Now, we might see a few more crooked numbers hung up this year, mainly from bonds, but it doesn’t mean every asset class is going to perform poorly. After all, in that game the Nationals did score nine runs of their own.

So, if bonds are the Nationals pitchers giving up home runs to four separate St. Louis Cardinal hitters, stocks are the Nats’ offense. However, much like the offense in that one game (scoring four runs in the bottom of the eighth inning), stocks’ efforts this year are unlikely to fully offset the pain from their defensive counterparts.

Yet, there are reasons to be positive about the outlook for stocks — not unlike the optimism related to the Nationals’ offense that features wunderkind Juan Soto. For stocks, its improving earnings sentiment or more constructive valuations than at the start of the year.⁷

Overall, as outlined in a recent blog, we think it is prudent to structure portfolios around three tilts: Focus on defense and diversification to respond to higher volatility, seek real income with floating rate exposures as rates rise, and favor inflation-sensitive exposures like natural resource equities as inflation pressures remain.