Flow & Tell with iShares | May 2023

May ETF heat map

May ETF flows compared with index performance

The Bloomberg Aggregate Bond Index is about as basic as it gets when it comes to the US investment grade bond market, offering exposure to a large swathe of both government and corporate bonds. But while it may not often be the sexiest tactical allocation, it certainly was one of the most popular in May. US aggregate bond ETFs saw net inflows of $7.7bn over the month.³ May marked the exposure’s fourth consecutive month of inflows, in line with recent historical trends — the exposure has only registered 3 months of outflows in the last 3 years.

While flows flocked to the front of the curve in Q1 amid elevated yields, many investors began adding longer-dated exposures in a “flight to quality” trade in March, following severe bond market volatility — a duration preference that remained in May. We maintain our up in quality preference, also reflected in the Bloomberg Aggregate Bond Index composition, with roughly 70% of holdings notching a AAA-rating, while only 12% of the index sits in the lowest portion of the investment-grade bond market (BBB).⁴

The macroeconomic backdrop of 2022 was marred by soaring interest rates, creating a turbulent atmosphere that delivered the year’s “tech wreck” — sector juggernauts saw huge losses as Meta dropped two-thirds of its value, Amazon’s market cap halved, and the tech-heavy Nasdaq clocked its third-worst year on record (behind only 2008 and the dotcom bust of 2000).⁵

That story has played out in reverse this year: tech’s shares of major indexes have soared as the sector continues to sharply outperform the broader market. Part of the tech frenzy can be traced to a flight to relative safety in companies with strong balance sheets, demonstrated by trading in March, when the five largest US tech companies each climbed over 10% despite two regional bank failures jolting global markets.⁶ Fervor over artificial intelligence reflects part of the price action as well, strengthened by the earnings success in behemoths like chip maker Nvidia.

Flows follow suit: the tech sector saw its largest week of inflows last week since December 2021.⁷ Globally, tech focused ETFs popped from $1bn worth of YTD inflows at the end of April to more than $7bn today in broad based buying.⁸

Economic activity in Japan has rebounded in 2023, with GDP growing at an annualized rate of 1.6% in Q1.⁹ Strong domestic demand, a rebound in tourist spending from the reopening in China, and resilient manufacturing activity underpins the growth. There is reason for the optimism to persist with Q2 economic data also pointing to robust activity.

Personal consumption, which makes up the largest portion of GDP, increased by 0.6% quarter-over-quarter in the first quarter, led by tourist-adjacent services like lodging and transportation.¹⁰ In May, Japan services PMI rose to a record 56.3, expanding at the largest rate on record, boosted by robust tourism activity and domestic spending.¹¹ May also saw manufacturing activity touch expansionary territory for the first time since October 2022.

The robust economic activity, coupled with the potential end of ‘yield curve control,’ helped propel the MSCI Japan Index to its highest level in over 35 years. Investors have taken notice, adding $1.2bn to Japan ETFs in May — the highest single month of inflows since 2020.¹²