Flow & Tell with iShares | September 2023

September ETF heat map

September ETF flows compared with index performance

The S&P 500 sank to three-month lows in September, notching its worst monthly performance of the year as surging bond yields and rising oil prices hauled most sectors into negative territory. In a month marked by broad selloffs, flows followed performance, moving directionally the same in each of the eleven S&P 500 sectors.¹

Information technology landed as September’s second largest laggard (behind only rate-sensitive real estate), with the formerly high-flying Magnificent 7 turning negative as the FANG+ Index sank 7%.² Flows fared a similar fate with info tech sector funds shedding $2.6bn in its second largest month of outflows on the year.³ This negative corollary was widespread: each of the ten sectors with losses in September experienced outflows in their corresponding sector ETFs.⁴

Oil barreling towards $100 did aid one sector, however: energy inflows rose in tandem with the sector’s outperformance. The price of Brent crude, the international benchmark, climbed over 30% since the end of June, now resting at year-to-date highs thanks to sustained supply cuts from OPEC+ and sharp inventory draws.⁵ Energy equities have returned over 17% in the same period, reversing earlier losses.⁶ Energy ETFs reigned as the lone asset gatherer in September, posting inflows of $532mn and extending their quarter-to-date inflows of $1.8bn.⁷

While recent macro data has confounded to the upside, pointing to better-than-expected economic growth, investors aren’t buying the soft-landing narrative — at least not in fixed income ETFs. Instead, they’ve maintained a preference for higher quality fixed income exposures: Treasury, mortgage-backed securities (MBS), and municipal ETFs together gathered $10.7bn assets in an otherwise bleak month.

Treasury ETFs continue to dominate bond ETF flows. The sector added $6.9bn of inflows over the month and has comprised 61% of total bond ETF inflows on the year. Unlike recent months, however, duration preferences were mixed as flows were spread out across the curve. Across the board, Treasury ETFs were so popular that only 12% of funds observed outflows for the month.⁸

MBS ETFs have taken in over $7bn YTD and may be an attractive option for those looking for additional yield without taking on the additional credit risk associated with corporate investment grade and high yield markets.⁹ Recently, the mortgage basis has increased from a low of 62 bps on May 28, 2021, to 163 bps compared to similar duration U.S. Treasury bond yields.¹⁰

Fall has historically provided positive seasonal supply-demand dynamics for municipal bonds, as generous supply can lead to discounted bond prices. Despite relatively rich valuations, recent flows into muni ETFs have matched this sentiment as the sector gathered $1.4bn in September after observing $1.3bn of inflows in August.¹¹ The fall also presents an opportunity for tax-loss harvesting as the average municipal bond mutual fund has a cumulative negative price return over the last 1, 3 and 5 years.¹²

Coming into 2023, investor optimism around China’s reopening spurred strong performance and large allocations in ETF flows. However, since then, investor sentiment has cooled alongside economic data. The region has struggled with high rates of youth unemployment, a declining property market, and weak consumer activity.

In part due to the disappointing growth picture in China, investors walked away from broad EM ETFs, which saw $1.2bn of outflows in September.¹³ Meanwhile, EM funds without exposure to China had net-inflows on the month, extending its year-to-date trend of positive inflows each month since January. EM ex-China funds gathered $300mn in September, amounting to $822m since the beginning of August. Flows to these funds aren’t new: divergence of any sort between China and the broader EM cohort has often led to increased demand to separate exposures.