Flow & Tell with iShares – Summer 2023 standout ETF flows

August ETF heat map

August ETF flows compared with index performance

The stock market closed its best start of the year through July in 26 years, a feat led by info tech’s 46% return on the year as waning inflation and mounting AI optimism evoked newfound bullishness.¹ August took the air out of the trade, however, as the rally’s breakneck pace stalled with equity flows rebalancing away from H1 leaders.

The high-flying “Magnificent 7” are emblematic of this shift, with the FANG+ Index down over 3% in August after averaging a magnificent 10% monthly gain in the first half of the year.² Flows followed performance, with investors flocking to equal weighted exposures in search of a catch-up trade away from the year’s narrow leadership — indeed, EUSA (iShares MSCI USA Equal Weighted ETF) posted its fifth largest month of inflows in the past 5 years in July.³

This broader story unfolded across other exposures — flows rotated from growth to value in August, and outflows from defensive sectors financed inflows to cyclical funds. The positioning swap underscores an expected change in leadership as we step into the back half of the year, or at the very least, profit taking from the monthslong rally.

While investors continue to flock to high quality fixed income assets while awaiting the delayed effects of the Fed’s rate hiking campaign, a shift in duration preferences underscored August inflows.

At the start of the summer, the MOVE Index, the Treasury market’s measure of volatility, sank from yearly highs of over 130 to a monthly average of about 114 in both June and July. The decline in volatility alongside moderating inflation data led investors to step into the curve as they embraced the soft-landing narrative. Long-duration exposures emerged as the winner: long-end U.S. government ETFs posted their largest monthly inflow in over a year, gathering over $5.5bn.⁴

However, the duration extension proved to be short lived as bond yields surged in August. The 10-year Treasury note climbed to 13-year highs, while the 5-year yield returned over 5% — moves that sent investors to the front-end of the curve en masse. The backup in yields hailed from a confluence of factors: the BOJ relaxed their yield controls, Fitch downgraded the U.S.’s credit ranking, and economic data signaled higher growth expectations, a trifecta that spooked investors out of longer duration positions on fears of longer-term rates moving higher.

Short term Treasury funds added over $4.0bn in net inflows in August, a reversal from the four consecutive months of net outflows. Longer dated Treasury products fared an opposite fate, currently on track for their first month of outflows since January 2022.⁵

Many topics have been the fad of the summer — Barbie, Oppenheimer, T-Swift and Beyonce. But in the financial world, we have been playing close attention to rising real rates that have reached levels unseen since 2008 (talk about a comeback).⁶ Real rates are nominal interest rates adjusted for inflation, meaning the rate of return after subtracting the amount you lose from inflation.

Real yields have risen for a few reasons. Notably, U.S. bond yields climbed on the back of strong growth surprising to the upside, as robust economic prints from retail sales, durable goods, housing starts and personal income underscore resilience, not recession. This rosier growth data boosted yields while supporting our expectation that the Fed will keep interest rates higher for longer. Couple this with a meaningful deceleration in inflation — moderating inflation and higher nominal rates result in higher real yields.

While elevated real rates impact ETF flows in several pockets of the market, gold is drastic example. Gold and real rates often move inversely, as increasing real yields can make yield bearing assets, like bonds, a more attractive investment against non-yielding assets like gold. Since July, gold ETFs have shed $3.8bn. The trend is evident in the broader commodity suite, too — silver, crude, and broad market commodity funds have all been in negative territory since the start of July with outflows across the board.⁷