Flow & Tell with iShares | Summer 2024 ETF Flows

Small caps have had a rough go of late. But after spending the first half of the year trailing their large cap counterparts, they staged a powerful rally in July, rising ~10% on the month.¹ Small cap enthusiasm seems to have been sparked by June’s surprisingly soft CPI report, with the inflation-induced shift in Fed easing expectations resulting in the largest outperformance over the Nasdaq in more than two decades (to the tune of 11.5%).²

The flagship small cap fund, iShares Russell 2000 ETF (IWM), added $7.9bn in July, its largest monthly take on record.³ IWM call options also surged to multi-year highs as investors preferred to “rent” rather than own the rally, likely reflecting a degree of dubiousness in its durability.⁴

Alas, the price action (and corresponding inflows) proved short-lived. A sobering July employment report showed the labor market decelerating faster than expectations, throwing cold water on the small cap enthusiasm. Concern over the slowdown in the labor market sparked a sharp cyclical sell-off, with growth-sensitive small caps at the center of the retreat. In the first week of August, IWM saw its largest week of outflows since September 2021 as investors dialed down their risk appetites.⁵

• What to watch for the rest of the year: In our view, the trajectory for small caps will remain tethered to two things: the path of interest rates and U.S. growth data. While small caps may see another short-term bump with the start of a cutting cycle, we believe the recent weak manufacturing ISM, slower job growth, and higher unemployment rate tell a story of decelerating growth and see risks in highly cyclical parts of the market.

2024 marked a watershed moment for active ETFs with over $150bn in YTD net inflows — more than double 2023’s total figure.⁶ The flows come in tandem with new launches, as over 200 active ETFs have hit the market, already eclipsing the previous record for any first half of a calendar year.⁷ Active ETFs accounted for 32% of all net ETF inflows in June, while only representing 8% of all ETF AUM — a signal of both increased adoption, and room for growth.⁸

Under the hood, active strategies have been favored in underperforming segments as investors hunt for alpha.⁹ For example: the Morningstar Large Growth ETF category has seen flows predominantly move into index funds (93% index vs. 7% active) as growth indices returned nearly 25% in the first half of the year alone. Most flows into value ETFs, however, have been channeled to active funds (59% active vs. 41% index) as value indices trail the broad market’s returns.¹⁰

• What to watch for the rest of the year: The accelerated adoption of active management is likely a durable trend, especially as we head into a volatile back half of the year (election uncertainty, geopolitical tensions, and the path of interest rates, oh my!). As active ETFs are increasingly added in ‘model portfolios’ — some of which use ETFs as building blocks to create diversified portfolios — look for greater inflows and utilization of expertise in certain pockets where active managers may have an edge.

Fixed income ETFs managed to earn a new accolade this summer: the global industry saw $60bn inflows in July alone, hitting a new monthly record for the ETF asset class.¹¹ The U.S.-domiciled team snagged a medal as well, with $92bn added in May — July, the largest ever inflow to fixed income ETFs over a 3-month period.¹² New asset growth was led by both corporate and U.S. Treasury products (adding $25bn each). Broadly, fixed income inflows stemmed from investors taking down risk — equity markets flirted with new all-time highs after posting 15% H1 gains — and adding hedges as economic growth fears began to mount and returns in H2 appeared unlikely to mirror that double-digit figure.¹³

Flows slowed in August (to less than half July’s total) across fixed income sectors as rates repriced dramatically.¹⁴ Notably, the barbell trade remained in vogue, with short term Treasury ETFs adding $3.5bn, while long term funds gained $3.9bn.

• What to watch for the rest of the year: Bond investors are looking ahead to the September FOMC, likely to kick off easing after the benchmark policy rate remained steady within the 5.25% – 5.5% for the last fourteen months. Markets are currently pricing in just over four 25bp cuts by the end of the year.¹⁵ We believe this is the last best time to extend duration and prefer the belly of the curve.

Bitcoin ETPs experienced their own summer doldrums, with the iShares Bitcoin Trust ETF (IBIT) on track to clock its smallest month of inflows since inception in August, continuing the trend of slowing flows over June and July. The subdued totals follow a period of sharp volatility for the underlying asset — Bitcoin fell below $50,000 in early August, its first time crossing south of that threshold since February¹⁶. Much of the price pressure resulted from recessionary fears at the start of the month with the sharp global sell-off accelerating the crypto market decline as investors appeared to unload their most risk-on positions. While it has recovered from the lows, it remains well off its record highs of $72,000 in March.¹⁷

Despite adding smaller totals, Bitcoin ETP flows have remained in positive territory. By contrast, the newly minted Ethereum ETP cohort was battered by a macro backdrop rife with headwinds, launching amid large market swings and equity rotations. In the first 25 trading days after inception, the Ethereum spot ETPs saw net inflows on only 8 sessions (a sharp divergence from the spot Bitcoin ETP’s 19 days of net inflows).¹⁸

Bitcoin ETP trading sizes also suggest a pickup in institutional adoption, while the newer Ethereum ETPs have seen a strong retail bias.¹⁹

• What to watch for the rest of the year: Crypto price action has bounced sharply over the past few months. Between election headlines, new products, and upcoming U.S. data releases, we expect the volatile asset class to see further swings — keep an eye on flows as a proxy for crypto sentiment.

The iShares Trusts are not investment companies registered under the Investment Company Act of 1940, and therefore are not subject to the same regulatory requirements as mutual funds or ETFs registered under the Investment Company Act of 1940. Investments in these products are speculative and involve a high degree of risk.

Sectoral bets this year largely continued 2023’s tech (and friends) trend, with info tech netting a standout $23.6bn in inflows so far this year as AI optimism continued to spur demand.²⁰ While most other sectors moved sideways or saw outflows, a new exposure podiumed as the second favorite sector of the summer: real estate.

July saw the largest month of outperformance for the real estate sector vs. the broad market in five years, led to the upside by real estate management (and the industry group’s 17% return).²¹ Rather than one driving factor, the sector’s performance hailed from a handful of catalysts: anticipated rate cuts, lower long end rates and positive seasonals all likely contributed to the strong returns. Further, data center optimism on the back of AI expansion likely buoyed performance as well.

In turn, real estate flows have reversed from 2023’s negative territory to net inflows in June, July and August — with August inflows tracking as the most positive month for the sector since September 2021.²²

• What to watch for the rest of the year: We see potential tailwinds ahead as policy rates (and therefore, mortgage rates) fall from current highs. After being in outflow mode for both 2022 and 2023, the sector stands to benefit from a further positioning upswing as investors add back to the under-owned sector. We prefer getting more selective within the sector — we think commercial real estate is likely to remain a drag as vacant commercial spaces struggle to return to pre-pandemic levels.