U.S. ETF inflows remain strong in confounding market

Net inflows to U.S. exchange-traded funds are on track for their second-highest year ever, but the tone and tenor of flows has shifted just as significantly as the markets

Through the third quarter ended Sept. 30, U.S. ETFs gained $411 billion in net new assets for a total of $6 trillion in assets under management, according to FactSet Research Systems Inc. While far less than 2021’s full year record of $942 billion in net new assets, money is still rolling into ETFs at pace that will eclipse the roughly $500 billion in 2020 flows.

Beneath the headline number, however, is a market that has given up conviction.

“There is a definite lack of flows into the precise, active risk set,” said Matthew Bartolini, head of SPDR Americas Research at State Street Global Advisors in Boston. Outside of defensive strategies — value, dividends, or utilities, for example — Mr. Bartolini has observed significant pullback from country funds, factor products and thematics.

In fact, the number of products experiencing inflows is headed for its lowest annual reading in 15 years, according to SSGA.

Through September, the average monthly percentage of ETFs seeing inflows was 57.4%, with only 50% of ETFs taking on assets last month.

“ETF investors have become very selective on where to be tactical,” Mr. Bartolini said.

That has also meant a shift away from the market’s largest and most liquid product, the SPDR S&P 500 ETF, which has experienced $21.7 billion in outflows this year to $331 billion in assets as of Sept. 30, according to FactSet Research Systems.

So-called “excess flows” data show the exodus from SPY is even more extreme.

Closing 2021 with $456 billion in assets under management, or 6.3% of all U.S. ETF assets, SPY’s year-to-date outflow through Sept. 30 was -5.3% of all ETF flows. That represents a $48 billion flow gap, according to data produced for P&I by Elisabeth Kashner, director of global fund research and analytics for FactSet in San Francisco.

Negative excess flows for heavily traded products such as SPY and the Invesco QQQ Trust are emblematic of the limited conviction of active traders in this market.

The Vanguard S&P 500 ETF (VOO), on the other hand, is favored by buy-and-hold investors and has seen positive excess flows, according to FactSet. At $36.6 billion or 8.9% of total year-to-date flows through Sept. 30, VOO’s net flows for the year are $20.6 billion higher than if it had simply gained assets commensurate with its year-end asset level (3.9% of the market).

“Flows to funds like VOO, Vanguard Total Stock Market, iShares Core S&P 500 and the Vanguard Total Bond Market are a testament to the steadfastness of strategic investors who allocate to core portfolio holdings regardless of recent market performance,” Ms. Kashner said.

According to a research note from SSGA’s Mr. Bartolini, low-cost flows — money going to relatively cheap funds — have made up 61% of all flows in 2022, “a capture rate well above their market share of 47.5 percent.”

Using flows to divine sentiment, however, can be challenging. For better or worse, fund flows often chase performance, but that’s not the case for the $12.1 billion in net flows to BlackRock Inc.’s $24.5 billion iShares 20+ Year Treasury Bond ETF. The fund, which sports a 17.6 year duration, is down nearly 30%, compared to a total equity market decline of 25%. “It’s a head-scratcher,” said SSGA’s Mr. Bartolini.

Elsewhere in fixed income, however, flows moved as expected in a rapidly tightening rate environment.

“The flight to quality and safety yielded short duration and cash management ETFs the winners,” said Reginald M. Browne, principal at market making firm GTS Securities LLC.

A huge rise in excess flows to products such as the SPDR Bloomberg 1-3 Month T-Bill ETF and the iShares Short Treasury Bond ETF helped push fixed income ETFs to nearly 30% of aggregate year-to-date flows, compared with 22% for 2021, according to FactSet.

“With aggressive Federal Reserve tightening, a generation of traders and investors are getting a lesson for the first time: risk-off across all asset classes,” Mr. Browne said.

Perhaps not having experienced the early days of wild swings in geared ETFs during the global financial crisis, some ETF investors are learning the hard way.

The ProShares UltraPro QQQ, designed to achieve three times the daily returns of the Nasdaq-100 index, has experienced $10.8 billion in net inflows so far this year. That’s roughly the same as the fund’s current market value.

“This struck me as madness at mid-year and continues to baffle,” said FactSet’s Ms. Kashner. “Dollars keep flowing in, even though (the Nasdaq-100) lost 4.46% in the third quarter.”