‘The switch was flipped’: ETF flows pick up as stocks, bonds set for gains in 2023

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US stocks and bonds have risen in 2023, in a big rebound after a brutal 2022.

The SPDR S&P 500 ETF Trust SPY is up 25.5% on a total return basis this year through Thursday, while the iShares Core US Aggregate Bond ETF AGG and Vanguard Total Bond Market ETF BND have each returned more than 5% on total returns. basis over the same period, according to FactSet data.

Both stocks and bonds are rising this quarter, continuing their gains after the Federal Reserve released its monetary policy statement and summary of economic projections on December 13.

“It’s been a wild ride,” John Croke, head of Active Fixed Income Product Management at Vanguard Group, said by phone. “The market has become comfortable that the Fed has won the battle against inflation,” with many investors appearing to accept that this has brought about a “hard-to-achieve” soft landing for the US economy.

ETF flows show that investors are being “emboldened” to take more risk in the markets, said Matthew Bartolini, head of SPDR Americas Research at State Street Global Advisors.

“It started in November,” Bartolini said by phone. “The switch was flipped.”

The massive SPDR S&P 500 ETF Trust saw record inflows of $20.8 billion a day on Dec. 15, a sign of investors’ enthusiasm for risk-taking and a reflection of the markets’ positive holiday trend, Bartolini said. He said the massive inflows may also have been influenced by the expiration of options contracts under so-called triple witching that day, which coincided with the rebalancing of the S&P 500 index.

Last month’s flows into exchange-traded funds pointed to bullish buying of riskier assets as investors pulled capital from cash-like government bond funds. They returned to making tactical bets through sector-focused stock ETFs, while also seeking exposure to high-yield, so-called junk bonds.

November was the first month this year with “significant flows” into ETFs, a trend that Bartolini said has accelerated so far in December.

‘Exuberance’

U.S.-listed ETFs have attracted more than $550 billion in inflows in 2023 as of Dec. 19, on pace to surpass $500 billion for the fourth year in a row, Bartolini added. For the first time, assets under management rose to more than $8 trillion early this week, he said.

Stocks and bonds have posted gains in the US this year, with investors expecting the Fed to start cutting rates in 2024 as inflation has fallen significantly from its 2022 peak. Markets took a beating last year as inflation skyrocketed and the Fed aggressively raised rates in an attempt to tame it.

Over the past two months, investor sentiment has shifted toward “more exuberance,” Bartolini said. He said “we are seeing money flowing in across the board” with risky investments in the ETF sector.

Meanwhile, Vanguard is “skeptical” that the Fed has achieved a “soft landing” and expects the US to see a “shallow recession” in the second half of next year, Croke said.

As investors enter 2024, he notes that they should add duration to their bond portfolios as many are overweight cash and are “hiding in the money markets.”

U.S. bonds look “fairly valued,” Croke added. Vanguard expects bond investors to be much better rewarded in the long term, with yields likely to remain higher than the levels seen before the Fed began raising rates in early 2022, he said.

Read: According to Vanguard’s 2024 outlook, the case for the traditional 60-40 mix of stocks and bonds becomes stronger at higher interest rates

More active bond ETFs in 2024?

According to Vanguard and BlackRock, demand for active bond ETFs has increased.

Earlier this month, Vanguard launched the Vanguard Core-Plus Bond ETF VPLS and Vanguard Core Bond ETF VC RB,
Both are actively managed, according to Croke, and implement strategies similar to the firm’s existing mutual funds. The desire for active bond ETFs among Vanguard’s clients has grown “significantly” over the past 24 months, he explains.

The asset manager now offers three such funds, following the launch of its first actively managed fixed income ETF in 2021, the Vanguard Ultra-Short Bond ETF VUSB.,
Kroke said. “We don’t think we’re done here yet when it comes to active bond ETFs.”

The US fixed income ETF sector saw inflows of $26.5 billion in November, with iShares taking in $13.4 billion, according to BlackRock, the world’s largest asset manager.

This month, the company launched the BlackRock Total Return ETF BRTR,
a diversified core bond fund that is actively managed. This followed the listing in May of the active BlackRock Flexible Income ETF BINC.

“We’ve heard loud and clear from investors that they would like to see these more popular strategies in the ETF wrapper as well,” Steve Laipply, global co-head of bond ETFs at BlackRock, said by phone. “I think we’ll see more active fixed income ETFs launched next year.”

Read: BlackRock’s Rick Rieder introduces his second ETF as active exchange-traded funds surge

Both index funds and active funds play a role in portfolios, with actively managed strategies aimed at generating excess returns, Laipply said.

For investors eager to get out of the cash — without taking a “strong view” on the possibility of a hard landing for the U.S. economy — “the belly of the curve looks attractive,” he added. Investors might consider turning to low-cost index strategies for exposure to that part of the bond market yield curve, he said, citing the iShares Core US Aggregate Bond ETF AGG and the iShares Core Total USD Bond Market ETF IUSB as examples.

Although yields have fallen from their peaks, “there are still huge opportunities for fixed income in 2024,” Laipply said. BlackRock is “very strong on this idea of ​​getting out of cash flow and increasing your allocation to fixed income again.”

As usual, here’s your look at the best and worst performing ETFs from the past week through Wednesday, according to FactSet data.

The good…

…and the bad

New ETFs

• Texas Capital Bancshares on Thursday announced the launch of the Texas Capital Texas Small Cap Equity Index ETF TXSS and Texas Capital Texas Oil Index ETF OILT.

• ProShares said on December 20 that it has launched the ProShares S&P 500 High Income ETF ISPY,
  which aims to track the performance of the S&P 500 Daily Covered Call Index. The company said the index is “designed to replicate a daily covered call strategy where call options are sold every day with one day to expiration.”

• PGIM Investments announced on December 19 that it has launched four actively managed ETFs: the PGIM Jennison International Opportunities ETF PJIO,
  PGIM Jennison Better Future ETF PJBF,
  PGIM Jennison Focused Mid-Cap ETF PJFM and the PGIM Short Duration High Yield ETF PSH.

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