ETF flows point to ‘skittish’ investors as it’s ‘a little unwieldy out there’ after Fed rate hikes

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Flows into exchange-traded funds leading up to the Federal Reserve’s policy decision on Wednesday have reflected caution on the part of investors.

“Things have become a little unwieldy out there,” said Nate Geraci, president of wealth-management firm The ETF Store, by phone, citing recent regional-bank tumult tied to the Fed’s aggressive interest rate hikes over the past year and the looming U.S. debt-ceiling deadline.

U.S. stocks closed lower on Wednesday after the Fed announced its decision to raise its benchmark rate by a quarter percentage point to a target range of 5% to 5.25%, from near zero a bit over a year ago.

“All indications are that the Fed is going to pause” its rate hikes and further assess how much damage has actually been done” from them in the past year, said Geraci. The Fed will also be looking at “whether inflation is tracking back towards their 2% target at a fast enough pace.” 

To Geraci’s thinking, “the main question” is whether the U.S. is heading for a recession, and if so, how deep it may be. 

“It’s clear from the flows that investors are skittish right now,” he said. “They’re taking a much more cautious approach to the markets.”

Flows of capital into exchange-traded funds were weak in April, hurt by softer-than-usual demand for equity ETFs, according to a State Street Global Advisors report. 

U.S.-listed ETFs attracted a total $29.3 billion last month, down 34% from their five-year average, the report shows. Although stocks funds represented slightly more than half of total inflows, demand for equity ETFs in April slumped 44% below their five-year average. 

April’s ETF flows were “subdued,” signifying a “hesitancy” to take risk, said Matthew Bartolini, head of SPDR Americas research at State Street Global Advisors and author of the report, in a phone interview. 

While weak demand for equities dragged down overall flows, investor interest in fixed-income ETFs appeared steady in April, with inflows edging up 1% from their five-year average, the report shows.

Fixed-income flows

Broad-based aggregate bond ETFs led fixed-income flows in April, attracting $5.6 billion, while high-yield bond funds had “a major bounce back” with $5.3 billion of inflows, State Street found.

Still, ETFs that buy high-yield bonds, also known as junk debt for their below-investment-grade ratings, have suffered $3.3 billion in outflows so far this year, the note shows.

Meanwhile, government bond ETFs saw $1.6 billion of inflows last month, led by long-duration funds, “as investors continued to position defensively,” according to the report. On a year-to-date basis, short-term bonds have captured the most flows within government debt.

“Treasury ETFs continue to shine,” with investors appearing to use a “barbell approach” to gain exposure both to short-term and long-term debt, said Geraci.  

So far this year, investors have poured $45.8 billion into government bond ETFs, which far exceeds year-to-date flows into other areas of fixed-income tracked by State Street through April.  

Equity ETF flows

ETF investors had a stronger appetite for U.S. stocks than international equities in April, but so far in 2023, equity flows are largely “still going to the international exposures,” Bartolini said.

Non-U.S. equity funds have seen almost three times more inflows than U.S. stock ETFs this year through April, the State Street report shows. International funds attracted about $35 billion in the first four months of 2023, compared with $12 billion for U.S. equity ETFs over the same period.

“U.S. stocks are not cheap right now by historical measures,” said Geraci.

Among international funds, investors have shown a preference this year for ETFs broadly targeting developed markets excluding the U.S., according to flows tracked by State Street. 

Meanwhile, shares of the SPDR Portfolio Developed World ex-US ETF
SPDW,
-0.34%
have risen 9.7% this year through Wednesday, beating the SPDR S&P 500 ETF Trust’s 6.7% gain over the same period, FactSet data show.

“The fortunes of international ETFs, in my opinion, are definitely tied to the dollar,” said Geraci. “If the Fed does pivot, and the dollar weakens, that could be a tailwind for international equities.”

As usual, here’s your look at the top- and bottom-performing ETFs over the past week through Wednesday, according to FactSet data.

The good…

…and the bad

New ETFs

• Breakwave Advisors and ETF Managers Group announced on May 3 the launch of the Breakwave Tanker Shipping ETF
  BWET,
  -0.13%,
  a fund that provides “long exposure to the crude oil tanker shipping market through a portfolio of near-dated futures contracts on indices that measure the cost of shipping crude oil.”

• Touchstone Investments said April 28 that it launched the Touchstone Climate Transition ETF
  HEAT,
  -0.40%,
  an actively-managed fund sub-advised by Lombard Odier Investment Managers. The new ETF began trading on May 2.

• Allianz Investment Management said May 1 that it launched the AllianzIM U.S. Large Cap Buffer10 May ETF
  MAYT,
  -0.45%
  and AllianzIM U.S. Large Cap Buffer20 May ETF
  MAYW,
  -0.18%,
  funds that aim to provide a downside buffer against market drops as well as “upside potential” of the SPDR S&P 500 ETF Trust
  SPY,
  -0.43%
  up to a stated cap.

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