Recent ETF flow patterns show investors are getting a little nervous. They’re worried about the spike in interest rates and that the equity rally is getting a bit long in the tooth.
For example, long-only ETFs have experienced a rare outflow the past month while investors plowed money into leveraged and inverse funds that are popular as hedging strategies.
“The quarter did start off with very strong inflows, to the tune of $35.3 billion in the first three weeks. Over the last month, however, money flows have done a U-turn, with ETFs losing $6.3 billion as investors redeem their holdings,” says Nick Colas, chief market strategist at ConvergEx Group.
In particular, investors have been dumping U.S. stock ETFs the past 30 days with the category seeing net redemptions of $7.3 billion. Fixed-income ETFs have experienced outflows of $3.5 billion as interest rates rise.
“Surprise: International equities are the bright spot over the last 30 days, with $2.8 billion in fresh money at a time investors are otherwise heading for the exits,” Colas wrote in a note Wednesday. “Too early to claim of change in sentiment away from long-favored U.S. stocks, but something to watch over the second half of Q3 2013.”
There are currently more than 1,500 exchange traded products listed in the U.S. with about $1.5 trillion of assets.
“ETF money flows show where investors of all stripes are focusing their attention at any given time,” Colas said. “The ETF industry typically gathers assets like a car with cruise control gobbles up highway miles – steadily and reliably.”
During the first half of 2013, ETFs experienced solid inflows with $74 billion moving in, and the third quarter was off to a strong start. However, the industry has seen outflows the past month, possibly on concerns the market is overstretched.
“What is notable about these redemptions is that they do not come against a backdrop of any real volatility. The CBOE VIX Index is all of 15 at the moment, near its one month highpoint but well below its long term average of 20,” Colas remarked.
“Yes, interest rates have spiked and equity markets have turned lower in the last month. Granted, trading in August is always lackluster, so perhaps large ETF sell orders have a harder time finding immediate buying interest,” the strategist added. “In the absence of that large offsetting purchase order, you might see redemptions.”
The implication is that recent ETF flows could be the result of a so-called buyers’ strike.
Conversely, leveraged and inverse ETFs have been very popular the past month.
“These products, which typically reset daily and offer a 2x or 3x inverse return on a given index or asset, are typically about 4-5% of total ETF money flows. They are, for example, 4.6% of 2013YTD flows. In the last month their flows are positive when the industry itself is negative, essentially making them +100% of the total. Put another way, investors have added $1.1 billion in fresh capital to these generally aggressive hedging strategies in the last 30 days,” Colas wrote.
“Again, remember that the last 30 days may seem cruel because there is so little volume or because we’ve had a bit of a roil in bond land,” he concluded. “But let’s not pretend anything serious has happened yet. The VIX is still 33% below its long run average and the long end of the year curve is still quite benign by historical standards. If this little dose of market volatility is enough to push $1 billion into hedging-oriented ETFs in 30 days or pull six times that amount out of longer-term strategies, what will September bring?”