Despite August’s light activity, U.S.-listed exchange traded funds (ETFs) saw $24.7 billion in net new flows for the month, bringing the year-to-date total to $175 billion. We’re still well off last year’s pace though.  At this time in 2017, the ETF industry was at $299 billion in net new flows, well ahead of 2016’s $143 billion pace. While 2018 is unlikely to match 2017’s spectacular results, the ETF industry has settled into a trend of solid flows.

Domestic assets continue to dominate ETF flows, with nearly 90% of net new flows coming from either domestic equity or fixed income during August. Unlike other months, international funds didn’t hold flows hostage to nearly the same extent, contributing almost $5 billion in net flows for the month. Meanwhile, commodity ETFs saw their worst month since July 2017, as investors exited precious metal ETFs as a result of ongoing pressure on gold.

Exhibit 1: U.S. Equities Continue to Dominate Flows

International Developed Still Struggles, but European Economic Data May Hint at a Turnaround

With global trade tensions and a significantly stronger dollar, international ETFs have struggled to get off the ground following a record year in 2017. The international developed segment has seen net outflows of just over $6 billion year-to-date, after $70 billion in net new flows during 2017.

As U.S. economic data has come in repeatedly above trend, European data has been going the other way. In fact, the difference between the surging Citi U.S. Economic Surprise and the falling Citi Eurozone Economic Surprise Indices hit a decade high in April. During the following three months, U.S. equities outperformed their European counterparts by more than 9%. This relationship has proved inconsistent over long periods of time, but more recently economic data and return trends between the two regions have been significantly linked, particularly since the start of 2016. In August, the “surprise spread” narrowed in favor of Europe, as Germany printed strong GDP and business confidence figures, while U.S. expectations may have gotten ahead of themselves. Let’s watch to see if recent economic data can support a different trend toward the end of 2018.

Exhibit 2: Euro Economic Data Surpise May Boost International Developed Flows

Mixed FAANG Earnings, and a Rotation to Healthcare

With U.S. equity returns surging in aggregate, expectations are high for certain growth areas of the market, such as technology. While these companies boast superb trailing growth rates and hold a special place in the heart of the increasingly digital consumer, recent earnings reports have shown signs that the tech trade is becoming more nuanced. For example, within the market-leading FAANG group (comprising Facebook, Amazon, Apple, Netflix, and Google), earnings season witnessed a plummeting Facebook and a soaring Apple.

With cracks emerging among technology shares, investors have looked to other sectors to provide upside. Healthcare is one of those sectors – with returns north of 11% this quarter through August and a remarkable $4.2 billion in net new flows, the largest two-month flow for the sector since June and July of 2015. Meanwhile, Energy has seen a reversal of sorts this quarter – the sector is off nearly 2% quarter-to-date and category flows have followed suit to the tune of $1.4 billion in net outflows.

Exhibit 3: Performance and Flows Positive for Healthcare, Negative for Energy

Growth Strengthens but Investors Favor Value ETFs

Last month, we wrote about the strong outperformance of value relative to growth, and value’s subsequent strong weekly inflows. In August, equity style returns made a strong move back to the longer-term trends that we’ve seen, with growth outperforming value by 3.99%, the largest outperformance spread since February 2009.1 Interestingly, ETF investors seem more concerned with growth’s go-forward valuations, and have placed nearly $4 billion in net new flows toward value ETFs at the expense of growth over the past two months.

Exhibit 4: Growth Posts Strong August Returns but Investors Favor Value ETFs

Emerging Markets Attract Interest Amid Swoon

Emerging markets (EM) have been an area of distress this year, in large part thanks to a fiercely stronger dollar exposing certain central banks with foreign account deficits. Meanwhile, high yield bonds have been a relatively strong performer in what has been a difficult year for fixed income, as credit spreads have narrowed quickly. In fact, the junkier parts of credit have shown strength this year, with CCC paper outperforming BB paper in aggregate year-to-date.2 As EM credit spreads have widened with high-yield spreads narrowed, the spread between the two has compressed to a now 10-year low. Despite this record divergence, investors added roughly $2.5 billion to EM equity and fixed income ETFs in August, the most since the start of the year.

Exhibit 5: EM Assets See Inflows Amid Underperformance

September brings back school, the inklings of colder weather, and the end of vacation. As trading activity picks up, ETF flows will continue to move dynamically with the market. So far, the third quarter has witnessed a strong overall trend for ETF flows, with about $60 billion in net new dollars raised. We’ll maintain a watchful eye during September to see if industry momentum is sustained.

 
  1. ^Source: Morningstar, as of 8/31/18. “Growth” and “Value” defined by Russell 1000 Growth and Russell 1000 Value Indices respectively.
  2. ^Source: Bloomberg, as of 8/31/18. Credit spread data from Credit Suisse OAS Indices.