After shattering annual records last year, ETF flows got off to a fast start in January. Driven by massive equity flows, total ETF flows last month were nearly $40 billion greater than those in January 2017! More specifically, U.S.-listed ETFs took in over $78 billion last month, driving total assets to over $3.6 trillion across more than 3,000 funds.

While January often sees investors adding to ETFs as they have become a more popular investment vehicle, the pace of flows seems to suggest something more significant than simply investors shifting assets from other investment vehicles to ETFs. In other words, it may be a sign that investors who have been on the sidelines are getting interested in the market following a year of stellar performance. While recent volatility may test investor confidence, we feel that flows will be resilient.

Overall Flows Are on a Record-Setting Pace

Among equity ETFs, flows in January 2018 were $40 billion greater than in January 2017. U.S. and international equity flows were 2.7 times and 2.1 times greater, respectively, than one year ago. Fixed income inflows, at $9 billion in January, were actually down $4 billion from January 2017. Smaller categories, such as alternatives, asset allocation, currency, and commodities, experienced greater interest in 2018 than in 2017. Given the sharp increases in U.S. interest rates toward the end of the month, the inflows may represent asset allocation moves.

Equities Living Large

Digging deeper, U.S. large cap equity ETFs took in over $32.7 billion of inflows, a substantial increase compared with last January’s $198 million of inflows. In contrast, small cap equity ETFs experienced $190 million of outflows this January compared with last year’s $4.1 billion of inflows. As noted in our 2017 ETF Flow Update and 2018 Outlook, ETF investors may continue to favor large caps at the expense of small caps, especially if large caps continue to outperform, which they did in January.

Sector-based products are off to a strong start, with $8.4 billion of inflows compared with last year’s $6.1 billion. This January’s top flow gatherers include technology and industrials, while consumer staples and discretionary have seen the greatest outflows.

Smart Beta Flows Shift to Multi-Factor Strategies

Smart beta strategies continue to grow, adding nearly $1.8 billion of new money to start the year. Multi-factor strategies continue to gain share among investors, with January setting a record for the strongest ever month of inflows. Should volatility continue, it will be interesting to see if investors begin to rely more on multi-factor portfolios instead of attempting to time individual factor allocations. Among single factors, value, a factor favorite for investors in 2017, saw outflows of $2.1 billion during the month. As the value factor has underperformed the broad market by more than 2% over the past year, the outflows may reflect a loss of patience from investors who placed $18 billion into value-oriented strategies in 2017.1

Fixed Income Does Not Follow Performance

The $9 billion of inflows into fixed income ETFs helped push assets under management to over $591 billion, which is nearly $136.1 billion more than total fixed income ETF assets one year ago. In another potential sign of asset allocation trends, aggregate bonds saw the greatest inflows of $4.9 billion.

While fixed income performance favored risk, investor sentiment was quite defensive. The Bloomberg Barclays U.S. Aggregate Bond Index fell in January, but investment grade bond funds saw inflows of $3.2 billion last month. On the other hand, high yield ETFs experienced outflows of nearly $2.2 billion, even with positive performance. This divergence within credit markets may signal weakening risk appetite from ETF participants. In addition, emerging market bond funds saw inflows of over $2.8 billion, which equates to an 11.3% increase from assets at the end of December.

What the Rest of the Year May Bring

The harmonious rise of markets in 2017 continued into the first month of this year, and ETF flows followed suit. While we expected strong ETF flows in 2018, not many expected this level of flow velocity. Flows will naturally ebb with market performance, and every month may not be as robust as January. This being said, January’s pace certainly set the stage for another record-shattering year of ETF flows.

  1. ^Source: Morningstar Direct. Performance measured by FTSE Russell Indexes. As of 1/31/2018, the trailing 1-year total return for the Russell 1000 Value Factor Index was 23.81%, while the trailing 1-year total return for the Russell 1000 Index was 25.84%. Past performance does not guarantee future results.