How Come ETF Inflows Are Up, but Stocks and Bonds Are Down?

Riddle No. 2: Why are energy funds not the king of new investment dollars?

Stocks and bonds have had a rough 2022. The S&P 500 is down 18.2% this year. Its bond equivalent, the Nonetheless, exchange-traded funds have been gaining investment dollars.

Equity ETFs got $187 billion in inflows in 2022 through last Thursday, and bond funds bagged $64 billion, according to Strategas, the market strategy arm of financial services firm Baird. Over the past five years through last Thursday, inflows to stock ETFs (which overwhelmingly dominate exchange-traded funds) for 2022 are the second strongest, beaten only by 2021’s same-period showing.

The current year’s inflows are not keeping up with “the blistering pace of 2021, but still [it’s] a strong year for overall equity flows,” says Todd Sohn, ETF strategist at Strategas.

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Given the rocky markets of 2021, how did this happen? One possible explanation Sohn raises: Investors are buying ETFs on the dips, especially bond ones. If so, that suggests that ETF investors—who are mostly longer-term-oriented than the hot-money crowd in individual names—want to get in on bargains, with the expectation that investments will recover in the future. History shows that has been a pretty safe bet.

On the equity side, there has been a big shift into defensive sectors. For a snapshot of the equities landscape, look at iShares Momentum ETF’s sector weighting in May. Strategas data shows that health care gained the most in market weight, leading others with a 28.8% share (double its April position). Consumer staples were up fourfold, to 16.7%. Utilities were at 4.6% from near-zero.

Meanwhile, money has flowed out of tech and financial ETFs. For tech, the high valuations of recent times likely were unsupportable, and rising interest rates harm their future expected returns. Financials have a mixed picture: Higher interest rates will help banks, but mergers and initial public offerings are flagging, which isn’t good for Wall Street. “There’s credit risk, too,” notes Sohn, with a weakening economy leading to more defaults and bankruptcies.

Puzzlingly, energy is a top performer, and yet not a magnet for ETF investors. Sohn attributes that to the green-mindedness of some investors. Plus, investors remember the past decade, when energy companies were doing poorly amid low oil prices. In 2016, oil was below $30 per barrel, about one-fourth of today’s level.

Another seeming head-scratcher: Despite the horrendous plummet in tech stocks, growth ETFs garnered $5.6 billion in inflows last month. Sohn thinks investors are “bottom fishing,” looking for good bargains in an industry that surely will return.

On the bond side, the laurels go to Treasury ETFs, which pulled in almost $18 billion in fresh money in May, which Strategas dubs a record. Sohn says the appeal owes to “anxious equities,” meaning the money is coming from stock investors spooked by recurrent stock slides.

Corporate and municipal bonds are also doing well enticing new money. Probable reason: Investment-grade corporates and local governments have a lot of cash to buffer them from any economic falls.

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