ETF investors showed ‘a lot of restraint’ in the first quarter. Here’s why bonds won them over.

Bonds have been the hot spot for money flowing into exchange-traded funds this year. 

ETFs that buy bonds raked in $53 billion during the first quarter, or 65% of total inflows for U.S.-listed exchange-traded funds, according to a State Street Global Advisors report. That amounted to 114% more than the historical 10-year average for bond ETFs during a first quarter, the report says.

But overall flows into ETFs were slower than usual in the first three months of 2023, with the total $81 billion falling 6% below the historical first-quarter average. Flows were hurt by a big drop in equity inflows, the report shows, even as stocks climbed in the first quarter. 

Investors showed “a lot of restraint” in terms of adding capital to “risk assets,” said Matthew Bartolini, head of SPDR Americas research at State Street Global Advisors, in a phone interview. “What actually attracted money was very defensive bond areas, as well as some tactical positioning overseas where there’s better vital signs than inside the U.S.” stock market.

‘Rush of assets’

Government bonds led inflows into fixed income ETFs, with “ultrashort” duration funds being particularly popular with investors, according to State Street.

In the “rush of assets” flowing into ultrashort government bonds, the SPDR Bloomberg 1-3 month T-bill ETF
BIL,
+0.01%
took in “the lion’s share” of those inflows, said Bartolini.

The fund, which invests in Treasury bills maturing in one to three months, has around $30 billion of assets under management, according to FactSet. The ETF, which saw a total return of 1% in the first quarter, posted a small gain last year even as stocks and bonds broadly dropped.

Investors sought exposure to ultrashort government bonds in the first quarter amid “market jitteriness” surrounding the recent “banking crisis,” said Bartolini.

Underscoring those fears, shares of the SPDR S&P Regional Banking ETF
KRE,
+1.48%
tumbled after last month’s collapse of Silicon Valley Bank and Signature Bank, down more than 27% so far this year based on Thursday afternoon trading, according to FactSet data, at last check.

“The highest quality parts of fixed income” drew investors in the first quarter, particularly in March, said Gargi Chaudhuri, BlackRock’s head of iShares investment strategy for the Americas, in a phone interview. 

As examples, she cited strong flows into the iShares 0-3 Month Treasury Bond ETF
SGOV,
+0.03%
and iShares 7-10 Year Treasury Bond ETF
IEF,
+0.03%.
With the iShares 0-3 Month Treasury Bond ETF, “you’re not taking any duration risk,” she said. It may also be a fund that some investors have considered as a place to allocate some of their cash amid any concerns about the “viability” of their financial institution.

The ETF has attracted investors seeking “preservation of capital,” she said, adding they’ve also been drawn to its earnings a yield of “close to 5%” and the ability to easily trade in and out of the fund.

The yield on the three-month Treasury bill was trading around 4.84% on Thursday afternoon, according to FactSet data, at last check. 

By contrast, the iShares 7-10 Year Treasury Bond ETF provides exposure around “the belly” of the yield curve and has a “fair amount of duration risk,” said Chaudhuri. She said the fund may work as a “ballast” in investment portfolios in an economic slowdown as rates fall.

But at this point, after yields dropped significantly following the banking turmoil, said Chaudhuri, “I wouldn’t tell investors to allocate there just this moment.” Bond yields and prices move in opposite directions.

Time for TIPS?

At this juncture, “if you’re looking to add duration to your portfolio, TIP is what we think is a really good addition in portfolios now,” Chaudhuri said, referring to the ticker of the iShares TIPS Bond ETF
TIP,
+0.23%.
The fund tracks an index of U.S. Treasury inflation -protected securities, or TIPS.

While the Federal Reserve has aggressively hiked interest rates over the past year to battle high inflation, the recent banking turmoil stoked recession fears and traders are now betting the Fed could end up cutting rates in 2023. That might leave inflation lingering a bit higher than previously anticipated, which means investors may benefit from a “tactical” allocation to real rates through an ETF like TIP, according to Chaudhuri. 

In other flow trends in the first quarter, investors favored investment-grade bond ETFs over riskier high-yield debt, the State Street report shows. Investors pulled more than $8 billion from high-yield corporate bonds over that period.

‘Quite hesitant’

Overall inflows into U.S.-listed ETFs were lower than average for the first quarter as investors shunned U.S. equities and risky assets, said Bartolini. 

While investors contributed a sluggish $29 billion to equity funds in the first three months of the year, ETFs focused on U.S. stocks had “minor outflows,” the State Street report shows.

ETF investors have been “quite hesitant” to add capital to the U.S. stock market, where there’s an “unattractive cocktail” of high valuations, weak earnings sentiment and recessionary fears, said Bartolini. They showed a preference in the first quarter for developed-market equities excluding the U.S., including a “tactical” allocation to European equities, he said.

Read: International stocks outperform, decouple from U.S. equities by ‘unusual degree’

The U.S. stock market rose in the first quarter, with shares of the SPDR S&P 500 ETF Trust
SPY,
+0.39%
rising slightly more than 7%, according to FactSet data. The Invesco QQQ Trust
QQQ,
+0.67%,
which tracks the technology-heavy Nasdaq-100 index, jumped 20.5% during the first three months of this year.

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

• VanEck said Thursday that it launched the VanEck Robotics ETF
  IBOT,
  +0.47%,
  a thematic equity fund that aims to invest in “global companies that are driving and benefiting from the growth of the robotics industry.”
• DWS announced April 5 that it listed the Xtrackers MSCI USA Climate Action Equity ETF
  USCA,
  +0.47%,
  a fund providing exposure to large and midcap companies in the U.S. that are “leading their sector peers in taking actions relating to climate transition.”
• Teucrium Trading said April 5 that it launched Teucrium AiLA Long-Short Base Metals Strategy ETF
  OAIB,
  +0.24%,
  that invests in a “strategy holding both long and short positions in base metals futures contracts” listed on the Chicago Mercantile Exchange and the London Metal Exchange.

Weekly ETF reads