How ETF flows reflect geopolitics

The divergence in performance between fixed income and equity ETFs was startling.

Bond strategies added €60bn (£50bn) of net new assets over the course of the year, with a steady addition of funds from month to month.

This reflected the calmness of the fixed income markets.

There was no major change in interest rates or central bank policy around the globe.

In addition, credit markets remained placid.

A year of two halves for equities

Equity ETFs, however, were much less popular for the first half of 2019. During the summer, there were almost zero net new assets.

But that altered in the last six months of the year with net new flows reaching €50bn by December.

Volumes into these strategies accelerated over the last few months of the year.

Key points 

• Equity ETFs were more popular in the second half of 2019 than the first half
• This reflected change in sentiment about geopolitics
• The European ETF industry attracted record assets in 2019

During the first six months of the year, fixed income flows were 80 per cent of all flows. By the end of the year, this had declined to 60 per cent.

The change in the fortunes of equity ETF volumes reflects the strong shift in sentiment over the summer.

The wider variety of fixed income ETFs now available offers a new source of diversification

During the first half of the year, investors were feeling cautious and avoiding risky assets.

This tentative attitude echoed concerns about the US-China trade wars, Mario Draghi’s departure from the European Central Bank and the UK’s intractable Brexit discussions.

Investors were also worried whether the Italian budget would be approved by the European Commission.

In July and August, sentiment started to change.

Talks between the US and China became more positive and Christine Lagarde’s appointment to the head of the ECB was well received.

In addition, the appointment of Boris Johnson as prime minister heralded the end of the Brexit parliamentary stalemate.

And the tension between Italy and the EU was resolved.

As a result, investors became less wary and started to view risky assets more favourably – they started to allocate to equities again.

Allocation to equities picked up over the last few months of the year as those geopolitical tensions retreated further.

A new deal was agreed between the US and China and Mr Johnson’s election win meant the UK will now leave the EU.

While there is still no clarity about the future relationship between the UK and the EU, investors think the level of uncertainty has been reduced.

That is because they believe, whether or not a deal is agreed, any negative economic impact will be principally felt by the UK rather than the remaining 27 members of the union.

Structural shifts

The difference in the performance of fixed income and equity flows also reflects continued changes in the architecture of the funds market.

After several years of equities’ uncontested domination, the wider variety of fixed income ETFs now available offers a new source of diversification.

Looking back at 2010, adoption rates of equity ETFs among institutional investors were around 90 per cent of the total investable universe, while those of fixed income ETFs were only around 45 per cent.

Equity adoption rates remain around the same levels today, while fixed income rates have increased to 65 per cent.

In other words, part of the linear progression of fixed income flows in 2019 is a reflection of investors’ movement towards low-cost, transparent ETFs.

While this reallocation is still happening in equities, the pace is more rapid for fixed income vehicles thanks to the increasingly diverse range of products. 

The reactivity you need

The rapid turnaround in the fortunes of equity ETFs as investor sentiment shifted also illustrates the use of these strategies as a tactical investment device.

Some investors may be using ETFs as a way to take advantage of short-term trends.

But for institutional investors, these strategies offer a way to participate in a trend that emerges over the course of a few quarters.

Pension schemes and insurance companies are in some ways similar to slow-moving tankers.

Changing the course of investment allocation takes time; investment committees need to be consulted and new strategies have to be selected.

Allocating to ETFs allows these investors to relatively quickly take advantage of an emerging trend, while they decide on a longer-term course of action.

New flows here to stay

Despite the rising demand for equity ETFs in last quarter of 2019, flows to fixed income ETFs did not decrease.

In other words, net new assets into equity ETFs did not come from a shift in demand, but from net new subscriptions, with investors increasing their existing allocation in ETFs or with new investors joining the market.

The European ETF industry attracted record net new assets of more than €100bn in 2019.

Irrespective of short-term trends in ETF flows, volumes into these strategies are expected to increase further in the next few years.

The popularity of these funds will be driven by their utility as low-cost, transparent core asset holdings.

In addition, ETFs are well-suited for making tactical allocations in response to short-term macroeconomic trends, as they are easier to use compared to more traditional fund structures.

Fannie Wurtz is global head of ETF, indexing and smart beta at Amundi