U.S. Fund and ETF Investors Continue to Favor Foreign Issues in 2023

Not surprising given the uptick in inflation data, hawkish comments by Federal Reserve officials, and rising interest rates, investors were net redeemers of fund assets (including conventional funds and ETFs) for the third week in four, withdrawing a net $2.1 billion for the Refinitiv Lipper fund-flows week ended Wednesday, February 22. Investors were net purchasers of money market funds (+$5.4 billion) while being net redeemers of equity funds (-$5.6 billion), tax-exempt fixed income funds (-$1.7 billion), and taxable bond funds (-$295 million) for the week.

During the fund-flows week, the U.S. Bureau of Labor Statistics reported that inflation at the wholesale level rebounded in January as the producer price index rose 0.7% for the month—its largest rise since last summer. Adding to investor consternation, two non-voting members of the Federal Reserve Board voiced their opinions that the rate hike implemented during the most recent FOMC policy-setting meeting perhaps should have been 50 basis points (bps) rather than the 25-bps hike announced on February 1.

For the week, the average equity fund (including ETFs) witnessed market declines of 1.01%, while its taxable fixed income counterpart declined 0.23%. On the equity side, the alternative funds (+0.24%) macro-classification posted the only plus-side return, followed by commodities funds (-1.01%) and mixed-assets funds (-1.19%). World sector equity funds (-2.27%) witnessed the largest declines for the week, bettered by domestic sector equity funds (-2.08%).

Focusing on individual equity classifications and given the general declines for the week, it wasn’t surprising to see Dedicated Short Bias Funds (+3.87%) posting the strongest returns in the equity universe, followed by Alternative Equity Market Neutral Funds (+0.27%) and Alternative Managed Futures Funds (+0.27%). On the flip side, Equity Leverage Funds (-4.50%) suffered the largest weekly declines, bettered by Precious Metals Equity Funds (-4.15%) and Natural Resources Funds (-3.67%).

Despite the Fed’s increased hawkish tones and Fed funds futures traders pricing in a 73% probability that the Fed will raise interest rates by 25 bps on March 22, followed by another 25-bps hike in May, according to CME FedWatch Tool, the 10-year Treasury yield only rose seven bps for the flows week. This caused minor declines in taxable bond funds, with Ultra-Short Obligation Funds (+0.06%) posting the only positive returns for the week of the seven taxable fixed income macro groups, followed by short/intermediate U.S. government & Treasury funds (-0.08%, including ETFs) and general U.S. government & Treasury funds (-0.15%). World taxable fixed income funds (-0.45%) and alternative bond funds (-0.28%) were the laggards of the macro-classification.

With the rise of geopolitical tensions and some flight to safety during the week, the longer-dated General U.S. Government Funds (+0.12%) and Short U.S. Treasury Funds (+0.03%) classifications posted the only returns in the black in the taxable fixed income universe, with Emerging Markets Hard Currency Debt Funds (-0.55%) and International Income Funds (-0.54%) witnessing the largest one-week declines.

With the world equity funds (-19.59%) macro-classification suffering the largest 2022 declines in the equity universe, the reopening of China’s market, positive shifts in the supply chain, and some domestic equity issues looking a little pricy, many pundits are becoming a bit more bullish on markets outside of the U.S.

During the fund-flows week, U.S. investors were net redeemers of the domestic equity funds (including ETFs) macro-group for the eighth consecutive week, pulling out a net $7.1 billion this last week, while being net purchasers of nondomestic equity funds for the seventh week in a row, injecting $1.6 billion.

Year to date, the international equity funds and ETFs macro-group attracted the largest amount of net new money in the equity funds universe, attracting $16.0 billion, while small-cap funds (+$4.2 billion), equity income funds (+$2.7 billion), the commodities heavy, sector-other funds (+$2.3 billion), and sector-financial/banking funds (+$2.1 billion) took in the next largest sums, while domestic large-cap funds (-$17.4 billion) and global equity funds (-$3.3 billion) were the pariahs.

Drilling down a bit deeper in the year-to-date flows, we note that European equity funds & ETFs took in the largest sums of net new money of the international funds macro-group so far this year, attracting a net $7.6 billion, followed by emerging markets equity funds (+$7.1 billion), Pacific Region Funds (+$4.7 billion), and Pacific Region ex-Japan Funds (+$4.2 billion). While not shown in detail in the flows graph above, most, if not all, of the inflows into these groups can be attributed to ETFs. As we have reported, conventional equity funds continue to experience net redemptions.

Looking at the summary numbers can be a bit misleading. Year to date, investors have injected a net $24 billion into the conventional funds and ETFs, padding the coffers of taxable bonds (+$32.7 billion) and municipal bond funds (+$5.6 billion). However, they were net redeemers of equity funds (including ETFs) and money market funds to the tune of $8.3 billion and $6.0 billion, respectively.

That said, the breakdown between conventional funds and ETFs is quite different. While both taxable bond funds (+$12.9 billion) and ETFs (+$19.7 billion) attracted net new money year to date, conventional equity funds handed back some $25.0 billion, while their ETF counterparts took in $16.7 billion. On the tax-exempt bond fund side, it appears investors favored conventional municipal bond funds, injecting $7.4 billion, over municipal bond ETFs, withdrawing $1.7 billion so far in 2023.