October ETF Flows: Volatility Higher, Flows Lower
- Driven by a lack of tactical risk-on positioning, inflows were just $34 billion, roughly 40% below their historical average.
- Equity flows were a muted $16 billion, held back by sectors’ $6 billion of outflows and non-US geographies net outflows of -$2.1 billion.
- Bonds saw $18 billion of inflows driven by $13 billion into ultra-short government bond funds; credit sectors saw $13 billion of outflows led by $5 billion out of high yield.
Dating back to 1956, September and October returns for the S&P 500 Index have been, on average, weaker than other months.1 That trend has continued in 2023, with the S&P 500 falling -4.8% and -2.2%, respectively. Hawkish monetary policy, uneven earnings sentiment, and renewed geopolitical risks were the catalysts for this fall’s “fall.”
There is hope, however. November returns, on average, have been the best —producing an average monthly return of 1.66%.2 December is right behind with the third-best average gain of 1.30%.3
But relying on historical patterns at a time of renewed episodic volatility may not be enough to resolve the weak sentiment and risk-off attitudes. Cross-asset volatility has soared over the past few months for reasons including:
- The higher-for-longer mantra raising funding concerns for firms
- Violence in the Middle East disrupting commodity markets
- Political discourse around spending and deficits
- Election cycles impacting economic momentum
The return of episodic cross-asset volatility has naturally disrupted buying behavior, leading to below average inflows and limited tactical risk-on exposure usage.
Limited Interest to Go Risk-On Tactically
With sentiment restrained, buying behavior was equally subdued. October had $34 billion of inflows, roughly 40% below the recent three-year historical monthly average. In fact, it’s the ninth month this year where ETF flows were below this near-term average.
A lot of the weakness in inflows stems from a reduction in risk-on tactical behavior. Sectors, for example, have posted outflows in six out of the ten months this year, including October when they shed $6 billion.
As a result, year-to-date outflows are now over -$15 billion, which would be a calendar year record. And, last month saw only one sector (Energy) receive meaningful inflows, likely a product of rising oil prices and its derivative impact on earnings.
Figure 1: Sectors Post Heavy Outflows
| In Millions ($) | October | Year to Date | Trailing 3 Mth | Trailing 12 Mth | Year to Date (% of AUM) |
| Technology | -991 | 3,235 | 1,866 | 2,716 | 2.18% |
| Financial | -3,634 | -3,313 | -8,011 | -4,773 | -5.34% |
| Health Care | -1,370 | -8,672 | -3,014 | -6,465 | -8.34% |
| Consumer Discretionary | -1,732 | 3,324 | -529 | 2,522 | 14.53% |
| Consumer Staples | -670 | -2,077 | -2,994 | -401 | -6.59% |
| Energy | 2,685 | -5,885 | 3,871 | -6,359 | -6.79% |
| Materials | 4 | -2,233 | -1,634 | -2,084 | -6.09% |
| Industrials | 69 | 1,567 | -635 | 2,289 | 4.67% |
| Real Estate | 146 | -2,413 | -189 | -1,492 | -3.45% |
| Utilities | -582 | -1,452 | -1,263 | -1,657 | -5.55% |
| Communications | 90 | 2,407 | -573 | 2,256 | 20.87% |
Source: Bloomberg Finance, L.P., State Street Global Advisors, as of October 31, 2023. Top two/bottom two categories per period are highlighted. Past performance is not a reliable indicator of future performance.
In another sign of muted tactical usage, Smart Beta funds posted $400 million of outflows. And tactical non-US exposures, such as emerging markets, regional, and single-country funds had net outflows of almost $4 billion. Thematic funds had $750 million of outflows as well.
With tactical risk-on instruments out of favor amid bouts of volatility, restrictive monetary policy, and uneven growth trends, secular, strategic allocations have propelled flows so far in 2023.
And surprisingly, two mutually exclusive asset categories, comprise 89% all inflows year to date:
- Low-cost ETFs, with over $223 billion
- Active ETFs, with over $102 billion
Low-cost flows make up 61% of all flows this year, while active flows represent 28% (Figure 2).
October flow patterns also underscore the 2023 trend of secular, strategic use over tactical. Low-cost ETFs had $23 billion (66% of all flows) while active ETFs had $16 billion (47% of all flows).
All other funds, added together, had net outflows of -$4 billion. This is a stark difference to how current AUM is comprised, as active makes up just 6% of AUM while low-cost accounts for 48%.
Risk-Off Vibes on Display with Bond ETF Flows
Equity ETFs took in less than $20 billion in October, well below their historical monthly average of $40 billion a month. This marks the eighth month this year where equity flows were below average.
Fixed income ETFs had stronger flow trends. October inflows, powered largely by one sector, were $18 billion and above their historical average of $16 billion.
The relative difference between stock and bond ETF flows further illustrates this risk-off investor sentiment. The rolling 90-day flow differentials between equity and bond ETFs show investors are becoming increasingly hesitant to express risk.
After having moved higher at the start of the summer, the rolling 90-day average sagged and is now below the long-term median (Figure 3). Having trended lower for four straight months, it’s now right at the 33rd percentile.
Of the $18 billion into bonds, $13 billion flowed into ultra-short and short-term government funds in October — their third-best month. Those flows reflect the one clear tactical use by investors and underscore the risk-off vibes visible elsewhere.
De-risking meant investors avoided credit sensitive exposures. Investment-grade bond exposures saw $4.6 billion of outflows. High yield lost $5.4 billion and now has nearly $11 billion of outflows in 2023. Senior Loans shed almost $100 million in October and have lost over $1 billion on the year, adding to the weakness in sentiment toward below investment-grade credit.
Figure 4: High Yield On Track to Have First Back-to-Back Years of Outflows
| In Millions ($) | October | Year to Date | Trailing 3 Mth | Trailing 12 Mth | Year to Date (% of AUM) |
|---|---|---|---|---|---|
| Aggregate | 6,248 | 54,719 | 13,926 | 69,795 | 13.28% |
| Government | 21,459 | 106,851 | 40,658 | 118,871 | 38.17% |
| Short Term | 13,091 | 54,467 | 25,872 | 58,747 | 33.42% |
| Intermediate | 2,872 | 20,541 | 7,094 | 23,996 | 23.54% |
| Long Term (>10 yr) | 5,497 | 31,843 | 7,693 | 36,128 | 70.12% |
| Inflation Protected | -1,083 | -12,563 | -3,438 | -15,949 | -16.12% |
| Mortgage Backed | 2,009 | 9,720 | 2,652 | 11,102 | 19.45% |
| IG Corporate | -4,684 | 1,264 | -9,107 | 8,753 | 0.56% |
| High Yield Corp. | -5,419 | -10,879 | -7,936 | -7,339 | -16.49% |
| Bank Loans | -85 | -1,463 | 501 | -1,793 | -11.00% |
| EM Bond | -1,732 | -1,243 | -2,849 | -502 | -4.67% |
| Preferred | -247 | -185 | -417 | -854 | -0.56% |
| Convertible | -889 | -1,415 | -974 | -1,405 | -22.85% |
| Municipal | 2,559 | 8,916 | 5,278 | 18,492 | 8.40% |
Source: Bloomberg Finance, L.P., State Street Global Advisors, as of October 31, 2023. Top two/bottom two categories per period are highlighted. Past performance is not a reliable indicator of future performance.
The de-risking in bonds is sharper when comparing the cumulative flows trends between the ultra-short and short-term government bond sector and below investment-grade ETF exposures (high yield and senior loans). They have been moving in different directions all year, as investors sought stability over high income (Figure 5).
Position for Episodes of Volatility
Markets last endured volatility like this in 2018. Back then the Federal Reserve was tightening policy while broader economic and earnings growth was meager. The political landscape was fraught and the market had dual drawdowns in both February and December of that year.
Yet, for most part of the year the CBOE VIX Index traded below its historical average — much like this year. While the VIX rose in October, registering seven days above its 30-year average, it has spent 79% of the days this year below its historical average. But according to historical trends, the VIX usually trades below its long-term average 60% of the time.5
Episodic volatility can impact markets because of an uneven earnings environment. If there was a stronger fundamental backbone, macro risks would have a harder time disrupting sentiment. However, earnings results, reactions, and guidance have been weak.
In the US, Europe, Japan, and emerging markets, growth for 2024 was revised lower recently.6 And the latest reports show either low or negative top-line revenue growth in the different regions.7
But a full “T-bill and chill” approach and de-risking all asset class exposure could miss out on gains. Notably, global stocks, led by the US, are still up in 2023.
Going forward, to navigate the return of potentially more frequent periods of episodic volatility alongside positive, but slowing, growth, consider:
- Infusing fundamental stability within equities to balance upside and downside
- Focusing on high quality shorter-duration bonds between 1-3 year maturities where elevated yields offer income and the potential minimize rate volatility and total risks
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