What The Flows Show: The Great Duration Rotation

Includes: DIA, IVV, IYY, SPY, VOO, VTI
by: Dodd Kittsley

Adding fuel to the great rotation debate, February inflows of $10.6 billion into equity exchange-traded products (ETPs) ensured the strongest two-month start on record for the category ($47.1 billion year to date). But a closer look at flows suggests less of a great rotation from bonds to stocks, and more of a "duration rotation" within the fixed-income category. In fact, compared with January's record ETP flows and risk-on behavior, investors in February seemed to be more focused on fine-tuning portfolios in anticipation of policy shifts and future rising interest rates.

Within equities, developed market equity ETPs led the charge in February, gathering $13.0 billion, including $7.3 billion in non-U.S. exposures. Investors' continued appetite for yield was evident in dividend, real estate, and preferred stock ETP inflows, which gathered $1.6 billion, $1.5 billion, and $0.7 billion, respectively. Dividend ETPs have made a significant comeback after stalling in the last quarter of 2012, when negotiations over the U.S. fiscal cliff placed tax treatment of dividends in limbo (see below).

Dividend Income Equity ETP Monthly Flows

Another significant theme in February equity flows was the surge of interest in low or minimum volatility ETPs. The category attracted average monthly flows of $926 million for the first two months of 2013 -- more than double the average monthly flows of $416 million in 2012. These funds seek to provide exposure to a particular equity segment, such as emerging markets or global stocks, with less price volatility than traditional market-cap weighted indexes. With more of these funds becoming available and concerns about market volatility persisting, we'd expect the trend to continue at least in the near future.

Fixed-income ETPs may have experienced lower net inflows than their equity counterparts last month, but movement within the category was informative. Rather than signifying a great rotation from fixed-income to equities, ETP flows illustrated more of a rotation into shorter-duration assets (see below). On a year-to-date basis, eight of the top 10 asset-gathering bond ETPs were either short-term or floating rate exposures. This is a big departure from last year, when short-term and floating products composed only two of the top 10 asset-gathering ETPs. This seems to indicate an increased fear of rising interest rates, since these products are generally less sensitive to changes in rates.

Year-to-Date Fixed Income Flows by Duration Category

And finally, it's worth noting the record outflows experienced by gold ETPs last month. Set against the backdrop of rising equities, a strengthening U.S. dollar and low U.S. Treasury bond yields, the investment appetite for gold waned to the tune of $5.6 billion in outflows ($6.8 billion YTD). In fact, February was the worst month ever for outflows in gold ETPs.

In all, February ETP flows continued to illustrate our feeling that markets in 2013 will be increasingly influenced by policy. The sudden aversion to gold, pronounced rotation into shorter duration bond funds, and increased interest in minimum volatility ETPs all indicate that investors are carefully watching political dealings and Fed movements, while trying to anticipate how these events will affect their portfolios.

Sources: BlackRock, Bloomberg.

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