Interest rates are climbing, sending fixed-income investors running for the hills. That’s the conclusion you might draw from glancing at October’s flows data, which showed fixed-income ETFs registering their first monthly outflow in three years.
That outflow, totaling $5 billion, came as the benchmark U.S. 10-year Treasury yield jumped to a seven-year high close to 3.26%.
But that’s not the whole story.
Looking at just last month’s flows data paints a bleak picture for fixed-income ETFs this year. But looking at the data for the year as a whole reveals a much more positive situation for the segment.
Year-to-date, through the end of October, a sizable $66.2 billion flowed into fixed-income ETFs—including $56 billion into U.S. fixed-income funds and $10.2 billion into international fixed-income funds—equal to more than 30% of all inflows for U.S.-listed ETFs in 2018.
The haul is even more impressive when considered against the backdrop of a big jump in interest rates to multiyear highs.
Embracing Higher Yields
The data suggest that, rather than running away from higher interest rates, investors are embracing them. Funds holding short-term debt, in particular, have seen their assets balloon.
The iShares Short Treasury Bond ETF (SHV), which holds Treasuries with maturities of one year or less, has nearly doubled its assets this year, taking in a whopping $7.6 billion of new money.
The iShares 1-3 Year Treasury Bond ETF (SHY), the iShares Floating Rate Bond ETF (FLOT), the SPDR Bloomberg Barclays 1-3 Month T-Bill ETF (BIL), the JPMorgan Ultra-Short Income ETF (JPST) and the PIMCO Enhanced Short Maturity Active ETF (MINT) have also seen tremendous success this year, with inflows of more than $3 billion each.
|Ticker||Fund||YTD Inflows ($M)||AUM ($)|
|SHV||iShares Short Treasury Bond ETF||7,577||15,592|
|FLOT||iShares Floating Rate Bond ETF||5,218||11,832|
|EMB||iShares JP Morgan USD Emerging Markets Bond ETF||3,800||14,744|
|SHY||iShares 1-3 Year Treasury Bond ETF||3,485||14,699|
|BIL||SPDR Bloomberg Barclays 1-3 Month T-Bill ETF||3,349||5,302|
|JPST||JPMorgan Ultra-Short Income ETF||3,202||3,317|
|SCHP||Schwab US TIPS ETF||3,183||5,859|
|MINT||PIMCO Enhanced Short Maturity Active ETF||3,155||11,200|
|BNDX||Vanguard Total International Bond ETF||2,933||12,101|
|FLRN||SPDR Bloomberg Barclays Investment Grade Floating Rate ETF||2,832||4,501|
|VMBS||Vanguard Mortgage-Backed Securities ETF||2,508||7,134|
|NEAR||iShares Short Maturity Bond ETF||2,067||4,944|
|AGG||iShares Core U.S. Aggregate Bond ETF||2,005||52,688|
|SCHR||Schwab Intermediate-Term US Treasury ETF||1,842||2,953|
|BSV||Vanguard Short-Term Bond ETF||1,746||25,302|
Note: Data measures inflows for the year-to-date period through 10/31/18.
By holding short-term debt (or floating-rate bonds, in the case of FLOT), these ETFs minimize interest rate risk, while still allowing investors to capture this year’s higher interest rates. That’s resonated with investors who want to take advantage of the rising rate environment without worrying about whether rates move even higher from here.
Other Factors At Play
In addition to being attracted to higher yields, investors may be parking their cash in short-term bond ETFs for safety. Let’s face it: It’s been a volatile year for the stock market, with three 8% corrections in the S&P 500 in just 10 months.
Short-term bond ETFs are a haven amid this volatility, especially as the outlook for long-term bonds is more uncertain.
Another factor driving demand for these ETFs: the reforms in money market funds that took place two years ago. Beginning in October 2016, the Securities and Exchange Commission said that certain money market funds—mutual funds that hold short-term debt securities—would no longer be allowed to have stable $1 net asset values (NAVs) and would have to convert to floating NAVs based on market prices.
The SEC also said that during times of stress and low liquidity, money market funds would have the ability to charge redemptions fees and temporarily block investors from taking their money out.
Together, these changes to money market funds made them more secure and better able to withstand a financial crisis, but at the expense of some of their coveted features. That may be pushing some former money market fund investors into short-term bond ETFs.