ETF Investors OK With Inflation: Morningstar

Attention may turn to small-cap targets in the second half of the year.

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Reviewed by: Daria Solovieva
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Edited by: Daria Solovieva

While investors have shown apprehension about investing in equity exchange-traded funds in the first half of the year, bond ETFs have been a more popular choice, suggesting investors aren't worried about inflation, according to the latest research from Morningstar Inc.  

So far this year, ETFs pulled in approximately $340 billion in assets, compared with $520 billion during the same time period in a record-setting 2021. One fund sector that stood out has been dividend ETFs. 

“Seven months into the year, dividend funds have pulled in $49.6 billion—24% of stock ETF net flows—despite representing only 7% of the total assets,” Morningstar Research Analyst and author of the study Ryan Jackson said in the report. 

Other categories, like commodity fund flows, have shown investors are confident that inflationary pressures will lessen. 

So far this year, we've seen investors really showing a lot more comfort with interest rate risk than we expected, implying that perhaps they think the worst of the inflation days are behind us,”  Jackson said on ETF.com’s Exchange Traded Fridays podcast.  

Shifting Attitudes

“Investors’ attitudes are shifting really on a dime and really in a pretty pronounced fashion,” he added. “And I think they deserve a little bit of credit for having the foresight at the end of last year and earlier this year, to kind of build up that wall against inflation and in the interest rate hikes that come with it.” 

Focused commodities funds attracted $12.7 billion in the first quarter, followed by outflows of $4.2 billion in the second quarter and $5.1 billion in July, ranking it among the worst outflows among all categories, according to Morningstar. 

For Jackson, these July trends signal that ETF investors have priced in inflation already. 

“What we've seen in the past, especially in July, as investors really, really loaded up on these long-term government bond portfolios, those are going to be most exposed to interest rate risk, instead of some of those shorter government bond portfolios that are better equipped to handle those rising rates," he explained in an interview.  

“What it kind of spells out for me is that investors largely think the effects of inflation and the rising rates, it’s really been priced into the market already,” he noted. 

In terms of the second half of the year, there are too many variables to predict if these trends will continue through the end of 2022. Morningstar and others continue to see pockets of the market that stand to benefit once the economic environment is characterized by a little bit more certainty. 

Since small-cap stocks tend to sensitive to the overall economy, it makes sense that investors have been earlier in the year, Jackson said.  

“I'm curious to see if July marks a kind of a harbinger for some market improvement rather than a little flash in the pan, if investors maybe start to roll the dice on some smaller companies.”  

 

Contact Daria Solovieva at [email protected]   

Daria Solovieva is a former managing editor at etf.com. Before joining etf.com, she worked as a financial journalist for leading publications all over the world, including Fortune, The Wall Street Journal, Bloomberg and others.