September capped a strong quarter for asset class returns and ETF flows. Investors poured $36 billion into ETFs during the month, bringing the quarter to more than $89 billion in net flows, narrowly outpacing the third quarter of 2017, which saw over $86 billion in net flows. At this time in 2017, ETFs had brought in a record $333 billion in net new flows. Although the strong third quarter brought us closer to that amount, so far in 2018 we have amassed $212 billion in net new flows, putting us roughly 37% behind 2017’s pace.
Growth Outperforms, But Investors Seek Value ETFs
The second-quarter earnings season featured some performance dichotomy around certain high-growth stocks, but that hasn’t slowed the overall “growth over value” trend. A flattening yield curve continues to underpin the structural engine driving growth equities. Long-end yields failing to keep pace with short-end moves upward show how the bond market is skeptical of the long-term growth story. Equity investors are displaying similar skepticism, bidding up any meaningful growth stocks.
The third quarter certainly reminded us of that tailwind–growth outperformed value by nearly 4%, widening the performance spread to over 13% in favor of growth. Third-quarter ETF style flows have deviated from this performance backdrop, as flows skewed toward value funds by nearly $5 billion relative to growth, perhaps an investor cry for less rich equities amid a 10-year bull market. Participants were burned by this “reversal anticipation” in late 2017 when they similarly placed more than $5 billion in value over growth only to see growth outperform value by more than 5% during the first three months of 2018.
Small-Cap Trade Losing Steam
After a brief period of outperforming large caps with dollar strength, small caps underperformed larger companies by nearly 4% during the third quarter, losing $25 billion in net flows in the process. This is to be expected, as standard asset allocation calls for greater weight to large caps than small caps given their historically more stable returns. However, when the VIX spiked earlier this year, investors found shelter in small caps, as both flows and relative performance depict in Exhibit 3. In fact, net flows into small caps outpaced large-cap ETF flows, quite the rarity in the ETF marketplace. This trend continued into the middle of the year, as the NFIB Small Business Optimism Index hit its highest level in 45 years during August, a display of small business confidence amid swift fiscal expansion. However, performance speaks louder than optimism, and as the small-cap “sugar rush” has tempered more recently as funds flowed back into large caps during the third quarter.
Healthcare Hits A Record Three-Month Inflow As Investors Rotate
