Investors Search For Diversification And Yield In Bond ETFs

Investors Search For Diversification And Yield In Bond ETFs

Challenging market and economic conditions dampened ETF cash flows in Q1 2023, but industry AUM continues to grow year on year, according to data recently released by the ASX and Vanguard.

The Australian ETF market recorded A$1.8 billion in cash flows during Q1 2023, down 47% from the previous quarter, and compared to A$2.8 billion in Q1 2022.

Market AUM however has increased from A$130 billion at the end of Q4 2022 to A$139 billion at the end of Q1 2023, reflecting an overall appreciation in the value of ETF assets.

“Rising interest rates and the soaring cost of living has likely impacted ETF flows, as investors have less discretionary income with which to invest,” said Minh Tieu, Vanguard’s Head of ETF Capital Markets, Asia-Pacific.

“With recent financial market volatility and continuing economic uncertainty, it’s also likely investors are seeking safety in defensive assets such as fixed income and cash ETFs in an effort to manage investment risks.

“The softening of flows this quarter is understandable considering how stormy global markets have been, but we expect flows to pick up as inflation is brought back under control. Meanwhile, in this current weather, investors who focus on long-term returns, ensure broad portfolio diversification, and stay the course will be best prepared to navigate any market turbulence.”

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Cash ETFs recorded A$430 million in Q1 2023, up significantly when compared to the same time last year when Cash ETFs recorded outflows of -A$555 million in Q1 2022. This suggests investors are seeking not only yield but also more liquidity than some current term deposits.

Focus on fixed income

Domestic bond ETFs recorded A$499 million in cash flows in Q1 2023 while international bond ETFs recorded A$448 million, down 32% and 9% respectively since Q4 2022. Although flows are down quarter on quarter, fixed income ETF flows are up significantly year on year with domestic bond ETFs up 52% and international bond ETFs up 61%.

Vanguard recorded positive cash flows across all fixed income ETFs, with Vanguard Australian Fixed Interest Index ETF (VAF) attracting A$15.7 million.

“Q1 2023 has delivered the biggest quarterly return on Australian bonds for over a decade, and recent demand suggests fixed income is firmly back on investors’ radars,” said Mr Tieu.

“As bond markets are typically forward-looking, future interest rate hikes and inflation have likely already been priced in. This means bond allocations and the cost of diversification are now cheaper than seen for many years, with other benefits such as income on top.

“Vanguard has recently reduced the fee of the Vanguard Australian Fixed Interest Index ETF (VAF) to 0.10% after a periodic product review, with the objective of passing value back to our investors and helping them keep more of their returns.”

The search for yield

Equity ETF flows also slowed in Q1 2023, with Australian equity ETFs receiving A$667 million in inflows and global equity ETFs seeing outflows of -A$113 million, down 18% and 134% respectively quarter on quarter.

Notably however, high yield Australian equity ETFs proved attractive in Q1 2023. Vanguard’s Australian Shares High Yield ETF (VHY) recorded A$183 million in flows and was Vanguard’s most popular ETF this quarter.

“It seems evident that investors are seeking out income sources which may account for the stronger flows into bond ETFs and high yield ETFs,” said Mr Tieu.

“For retirees in particular, income producing bond ETFs can be a source of steady income while providing diversification and a lower risk way to remain invested through the current market volatility.”