Investors have pulled significant assets from low volatility ETFs over the past month amid peak inflation predictions and ongoing risk-on sentiment.
According to data from ETFLogic, the iShares Edge MSCI World Minimum Volatility UCITS ETF (MVOL) and its ESG equivalent have seen a combined $930m outflows over the period while investors pulled $365m from the iShares Edge S&P 500 Minimum Volatility UCITS ETF (SPMD), as at 14 February.
At the other end of the spectrum, investors have been eyeing emerging market ETFs as a way to gain exposure to risk-on assets amid China’s reopening and the current rally in markets.
Meanwhile, Europe’s largest emerging market ETF, the iShares Core MSCI EM IMI UCITS ETF (EIMI) has seen $619m inflows while the HSBC MSCI Emerging Markets UCITS ETF (HMEF) has gathered $423m net new assets.
The shift away from low volatility ETFs has been driven by interpretations of an increasingly dovish Federal Reserve which hiked rates by 25 basis points (bps) at its latest Federal Open Market Committee meeting on 1 February.
“Markets applauded the words Fed chair Jerome Powell did not say rather than the ones he did,” Gargi Chaudhuri, head of iShares investment strategy Americas at BlackRock, explained. “He did not explicitly push back against the more optimistic market-implied rates of inflation and declined to say that the recent loosening in financial conditions was unwelcome.
“The primary tail risk is no longer a hard landing followed by Fed cuts, but rather continued strong growth even as inflation ticks down to the Fed’s 2% target. Combine the rising likelihood of this rosy outcome with record levels of cash seeking a place to go and you get a basic recipe for the risk rally.”
However, inflation remains the biggest risk to this year’s rally in risk assets. On Wednesday, the US Consumer Price Index (CPI) rose 6.4% year-on-year, above expectations of 6.2%, highlighting how the Fed’s job is far from done yet.
Powell has repeatedly warned the US economy “has a long way to go” before inflation hits the central bank’s 2% target but the market has so far ignored any hawkish signals.
“The inflation number reminds everyone of the difficulties faced, and we are still far too early to declare victory yet,” Marcus Brookes, CIO at Quilter Investors, warned. “For investors, patience and diversification is required as it is unlikely to be a smooth journey.”
This is also the view of Marko Kolanovic, chief global markets strategist and co-head of global research at JP Morgan, who warned markets “are complacent of risks”.
“Equity markets appeared to read this month’s central bank meetings as dovish while dismissing the weak Q4 earnings and the implications of the strong US payroll report for both monetary policy and corporate margins,” he continued.
“We see the equity risk/reward as skewed to the downside, as upside potential for markets is likely fairly limited given stretched valuations and high rates while downside could be meaningful.
“As such, we reinforce the defensive tilt in our model portfolio this month by covering our government bond underweight and moving slightly overweight, which we fund by reducing risk across equities, credit and commodities.”