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Investors have completely unwound last year’s purchases of European equity exchange traded funds amid deepening gloom as to the continent’s prospects.
They pulled a net $1.7bn from European equity ETFs in November, puncturing two months of relative calm, according to data from BlackRock. The resumed selling has taken net outflows from the sector since March to a cumulative $27bn, reversing inflows of $27.2bn witnessed during 2021.
The outflows are striking given that money has continued to pour into ETFs focused on US and emerging market equities, and that there is a structural “bid” for ETFs which are seizing market share from more traditional mutual funds at an ever-accelerating pace.
The exodus from European stocks has come despite the continent’s bourses outperforming on a relative basis this year, with the pan-eurozone Euro Stoxx 50 index down 9.6 per cent year to date, a more muted loss than the 17.8 per cent fall in the S&P 500 and 21 per cent slide in the MSCI Emerging Markets index, although the euro’s 6.8 per cent decline against the dollar will have worsened the picture for US-based investors.
Despite this, sentiment towards Europe remains grim, particularly among the foreign investors that led the charge into the continent last year.
“Because of developed Europe’s proximity to Ukraine, international investors have avoided Europe,” said Peter Sleep, senior portfolio manager at 7 Investment Management. “Economically, the impact of high gas prices and the higher likelihood of a recession has deterred investors.”
“US investors have more of a home bias than they have had in recent years because of the global economic challenges,” added Todd Rosenbluth, head of research at VettaFi. “There is an investor perception that the European recession will be deeper than in the US.
“There is greater confidence in a recovery in emerging markets than developed non-US markets.”
VettaFi’s own data suggested the picture was nuanced, however.
Among US-listed Europe-focused ETFs, some single-country funds, such as iShares MSCI UK ETF (EWU) and iShares MSCI France (EWQ) have taken in money this year, $594mn and $317mn respectively, while the sister iShares MSCI Germany ETF (EWG) has shipped $550mn.
“US investors are taking a broader perspective on investing in the US as opposed to a more targeted appetite across Europe,” Rosenbluth said.
“The UK has seen some inflows,” agreed Karim Chedid, head of investment strategy for BlackRock’s iShares arm in the Emea region.
Chedid attributed European bourses smaller losses this year in part to the weaker euro, which “has boosted export-orientated companies which form a big part of the Euro Stoxx 50”, meaning earnings have held up better.
He also believed European stocks were “significantly under-owned” by global investors, but was not turning more positive on the region.
“We need to see that the valuations have changed enough for a turnaround,” Chedid said. “When we get to that point, there is a lot of positioning to catch up.”
Change is afoot in fixed-income markets, however. BlackRock’s data show net inflows of $17.1bn into corporate bond ETFs in November, outpacing those to government bond ETFs ($11.9bn) for the first time this year.
The turnround has been particularly stark for high-yield bond ETFs. As of September 21 they had had cumulative outflows of $21bn this year; by the end of November that had shrunk to just $5bn. Cumulative inflows to investment-grade corporate bond ETFs have risen from $23bn to $36bn over the same period.
Chedid said this “remarkable” resurgence in flows was particularly noticeable for corporate bond ETFs with longer duration, another sign of greater comfort with risk.
“We are starting to see, especially for Emea, full duration exposure taken in credit, much more than we have in rates,” he said.
Rosenbluth also saw strong demand for riskier bonds, with the iShares iBoxx $ High Yield Corporate Bond ETF (HYG) attracting $3.6bn in November, the SPDR Bloomberg High Yield Bond ETF (JNK) $1bn and the iShares Broad USD High Yield Corporate Bond ETF (USHY) $592mn, even as lower-risk products such as the iShares 1-3 Year Treasury Bond ETF (SHY) and iShares Short Treasury Bond ETF (SHV) have seen outflows.
“These products have been largely out of favour,” he said. “Investors are both willing and needing to take on more risk to get higher yields. If the [US Federal Reserve] was continuing to hike you would get paid for the flight to safety to Treasury products. If it is getting closer to stopping, take on more credit risk.”
Chedid also believed this switch made sense. Investors were “cautious” about taking duration risk through government bond ETFs given that, with inflation remaining elevated “the central bank path is hard to call”, he said.
While unexpectedly aggressive rate increases would also be likely to weigh on corporate bonds, he believed that “some investors are taking the view, given where spreads are, that they are being compensated for duration risk”, whereas in government bonds they are not.
“It is more of a carry trade. Spreads [over government bonds] will not necessarily narrow but they won’t widen further, so you are just locking in the higher yield,” Chedid argued.
In recent years, he said, “bonds were more of a ballast in portfolios, not for yield, because that was very low across the board. Today bonds are for income again. That is a huge shift as we head into 2023.”