Investors are leaving European equity ETFs at the fastest pace since Brexit

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Investors withdrew money from European exchange-traded funds in August at the fastest pace since the 2016 Brexit referendum as fears of recession mounted.

The $7.7 billion out of the sector was the sixth consecutive month of net outflows, and just behind the $8.9 billion in net sales recorded in July 2016, according to BlackRock data, reflecting darkening sentiment at across the continent.

Amid war and soaring inflation, investors have been spooked by “a deepening energy crisis,” said Karim Chedid, head of investment strategy for BlackRock’s iShares arm in the US. Emea region. This was accompanied by a “hawkish reassessment” of European Central Bank policy “throughout August, particularly at the start [of the curve]he added, with markets now pricing in a 50% chance of a rate hike of 75 basis points, up from 50 basis points, at the bank’s next meeting on September 8.

“The yield curve shows [the market] expects a recession,” said Kenneth Lamont, senior fund analyst for passive strategies at Morningstar. “There is clearly a risk of being taken off the table. The market is positioning itself for the coming storms.

Despite the gloomy economic backdrop, Chedid said he was surprised by August’s outflows, given that European equities were already “underheld by investors, especially foreign investors”, according to BlackRock’s calculations.

Detlef Glow, head of Emea research at Refinitiv Lipper, said European investors had moved from an underweight in US equities in 2018 to an overweight now, attracted by stronger economic growth, lower oil prices energy and the tailwind of a rising dollar.

The exodus from European equities was even more shocking given that, globally, ETF flows indicated a modest recovery in risk sentiment in August.

Total worldwide admissions rose $2.5 billion month-over-month to $49.4 billion in August. The U.S. stock market led the way, with net inflows rising from $12.6 billion in July to $30.2 billion.

Chedid attributed the chasm in appetite for US and European stocks to differences in the makeup of the two stock markets, with Wall Street having a higher weighting in tech and healthcare stocks and factors such as “quality”. – stocks with a high return on equity, stable earnings growth and low leverage – which is “what you want to own when margins are under pressure and inflation is high,” Chedid explained.

By contrast, Europe is more exposed to cheaper value stocks and sectors such as banks, energy and industrials.

And while earnings projections “seem too high [and] have room to downgrade,” both in the U.S. and Europe, Chedid felt there was room for “bigger downside surprise” in the latter, given the clouds economic storms.

In another tentative sign of a recovery in risk appetite, emerging market debt ETFs saw their first net inflows since January, although the $1.4 billion in purchases only canceled out a fraction of the $11.7 billion in cumulative net outflows observed between February and July.

Lamont said the buying was geographically broad, with European-domiciled global emerging-markets bond funds seeing their biggest monthly inflows since 2013. This contrasts with the start of the year, when investors focused largely on beneficiaries of rising energy prices, such as the Gulf States.

Column chart of monthly net flows (in billions of dollars) showing emerging market debt ETFs

Chedid attributed the renewed enthusiasm to valuations, which have become more attractive after this year’s sell-off, combined with a view that emerging market central banks are generally ahead of developed markets in their rate hike cycle. .

Glow agreed, saying that “investors are looking for diversification in their portfolios and they may have found emerging market bonds to be at better valuations.”

Nonetheless, Chedid warned that the bulk of the flows had gone into hard currency bonds, the less risky half of the emerging market debt spectrum, and that it may be “too early to talk about a reversal”. , given that bond yields in developed countries had risen, so that “investors do not have to go far in their search for income”.

Line graph of cumulative flows, year-to-date (in billions of dollars) showing ETFs in the financial sector

However, ETFs specializing in financial stocks could be at a turning point. After a painful string of exits since March, they topped the sector sell-off chart in August with net inflows of $2.4 billion, despite continued selling off of European exposures.

Chedid attributed this to a combination of a strong second quarter reporting season and the steepening of the US yield curve seen in August, potentially improving banks’ net interest margins.

Overall, Glow argued that continued inflows into ETFs, even as mutual funds bled assets, demonstrated that “investors really favor ETFs in times of crisis,” such as in 2008, 2011. and 2020, when they saw year-round capital inflows despite economic turmoil.

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