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Stagnant Returns Didn’t Deter Bond Investors in First Quarter

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Key Takeaways

  • Government and investment-grade bond returns fell slightly while stocks rallied in the first quarter, but bond funds had greater net inflows at $151.8 billion in the period.
  • Actively managed exchange-traded funds (ETFs) continued taking market share from much larger passively managed ETFs.
  • Flows for emerging markets mutual funds and domestic large Growth funds went in opposite directions in the latest quarter; investors soured on money market funds late in the quarter.

Global equity markets in the first quarter extended their 2023 rally while bond returns stagnated as government bond yields rose. But one wouldn’t know that by looking at the quarter’s fund investment flows.

Net inflows into exchange-traded funds (ETFs) and mutual bond funds totaled $151.83 billion in the first quarter. That’s almost three times more than the $53.68 billion net inflows—reflecting fund sales minus investors’ redemptions—that went into equity funds.

The flows into bond funds occurred despite slight declines in government and investment-grade bond returns during the quarter. Those returns reflected the quarter’s 33-basis-point (bps) increase in the 10-year U.S. Treasury yield to 4.21%, and corresponding increases in European government bond yields, all of which helped drive yields higher on most fixed-income instruments.

The quarter’s bond returns contrasted starkly with strong global equity returns. The S&P 500 Index gained 10.2% in the quarter, with the MSCI All-Country World Index gaining 8.3%.

Active ETFs Gain Market Share

As they have for more than a decade, ETFs during the quarter continued dominating net inflows, compensating for continued outflows from traditional actively managed mutual funds—particularly U.S. stock funds.

Quarterly net inflows into U.S. stock ETFs within Morningstar’s traditional style and size paradigm totaled $94.6 billion, whereas investors withdrew a net $69.6 billion from similar U.S. actively managed mutual funds.

However, actively managed ETFs continued making inroads in the broader investment landscape. Though passively managed ETFs tracking pre-determined benchmarks attracted $118.86 billion in net inflows in the first quarter, active ETFs garnered $57.24 billion.

The latter category’s quarterly net inflows equaled almost 10% of its $576 billion in assets, compared with about 1.8% for the $6.5 trillion passive ETF market and 1% for smart-beta ETFs. In other words, active ETFs drew about 30% of all ETF net inflows despite accounting for just 7% of the overall ETF market.

Emerging Markets Flows Shine; Large Growth, Not So Much

The MSCI Emerging Markets Index gained just 2.4% in the quarter, a fraction of the gains enjoyed by developed market stocks. Nevertheless, funds focused on EM stocks were one of the few equity categories among actively managed mutual funds that experienced net inflows.

Actively managed diversified emerging markets equity funds captured $4.8 billion in net inflows in the quarter, with funds managed by Fidelity attracting the majority of that amount.

Conversely, actively managed funds focused on large U.S. Growth stocks suffered $31.7 billion in net outflows during the quarter.

Large actively managed Growth funds such as Peter Lynch‘s Fidelity Magellan fund once were considered the darlings of the mutual fund industry. But the category’s assets have fallen to $1.8 trillion during investors’ ongoing steady march to cheaper ETFs.

Meanwhile, money market funds attracted $18 billion net inflows during the quarter as yields remained attractive. But investors soured on them late in the quarter, withdrawing a net $92.1 billion in March.

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