Index Fund Inflows & Outflows Show Which Asset Classes Are In Favor

Index funds are a curious thing. 

On the one hand, plenty of long-term investors swear by them as a way of automating retirement investing and creating an allocated portfolio. 

On the other hand, some investors correctly point out that an over-reliance on index funds can limit other investment opportunities and force investors to cede control of their holdings.

Index fund investors do have the option of diversifying through single stocks and thematic funds, such as those focusing on a specific trend, such as cloud computing, China Internet, robotics, pet care and clean energy. You can even overweight your portfolio toward specific sectors or regions if you believe these markets are well-positioned to show gains. 

There’s an ETF for essentially any theme you want, although ETFs tracking bitcoin and other crypto assets have not yet launched, as the Securities Exchange Commission has not issued approval yet. 

In August, ETFs listed on U.S. exchanges brought in more than $67 billion.

The granddaddy of ETFs is the SPDR S&P 500 ETF (ASX: SPY), which launched in 1993 and currently has $403.7 billion under management. In August, it added $5.1 billion. 

Meanwhile, the Vanguard S&P 500 ETF (NYSEARCA: VOO) added more than $4.8 billion. 

Not to put too much emphasis on the S&P 500. Funds tracking that index are a good way to get exposure to large-cap domestic stocks, but many investors fail to see beyond that particular asset class. 

That’s where the concept of opportunity cost enters in. It’s true that U.S. equities have, on the whole, outperformed other asset classes in the past several years.

However, by investing in something that tracks another asset class, you have a piece of other investments as they rise. 

For example, the KraneShares CSI China Internet ETF (NYSEARCA: KWEB) attracted $1.4 billion in new investment last month. Investors continue to seek opportunities in China, despite worries about that country’s clampdown on tech companies headquartered there. 

Chinese equities are in a nascent uptrend, having bottomed out in mid-August.

The KraneShares CSI China Internet ETF advanced 8.26 in the past month, after declining 25.19% in the past three months and 31.38% year-to-date. As the price rose, upside volume was above average, a good sign of renewed investor confidence.

It’s also a great example of how investors eventually swoop in to purchase shares of an asset that’s been beaten down. Does that mean this fund, or Chinese Internet stocks as a whole, will become the next high fliers? Of course not. But it does show that investors are rotating into this asset class right now. 

In what I consider something of a surprise, investors also added net inflows to domestic fixed income. In particular, the iShares iBoxx USD Investment Grade Corporate Bond ETF (NYSEARCA: LQD) added $2.5 billion, while the iShares TIPS Bond ETF (NYSEARCA: TIP) added $1.7 billion.

Here, too, the inflows followed a period of net outflows. It’s no secret that the bond market is dramatically underperforming equities. In essence, investors who park their money in fixed income have been giving up a tremendous amount in return, versus the return from domestic equities. 

Year-to-date, the LQD ETF is down 0.77%. On a percentage basis, that’s not bad at all, and not the kind of decline that should, by itself, scare off any investor. Over the past three months, the downtrend appears to be reversing, with a gain of 2.75%, although shares gapped down Tuesday. 

For its part, the TIP ETF, which tracks the U.S. Treasury Inflation-Protected Securities Index, also fell Tuesday, and has been clinging to small gains throughout the year.

Are investors changing their tune about bonds? Over the medium term, it remains to be seen. But tracking charts or fund inflows and outflows can give you a good indication of how the broader asset classes within your portfolio - or those you’re considering adding - are performing.