Q2 flows show European ETF investors rediscovered the value factor

Flows into European exchange traded funds fell in the second quarter but this should be seen in the context of two extremely strong previous quarters.

Value funds performed well, but some of the most in-demand ETFs this time round were old favourites, including quality funds, broad US and global funds and those with a tilt to environmental, social and governance (ESG) principles.

The most popular of research provider Morningstar’s ETF categories were global and US large-cap funds targeting a mix of investment factors. When it came to individual funds, some of the most heavily bought names were mainstream and ESG-themed US equity ETFs, suggesting that the world’s biggest market had not exactly fallen out of fashion. Equally, some investors turned back to one of the decade’s leading investment styles, with €1.2bn going into quality factor ETFs in the second quarter, a turnround from a net outflow of €0.19bn in the previous quarter.

Flows into ESG ETFs slowed from a record €28bn in the first quarter to just over €13bn in the second quarter. The level of assets in ESG ETFs rose from €120.8bn to €140.4bn.

This article was previously published by Investors Chronicle, a title owned by the FT Group.

Yet Morningstar fund flow data also show that ETF investors across Europe continued to reckon with the prospect of resurgent growth and inflation in the second quarter. As Jose Garcia-Zarate, associate director of passive strategies at Morningstar, puts it, it was “too early to say that investors may be losing faith in the post-coronavirus pandemic economic recovery” as the quarter drew to a close. Three of the top 10 ETFs by net flows in the second quarter were value funds, with iShares Edge MSCI World Value Factor UCITS ETF (IWVL) in second place.

Value ETFs are now the second biggest factor subsector by assets under management, only sitting behind dividend ETFs. €3.74bn went into “value” products in the second quarter, compared with €5.28bn in the first quarter, although this may simply reflect lower overall demand for ETFs. However, the inner workings of factor ETFs need close scrutiny.

Investors have continued to weigh up the threat of inflation in other asset classes. Morningstar notes that flows into bond ETFs amounted to €10.1bn across Europe in the second quarter, up from €4.3bn in the previous quarter. Importantly, they “poured money” into duration-shortening strategies to mitigate the risk of rising interest rates amid inflationary pressures. Half of the 10 best-selling bond ETFs offered exposure to bonds with limited duration. Inflation-linked bonds in the US also pulled in funds.

Meanwhile, Morningstar noted in late July that the iShares China CNY Bond UCITS ETF (CNYB) had already become the second-largest bond ETF in the European market. It only launched in the summer of 2019, but it had more than $12bn across its different share classes in early June. In a year when Chinese equities have faltered, the ETF has held up relatively well, making a sterling total return of about 3 per cent in the first seven months of this year. By contrast, the CSI 300 index of Chinese equities was down by about 3.5 per cent in sterling terms over the same period.

Thematic funds have seen a slowdown in investor demand, but they continue to play a big role in the ETF space. Having racked up a record €5.5bn in the first quarter, flows into thematics fell back to €1.9bn in the second quarter. That said, assets in thematic ETFs reached a fresh high of €32.4bn in the second quarter, up from €29.4bn in the first quarter.

If flows have fallen back, thematic ETFs continue to proliferate in Europe, with nine launching in the second quarter alone, compared with a record 17 launches for the whole of 2020.

As with other thematics, these names focus on niche but potentially promising trends and sectors, from industries of the future to potential Covid-19 recovery plays. Very different examples from the first category include L&G Digital Payments UCITS ETF (DPAY) and Procure Space UCITS ETF (YODA). The digital payments ETF, unsurprisingly, has high allocations to the tech sector and the US, with 43 companies in the index it tracks. Its recent top 10 holdings include Shopify, PayPal and Square. The top 10 holdings made up about a quarter of the fund’s assets at the end of June.

Procure Space ETF had 35 holdings at the end of June, including Virgin Galactic and Trimble. Investors should note that, like some other thematic ETFs, it has a high fee of 0.75 per cent. It also faces some competition from recently launched Seraphim Space Investment Trust. The trust approaches the same theme in a notably different manner, with a focus on unlisted companies. The two funds are likely to carry different kinds of risk.

When it comes to Covid-19 recovery plays, one option that emerged in the second quarter is the Airlines, Hotels, Cruise Lines UCITS ETF (TRYP). The fund had 62 holdings at the end of June, with 44.1 per cent of its assets in airlines, 40.3 per cent in the hotel sector and 15.6 per cent in cruise lines. Its recent top holdings include Hilton Worldwide, Ryanair and Carnival.

Another interesting ETF to launch in the second quarter was Saturna Sustainable ESG Equity HANzero UCITS ETF (SESG). An actively managed global ESG equity fund, it stands out for incorporating carbon offsetting in its processes via projects focusing on issues such as forest conservation.

*Investors Chronicle is a 160-year-old publication from the Financial Times offering an expert and independent view of the investment market. It provides educational features, investment commentary, actionable tips and personal finance coverage. To find out more, visit investorschronicle.co.uk

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