Political wrestling over the extension of the debt ceiling — and risk of a U.S. default — is scaring investors. But many found a place to hide out with the best ETFs until the risk is gone.
"There's been a recent flight to quality among bond ETF investors," said Todd Rosenbluth, head of research at VettaFi. Most investors expect lawmakers to finally come up with a solution to avoid a U.S. default. But flows within ETFs show that investors aren't taking chances.
The Debt Ceiling Drama
The warnings of a U.S. default are unnerving markets. Treasury Secretary Janet Yellen warned lawmakers a default could happen as soon as June 1 if borrowing limits are not raised.
This shocked investors somewhat, who thought the Treasury had enough left of its current $31.4 trillion debt ceiling to keep functioning until September, says Tom Roseen, head of research at Refinitiv Lipper.
And markets are reacting.
Counterintuitively, nervous investors are buying funds and ETFs that own government debt. This type of debt is still seen as less risky than many corporate bonds. But in a new twist, investors are buying government debt that matures in months, not 10 years or more. Presumably, there's less risk in the short term, even in the unexpected event of a default.
There's been an "unusual rise in the three-month T-bill yield maturing in late-June to mid-July," Roseen said.
And ETFs are showing the fear, too. Investors poured $5.8 billion into mutual funds and ETFs in the week ended May 3. But they were net purchasers of short-term assets, putting $21.5 billion into money market funds. And they took out $14 billion from stock funds, $930 million from taxable bond funds and $846 million in tax-exempt fixed income funds.
"Even with the risk of default increasing, investors seem to expect a debt ceiling deal to occur and want to protect against the market volatility," Rosenbluth said.
Where ETF Investors Are Stuffing Their Money
Money market funds are a popular source of nervous money.
U.S. Government Money Market funds pulled in the most new money during the week ended May 3. Even with the U.S.' default at risk, it's still considered among the safest places to store money.
But some ETFs, too, are standing out.
In terms of ETFs, Rosenbluth says the largest flows in the week are going to BondBloxx Bloomberg One Year Target Duration US Treasury ETF. Such short-term bond portfolios are viewed as being less risky than those that pay off in 10 years or longer.
Similarly, other ETFs seeing inflows include iShares 3-7 Year Treasury Bond ETF, Vanguard Intermediate-Term Treasury ETF and SPDR Bloomberg 1-3 Month T-bill ETF. Again, the idea is that the shorter term the maturities of the debt, the lower the risk.
So what are ETF investors bailing out of? High-risk bonds issued by financially shaky companies. The iShares iBoxx $ High Yield Corporate Bond ETF and SPDR Bloomberg High Yield Bond ETF saw the greatest outflows, Rosenbluth says.
ETF Positioning In Stocks
Investors bracing for the debt ceiling showdown aren't just using short-term bond ETFs. They're making moves with stock ETFs, too.
Stock ETFs seeing inflows include sectors that tend to be stable during economic uncertainty. Those include Health Care Select Sector SPDR and Consumer Staples Select Sector SPDR, Rosenbluth said.
Similarly, stock investors are pouring money into ETFs that own less volatile stocks. Those include Invesco S&P 500 Low Volatility ETF and FlexShares US Quality Low Volatility Index.
"If the crisis is indeed averted investors will likely be happier to have stayed in the market rather than trying to time it," Rosenbluth said.
Debt-Ceiling Hideouts
ETFs seeing inflows in past weeks
| ETF | Symbol | Year-to-date total return | SEC yield |
|---|---|---|---|
| BondBloxx Bloomberg One Year Target Duration US Treasury | 1.58% | N/A | |
| SPDR Bloomberg 1-3 Month T-bill | 1.48% | 4.61% | |
| Vanguard Intermediate-Term Treasury | 3.61% | 3.56% | |
| iShares 3-7 Year Treasury Bond | 3.43% | 3.48% | |
| Consumer Staples Select Sector SPDR Fund | 3.34% | 2.36% | |
| Invesco S&P 500 Low Volatility | 0.02% | 2.27% | |
| FlexShares US Quality Low Volatility Index Fund | 4.16% | 1.66% | |
| Health Care Select Sector SPDR Fund | -2.19% | 1.55% |
Sources: Morningstar Direct, IBD, VettaFi
Follow Matt Krantz on Twitter @mattkrantz
