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ETF investors buy Treasurys, dump junk amid rising trade risks

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Client poured cash into ETFs that provide protection against the stock market turning sour as interest rates rise and trade tensions between the U.S. and China escalate.

It’s been a banner month for the iShares 20+ Year Treasury Bond ETF (TLT), which has taken in close to $2 billion in September, putting it on track for its second most monthly inflows ever. That includes $450 million of outflows earlier this week. The fund holds longer-dated Treasury bonds, which typically lose value as rates rise, indicating investors may be more concerned about trade risks than an impending yield surge.

“I’m not surprised to see stocks selling off and some money being put into bonds,” said Chris Zaccarelli, chief investment officer at Independent Advisor Alliance. “It sounds like a classic risk-off trade to me, and I think the escalation in the trade war is the catalyst.”

Bond trades aimed at limiting risk are becoming increasingly popular. Investors have yanked more than $2.4 billion from the iShares iBoxx High Yield Corporate Bond ETF (HYG) in September, putting it on track for a record month of outflows.

There’s $45 billion wrapped up in ETFs that track high-yield bonds, according to research by Bloomberg Intelligence analysts Eric Balchunas and Athanasios Psarofagis. Typically, that money exits as rates rise. Since 2013, average fund flows for high-yield bond ETFs were 88% lower in months when 10-year Treasury yields moved higher.

“High-yield can be much more linked to the performance of the broader economy, and even equity markets, than the Treasury curve or investment-grade,” said Jason Thomas, chief economist at AssetMark, which manages $47.5 billion.

The Fed agreed to raise its benchmark interest rate for the third time this year following its policy meeting Wednesday a quarter percentage point, to a range of 2% to 2.25%. Prior to the meeting, yield on 10-year Treasurys hit 3.1% Tuesday, its highest since May.

Pouring money into TLT as interest rates rise is “counterintuitive,” said Todd Rosenbluth, director of ETF research at CFRA Research.

Fees were nearly half the price of the top-performing active funds.
September 4

“TLT incurs more interest rate risk than nearly all other fixed-income ETFs, and as such has lost money in September,” he said. “Yet, investors concerned about stock market volatility may find comfort in the liquid exposure to Treasurys.”

The trade war between China and the U.S. intensified on Monday after the Trump administration imposed tariffs on $200 billion in Chinese goods, with Beijing vowing it would slap $60 billion in U.S. products in retaliation. And the tiff shows no signs of abating.

In a speech before the United Nations General Assembly Tuesday, President Trump accused China of engaging in “relentless product dumping” and intellectual property theft that “cannot be tolerated.” Meanwhile, China reduced tariffs on imports from trading partners, which could mean it’s digging in for a much longer trade fight, according to Zaccarelli.

That’s reason for caution, not a market rally, he said.

“I think the risks of a prolonged trade war are greater than ever,” Zaccarelli said.

Bloomberg News