Inflows Into ETFs Are on Track to Break Records, but This Wild Card Could Turn Everything Upside Down

Exchange-traded funds (ETFs) have seen record-breaking inflows in 2024, with many managers anticipating further increases, especially as the booming money market fund sector could play a significant role before the end of the year.

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Nate Geraci, president of The ETF Store, highlighted this trend during an appearance on CNBC’s “ETF Edge.” He pointed out that the $6 trillion currently parked in money market funds presents a key variable for the market's trajectory. "I believe that $6 trillion-plus in money market funds is the biggest wild card for the rest of the year," Geraci noted. He emphasized that whether the capital flows into REIT ETFs or the broader ETF market, it could act as a significant catalyst for change.

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The scale of this potential shift is substantial. According to the Investment Company Institute, money market fund assets reached a new peak of $6.24 trillion this past week. These assets have surged as many investors remain cautious, waiting for the Federal Reserve to make a move on interest rates. The consensus is that if the Federal Reserve reduces rates, the appeal of money market funds could diminish.

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Matt Bartolini, head of SPDR Americas Research at State Street Global Advisors, explained in the same interview that the yield from money market funds is likely to decrease once interest rates come down. "If yields drop, so will the returns on money market funds," Bartolini remarked. As a result, the capital that has been sitting on the sidelines in cash is expected to reenter the broader market. He described this shift as inevitable, particularly as the current appeal of holding cash begins to fade.

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Bartolini believes this returning capital could flow into a variety of higher-yielding areas, such as stocks and parts of the fixed income market. He also sees opportunities for increased ETF inflows. One area he specifically mentioned as potentially benefiting from this shift is gold ETFs, which have already garnered about $2.2 billion in inflows over the past three months. According to Bartolini, gold ETFs had a strong finish in 2023, and their outlook remains positive for the coming months.

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While gold ETFs may continue to perform well, Geraci expects larger ETFs, particularly those focused on mega-cap stocks, to gain from this transition. He also views the ongoing momentum as a sign that ETF inflows could approach the record levels set in 2021, when $909 billion flowed into these funds.

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"Assuming the stock market doesn’t suffer a significant pullback, I think we’ll continue to see strong investor interest in ETFs," Geraci stated. He is optimistic that inflows could surpass previous records, especially as market conditions appear favorable for continued allocation into ETFs. This optimism is rooted in the expectation that as rates fall and money market funds become less attractive, investors will increasingly look toward ETFs and other higher-yielding investments.

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The growing interest in ETFs reflects a broader trend where investors are actively seeking out diversified, cost-effective options. With ETFs offering exposure to a wide range of assets, including real estate, commodities, and fixed income, they have become a popular choice for both individual and institutional investors. This trend is expected to continue as long as macroeconomic conditions remain favorable and interest rates potentially move lower.

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As the Federal Reserve considers its next move, the behavior of money market funds and the broader implications for ETFs will be critical to watch. A rate cut could trigger a significant shift in capital allocation, with many expecting that a portion of the $6 trillion sitting in money market funds will flow back into the stock market and various ETF sectors. Additionally, ETFs focused on gold and other hard assets may continue to see strong inflows as investors seek to diversify their portfolios in uncertain times.

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At the same time, investors will need to remain cautious about potential market volatility. Although ETF inflows have remained robust, any significant downturn in the stock market could temper some of the optimism surrounding these funds. Nevertheless, with over $6 trillion of capital in money market funds and signs of a potential rate cut on the horizon, there is a high likelihood that ETFs will continue to attract substantial inflows.

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In summary, ETF inflows have already set monthly records in 2024, and the industry could benefit even more as the Federal Reserve’s rate decisions drive investors out of money market funds and into ETFs. Sectors like gold ETFs and mega-cap ETFs are expected to benefit the most, with the possibility of ETF inflows surpassing the record levels seen in 2021. As long as the stock market remains stable, the ETF market appears poised for continued growth.

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