ETF Edge - 2022 ETF Themes

Episode Date: January 3, 2022

Happy New Year! CNBC's Bob Pisani spoke with Tom Lydon, CEO of ETF Trends and John Davi, CEO and CIO of Astoria Portfolio Advisors. Coming off a record-breaking year for ETF flows, Bob kicks off 2022 with a deep dive into the most salient themes to watch for in the weeks and months ahead … everything from covid concerns and rising interest rates to rich-looking tech valuations, crypto, ESG and more. Plus, a brand-new ETF that aims to help investors not only protect against but also profit from rising inflation. In the ‘Markets 102’ portion of the podcast, Bob continues conversation with Tom Lydon from ETF Trends. Hosted by Simplecast, an AdsWizz company. See https://pcm.adswizz.com for information about our collection and use of personal data for advertising.

The ETF Edge Podcast is sponsored by InvescoQQQ, supporting the innovators changing the world. Investco Distributors, Inc. Happy New Year, everyone. Welcome to ETF Edge, the podcast. If you're looking to learn the latest insights on all things, exchange, traded funds. As always, you're in the right place. Every week, we're bringing you interviews, market analysis, and breaking down what it all means for investors. I'm your host, Bob Pazani.

Today on the show, coming off a record-breaking year for ETF flows, kicking off 2022 with a deep dive into the most salient themes to watch for in the weeks and the months ahead. Everything from COVID concerns, rising interest rates, rich-looking tech valuations, crypto, ESG, the whole smegggy. A brand new ETF also that aims to help investors not only protect against, but also profit from rising inflation. All that ahead. Here's my conversation with Tom Leiden, CEO of ETF trends, along with John Davy, CEO and CIO of Astoria Portfolio Tom, let me start with you. The big themes of 2021. We talked about it all last year. ESG, number one, number two, thematic tech, and finally the lack of a Bitcoin ETF.

But you say these may give way to a different narrative in 2022 based on inflation protection. Now, why are you saying that and what are you recommending? Well, Bob, we've seen concerns among the advisor community for the past year, and there have been areas like gold, which hasn't done as well, but energy, agriculture, base metals, a lot of those inflation areas that hedge during these times have done quite well. To the biggest by Invesco, we're up over 40 percent so far this year, and that's without gold participating. Gold tends to be a second half player. So if we do see continued inflation and rising rates in a 22, I think we're going to start to see gold kick in as well. You know, John, talking to you, I notice you have a similar call speaking to you in the last week. You say inflation themes will dominate, will be less focus on crypto and less focus on disruptive growth.

Explain that for us. Yeah, I just think, Bob, last year it was a perfect storm. You had, like, you know, COVID lockdown. They have supply chain bottlenecks. So it's a perfect year for inflation to rise. And, you know, I just think that, you know, there aren't enough tools out there that can provide, you know, a one-ticker solution for investors to kind of not only just protect.

See, you said interesting word. You said protect against inflation. You know, we had a story of advisors think you should, you know, look to embrace it and not only embrace it, but look to benefit. And that speaks to Tom's point, which is that things like cyclical stocks and pro-cyclical commodities like energy-based metals actually do well when inflation rises. So let's change the narrative away from protecting,

but to benefit from inflation. Because when I turn on CNBC every day, all I hear is guests on your show talking about how inflation is structural and interior stay. So I think we have to discuss a different narrative for inflation. I want to go back to the stock selection point because this is the question I get the most from investors here. the mean reversion question I call it. Growth, mostly technology, has outperformed everything since 2009,

since the Fed got very aggressive with monetary policy. And particularly in the last five years, growth and tech primarily has outperformed. So the question now is, is it time for value stocks, the pharmaceuticals, the banks, the energy stocks to shine? Tom, your thoughts on tech in 2022? to? Well, they've already started, Bob. You know, VLUE was up almost as much as the S&P 500 in 21. And obviously, from a valuation standpoint, those stocks are on sale compared to the stocks in the S&P 500. And as we talked about earlier, the equal weight strategy in the S&P 500 did just as well as the cap-weighted strategy. So the good thing is we're already starting to see more participation across all stocks. And then again, as you talk about the big swing that we saw in growth versus value in the last 10 years,

the divergence that we've never really seen before, things do eventually get back to the mean. And if you do have a diversified portfolio with both growth and value, you should do well over time. I think some of the areas that we continue to be concerned about is small cap participation hasn't been as great. Develop markets and merging markets, again, not as great. But from a valuation standpoint, they look really on sale compared to the S&P 500. John, your thoughts on growth versus value? I mean, I know energy had a good year, but energy is 3%. What about growth versus value?

And what about international stocks? They've also underperformed the United States over the last decade. Yeah, I think, you know, we talked about value when I was in a show back in June 2020. Actually, sorry, June 2021. And, you know, it's, as you said, I met you know, at the time, it's like an old school ideology. And, you know, I think at the end of the day, what works is that after a recession, like what we had in 2020, what typically works is value, inflation-linked strategy, cyclical.

and that, you know, we expect it to continue. I mean, the last 10 years, you've had this proliferation of tech and growth because interest rates have been a secular decline, and, you know, tech companies, you know, their value increases when you discount future cash flows. But as interest rates go out, I think tech stocks are going to be challenged. You know, I started my career, Bob, energy stocks are 25% of the S&P, now they're 3%.

You mentioned cryptocurrencies. Yeah. You know, energy stocks, the XLE basically performed the same as Bitcoin. last year, the Bitcoin has these massive, you know, fluctuations and massive volatility. So what's interesting is that, you know, energy stocks actually outperform crypto on a risk-adjusted basis. And I think that's going to, you know, continue for the next year or two. I think you're going to see a lot more rotation into the value, inflation, cyclical trade. Yeah, I would hope so. You know, I'm an old-school guy. I'm a, you know, Jack Bogle disciple,

myself, founder of Vanguard, have been a disciple for many years. And we both know, we all know all three of us, that over long periods of time, historically, value has outperformed growth and small cap has outperformed big cap. But it's been a long wait. Those guys who are into that philosophy have had a tough 10 years, particularly a tough five years. So there's a lot of people saying, okay, Bob, when? And it's a tough call to make. I certainly believe in mean reversion, you guys probably do. I certainly believe it's time for them to outperform. And the fact that the S&P energy is 3% of the S&P, as John says, is astonishing to me, given that Exxon was the biggest company in the United States 20 years ago, Exxon and General Electric. So I keep waiting for that

to happen. But I have to say, other than the interest rate rise, there are compelling arguments for keeping in growth, other than the interest rate problem that's happened many times. I want to move on and talk a little bit about inflows. It was amazing to me that in a year dominated by ESG and tech, thematic tech investing, most of the inflows were into plain vanilla ETFs. We had 900 billion in inflows. Tom, you and I talked about this. And most of it, I'm looking at the top six list here.

It was all S&P 500 ETFs that dominate the market or the triple Qs I see here. That's the NASDAQ 100. But that's pretty amazing. Just on an inflow basis, with all this talk about crypto, all this talk about, you know, small thematic tech investing, most of the money went into, again, the index guys, you know, won out. And Tom, will that continue into 2022? What would reverse that? Well, not a lot, Bob. I mean, it's just another great reason what ETFs are all about.

It's diversification. It's low cost. It's tax-affirce. efficiency, the first S&P 500 ETF that was put on the map back in 1983, it continues to be for all the right reasons. As more and more investors have shifted away and almost lost confidence in active management, they understand that core investing and core diversification is key and critical. More and more advisors have models that are wrapped around these core indexes. And we're going to continue to see flows as we've seen money.

come out of active mutual funds at the rate that we've seen money going into ETS. So it's all for the right reasons. It's really fun to talk about thematic strategies, crypto, gold, things like that. But when you look at where all the money's flowing, it's in those basic indexes and the ETSs around them. Yeah, John, you've had a very simple approach to this for a number of years now. You've advised investors to keep 70, 80% of their portfolios in low-cost index funds and then take the rest and try to add alpha. You advise still using thematic tech.

Is that balance still right? Take 70-80%, put them in low-cost index funds and take the rest and try to get some alpha. And where do you get alpha this year? Well, I think that, you know, that should still be the message. I think that they, you know, actively managed mutual funds last year had formed. billion of outflows. So that big number you just mentioned, I look at that as being reduced because a lot of it's just people continually shifting that of active management into passive. And I think it's because active managers just don't take enough risk. They charge too much.

But yeah, progn, 80% of your ETFs and tickers like, you know, VTI, IEMG, IEFA, you know, and then use like a sleeve of 15, 20% in things that you believe in. So we had a story about I just believe in inflation. So we've got strategies to kind of benefit from higher inflation. So I think your core should be cheap. You should hold it forever. And then on the margin, you change your sleeve periodically dependent on, you know, what are the latest trends in the marketplace.

I want to move on and talk about bond funds because it was quite amazing to me. Bond funds also had, for the most part, modest inflows, but they were all down for the year. Most of them were down about 1%, I mean, not a lot. But, you know, is there anything in the bond ETF universe, Tom, that you're looking at? John, you could take a crowd to track at this too. But is there any reason for us to look at it? What about high yield?

I internally get questions about high yield. People are throwing money still at high yield at 3.5 to 4%. Is that too risky now? Well, I think this is going to be a big story in 22, Bob. Most don't remember what it's like to invest in 50. fixed income during rising interest rates. It's just not good for a fixed income portfolio. We're surveying advisors all the time that are moving their 60-40 strategies to 70-30s or even 80-20. So what's happening is money is leaving the Barclay-Zag core strategy and either doing

one or two things, going over to the equity side and looking for dividend strategies, or they're going to real short-duration, active ETF strategies, or in fact, cash. We've got a record $7 trillion in money market funds, $15 trillion sitting in passbook accounts at banks. It's scary because people are concerned about what rising rates do. One final thing, on the other side of the barbell, they're looking at options overlay strategies. We've talked about strategies like Nationwide Newsie or Jeppy out by JEPI out by JPM out by JPM Morgan. It's a great way to get added incomes, in some cases, 7 or 8 percent while you also have some exposure to equities. And I think we're going to see more of those types of strategies come to the surface.

Yeah, you know, John, I propos of what Tom was saying, Vanguard's short-term bond fund was one of the – had some of the biggest inflows this year. It's kind of strange to see a short-term bond fund with enormous inflows, but that goes exactly to what Tom was telling us about. Now, John, last week you launched a new ETF to address these inflation issues we keep talking about. This is the Access ETF that you launched last week. Tell us a little bit about that, the Accessistory inflation sensitive ETF. Sure. So it's a PPI. It's kind of a play in the producer pricing next, which is one of the biggest inflation.

At the end of the day, you know, going back a year and a half ago, I was on CBC. and I said, look, I think rates are rising, inflation's rising. And what we're doing in our portfolios is that we're buying things like banks, industrials, energy, commodities, you know, some of the agricultural plays. And our core portfolio combined with our sleeve

became a little bit, you know, overwhelming. So we just thought, okay, if we're struggling with this, if we've got seven ETS that we're trying to use to cobble together an inflation theme, you know, let's look at a potential ETF that provides, you know, a one ticker solution that gives you broad

market exposure to not only cyclical stocks which benefit from rise in inflation, but also physical commodities, commodity equities, and then tips. So that's what PPI does. It has those four segments, cyclicals, commodity equities, commodities, and tips.

And I think, you know, again, the narrative is, you said earlier on the show, protect, but we think you should embrace it and then look for a strategy that benefit. So the ETF has, the four sectors are industrials, energy, materials, and banks. Those sectors historically have had, you know, the most sensitivity to rise in inflation, and then along with those commodities and tips that I mentioned.

You know, so we're excited for it. You know, I think next year it would be the theme of inflation ETFs out there. Yeah. And Tom, what do you think of this here? So what John's got here, 70, 80 percent in cyclical stocks, 10 to 15 percent commodities, five to 10 percent in tips. I get a lot of questions about tips these days, but I just don't quite get it. I understand it's inflation protected, but it's not going to, it doesn't seem like tips is going to provide you much inflation protection if you really want to try to do a little bit better. I don't know how or what you're advising, but what do you think about tips? I see they're just a very tiny part of John's ETF here. Well, there's a safety component there, and I think what John and his team has done is great because first of all, we have a, there's a lot.

a huge void of education on inflation and what it can do to client portfolios. And if you look at commodities in general, up until the last 12 months, it's kind of been an unloved area. So now, by being able to take those areas of the market to do well during times of inflation, I think what John is saying, it doesn't have to be scary. You can actually lean into it, embrace it, And you can do that by picking off certain sectors in the market and added it to your portfolio. John's done that with his clients and then said, hey, let's wrap all these areas up into one easy ticker. And then for those that don't have any type of inflation protection, they can buy that one ticker and to make it really easy. Hey, I'm a big fan of the traditional fund of funds if it's allocated the right way.

Here you've got a manager that's seasoned in spending a lot of time on the markets. and you get it all in one ticker, I think it's great. Yeah, here's an actively managed, you know, ETF in the inflation space. I think it's terrific. By the way, the access management team has an old friend of ours, Tom, Ben Fulton's on that, an old friend from the Power Shares days.

So we wish him well, of course. Always good to see a favorite old friend pop up again. I want to just talk about the two big stories for 2021. what happened? China and Kathy Wood. Tom, is it safe to bet against either of these asset classes? I call Kathy Wood an asset class, but you got to admit, John made this point earlier. It's hard to find active managers that really make big bets. You can get kind of like passive active managers, but Kathy Woods makes big bets. And she blew up on the upside and she blew up on the downside. Let's just handicap China and Kathy Wood. Yeah, well, first of all, Kathy Wood just did.

blow up on the upside last year. She's been at it for a while and has put up really, really good numbers. Her team has a long-term outlook. They haven't hidden the fact that their outlook is five to seven years. And although many people came in in the last 18 months, it's okay because, look, even though many folks are retiring in their 60s, they're going to live well into their 80s. I've talked about Kathy Wood and her lineup to younger people all the time. But listen, Bob, I'm going to be 62 this week, and I'm invested in Kathy Wood and will continue to be for the next 20 years because I know the future Fang stocks are going to come up in our portfolios. So you just have to ride it out, and if you're diversified, you're probably doing okay.

Quickly on China, China's not going away. China's going to continue to be a big part of the global infrastructure, and we are clearly intermingling with China on a daily basis. I think China's a buying opportunity. There are a lot of companies like crane chairs who do a great job. When you intermingle China and online buying, it's something that we're going to be talking about for the next 10 years. First, happy birthday, Tom. Always a pleasure to be with you. You're a few years younger than me, and you look terrific. So you got a lot more time to... a lot more time for you and I to interact together over the ears. John, your comments on Kathy Wood and China.

My thought on Kathy Wood is a lot of people say, ah, she failed. I don't think Kathy Wood failed. I agree with Tom. I think Kathy Wood succeeded in convincing everybody about the powers of disruptive technology. The problem is everybody believed her. They bought in and drove the prices up to crazy levels. And at some point, somebody's going to start asking about valuation questions,

particularly about certain companies that don't make any money or companies, you know, that are flattish for the next few years in terms of earnings. It will matter, and that's what's happened. The people have started saying, we don't hate these stocks. We just want to know what the right price is, given the environment we're moving into in 2022. So give us your take on Kathy Wood and China. No, I agree with a lot of what you guys said. I mean, at the end of the day, if you're trying to find the next fang stocks, I mean, she's probably the most qualified out there.

So look, I mean, she had five great years, one bad year, so I think that's, you know, that's okay. You know, I think the market environment has kind of changed in terms of like, you know, people are now starting to look at earnings and profitability a little bit more. I mean, at the end of the day, this is now the third year of the COVID recovery. So we are now late cycle, interest rates are rising. So I think that impacts, you know, the future discounted cash flows for a lot of tech companies. And a lot of the ones that I think in our portfolio, they're not really big. profitable, but I think she's the best to kind of look at the next bang stock. So, you know, I've always said when it comes to, you know, disruptive growth,

Bitcoin, you've got to size it appropriately in your portfolio. So it's got to be less than 5%. If it's less than 5%, then you can write out these waves. You know, for China, look, I've been on your show about many times talking about China. We liked it. You know, we were overweight. You know, it was a very difficult year last year for China. I don't think the, you know, the billion people out there, I still think there's a

way to monetize it. And we've always told investors it's a long-term play. So again, we size it appropriately in our portfolio. So I think you got to stick with China in your portfolio as well. I think the problem I have, my two cents on China is there's two kinds of investors in China. One are the value guys who are floating around saying, all right, if it's 15 times forward earnings or less, we're interested. And we don't care about the politics. Historically, it's performed well when you get 15 times forward or below. And there's a sort of a knee-jerk kind of investment ideology or strategy, a value strategy. I think the broader problem is with the people who are in the global community who are trying to figure out,

used to believe that you could have China as an investable play based on, say, market capitalization. And what's happened in the last year is people are now saying, wait a minute, the political risk factor around China is far, far higher than in other countries around the world. Therefore, do we need to completely relook the way we're investing in China because of the higher political risk factor? Or should we even consider investing in it, given the particular ideology involved in the country? So there's an overlay here in China that didn't really even exist a year ago. And that's one of the things that I'm having trouble dealing with. Should we say, yes, we need to be compensated for the higher political risk component. associated with it, or could you go even further and say, no, China's uninvestable at this point.

Tom, do you get my point here, how this debate's changed in the last year? You're right, Bob, but the key thing is China continues to grow. Their investable assets continue to grow. And with that, there's more demand from a global market cap standpoint. But to John's point, you have to allocate an appropriate amount. Listen, the U.S. and the rest of the world and China are always going to do saber rattling, and it's going to be part of the landscape going forward. So we have to know that. Does that mean you avoid it 100 percent? No. They're not going to shoot themselves in the foot. There's always going to be the back and forth, the ebb and flow, and that's something that's consistent with China over time. So you just have to factor that in

and then have the appropriate allocation. If it has a run-up, pull back, give it that five or 10% allocation and equity portfolios that's appropriate. But, you know, if you do overweight, you're going to live and die by the sword. It's a good point. All right, gentlemen, I'm going to have to leave it there. Now it's time to round out the conversation with some analysis and perspective to help you better understand ETFs. This is the market's 102 portion of the podcast. Today we're going to be continuing the conversation with my old friend Tom Lighten from ETF trends. Tom, one of the things we didn't get to talk about on the show was the whole trend this year of 2021 of mutual funds converting to ETF formats. We had a couple of notable ones in

2021. Do you expect to see that continue into 2022? And I would note, Tom, with almost 900 billion in inflows into ETFs, we saw outflows again from mutual funds. We did, Bob. And conversions from mutual funds to ETFs are definitely something that's going to increase. Seeing what dimension fund advisors did with over $30 billion of their flagship mutual funds in ETFs was really notable. And a lot of other companies are taking that to heart. Like you said, we've saw hundreds of billions of dollars come out of actively managed mutual funds where almost a trillion dollars came into the ETFs.

This trend probably is not going to abate anytime soon. So with that in mind, we have heard from a lot of the money. A lot of mid-sized companies, fund companies, who are very interested in making some conversions. As you know, though, Bob, part of the problem is they don't want to shoot themselves in the foot because almost 70% of the income or flows that are going into mutual funds today with established companies are through 401K plans. And they don't want to shoot the goose that laid the golden egg. So that's one of the biggest concerns or challenges in the conversion space.

What can we do about that? You and I have been talking about this for 10 years, about when ETFs will more effectively penetrate, which, for lack of a better word, the 401 case base, you've put your finger on the problem, the obvious money flows for the financial industry in it. But is there anything that's going to change that dynamic? Well, the industry claims that it's a plumbing issue. that fractional shares are something that's a big concern that they can't overcome. You know, I've always said, if we put men on the moon in 1960s,

why can't we get this thing figured out? The good thing is there's a lot of pricing pressure within mutual funds where the expense ratios of those funds that make up a big part of the 401K plans have continued to decline. So at one point in time, I think what we're going to see is the industry is going to step forward and say, we're going to figure this thing out, we're going to get the right pricing down, we're going to get the right plumbing down, because it just doesn't make sense. That advantage that those poor performing funds with higher expense ratios make up a big chunk of the funds that are available in these 401K plans is somewhat disturbed.

And as you know, from tracking this market for decades, if there's any outliers where there's a huge opportunity to chop expenses, that will eventually come. Do you believe this argument, though, that the main reason we can't get ETFs into 401K plans is the fractional share problem? Is that really the problem? Well, it's part of it. The other thing is, from a regulatory standpoint, there's not a lot of it. of motivation from the SEC, for example, to encourage the industry to move in that direction because there's enough choice right now. However, it's all about sales. So there are a lot of small plans out there, mid-sized plans out there that have some unbelievable expenses with some

fund options that just aren't that great. I think we can do better. I think so, too. I'm quite familiar with this. I've looked at many people's plans over the years, 401K plans, and while I am now starting to see a sprinkling of indexed plans, including target date funds, the Vanguard Target Date fund ETFs are doing very well in some of the 401K plans, I'm still very surprised at a lot of these plans that I look at, where I see one index choice option and a target date option, and then some fairly high-priced mutual funds thrown in with them. And I don't think the choices are that amazing for a lot of these funds. And I'm talking about, you know.

There will be pressure, Bob, on, there's more and more pressure on the plan providers. So those that are kind enough to offer this as a benefit to their employees, great. But at the same time, if they're not offering proper investment, allocations or proper choices, then that can work against them. So I think we're going to see more of that, more scrutiny over time. One final thought, as you're talking about target date funds, what's really interesting as you and I are in our 60s, and you look at people, our peers that are set to retire, I'm a little concerned about having most of the money in target date funds like a 2025

that would be in fixed income when we're entering a rising rate environment. I think that's something that we're going to be talking about as we come into the next year. Well, this is a different topic for a different day, but the whole idea of retirement is just changing so fast. I mean, I'm 65. I've told people publicly, I've changed from thinking of living day. to 95 or 100 now in the last 10 years. And, you know, that means if that's true, if I'm living in 90,

I got another 25 years of investing to go. I would be crazy to suddenly switch, you know, to, you know, 75, 25, 25 bonds to stock portfolio, like in the old days, you know, invest your age. That would be crazy. I mean, it would literally, I think would be ill-advised on being kind. I think it would be crazy. do that. Yeah. Well, it is. You're so right because, look, we haven't had, after 30 years of declining rates, we haven't had a significant period of rising rates or inflation. But right now,

for those that would have more than half of their portfolio in fixed income, but could live another 20 or 30 years, it just doesn't make a lot of sense. So folks like you and I need to talk more about it. Yeah, that is a topic for another show, something I feel very passionate about. And we'll drag Tom in for his thoughts on that in the future. Now, that's it for today. I'm Bob Pisani, and I want to thank everybody for listening. Make sure you tune in next week. And the meantime, you can tweet us your questions or topic ideas at ETF Edge, CNBC. Thank you all for joining. Inves QQQQQ believes new innovations create new opportunities. Become an agent of innovation. Invesco QQ, Invesco Distributors, Inc.