ETF Edge - Could recent volatility derail record ETF in-flows? 9/4/24

Episode Date: September 4, 2024

Volatility in the tech sector is rippling across the rest of the markets. On the other hand, the fed is also poised to cut rates again. ETFs have taken in record amounts of new money year-to-date but will they be able to log another full-year record?  Hosted by Simplecast, an AdsWizz company. See pcm.adswizz.com for information about our collection and use of personal data for advertising.

The ETF Edge podcast is sponsored by InvescoQQQ. Let's rethink possibility. Investco Distributors, Inc. Welcome to ETF Edge, the podcast. If you're looking to learn the latest insights on all things, exchange, traded funds, you are in the right place. Every week we're bringing you interviews, market analysis, and breaking down what it all means for investors.

I am your host, Bob Pisani. Could recent market volatility disrupt the record inflows we're seeing in ETS this year? Here is my conversation with Matt Bartolini, managing director and head of Spider America's research at State Street and Nate Geraci from the ETF store. Matt, every metric you give me the numbers. They looks like a record or near record. Monthly year-to-date assets under management is near $10 trillion. I see ETFs took in 73 billion in August. That's double the historical August average. So answer the question. Our investors going to continue to

put money into equity and bond ETFs if September and October are as volatile as yesterday. I mean, I think so. I mean, what we saw in August, we saw a significant spike in volatility to start the month. Through those first nine trading days, we still saw 17 billion of inflows over that time period while the market was in a drawdown. And some of that's because you have some secular usage of low-cost ETFs and some active strategies as well. But then as the market started to turn around, we saw another $56 billion come in as investors were trying to pick their spots as the market was really starting to broaden that rally and started to go. into different areas beyond just the traditional. So I think there's still a chance for

ETFs can continue to take in a record amount of flows. We put forth a projection of $950 billion for full year flows in 2024. And I think we'll get there, but it might be a little bit choppier as the market starts to reassess the macro environment. I think one of the areas that I think is probably going to pick up a little bit more is around gold ETFs. They've had about 2.2 billion of inflows the last three months, really strong flows last year. So I think the future is still bright for the overall industry. And like we might be able to hit that $950 billion target. Nate, your thoughts on all this,

ETFs, you heard him. We got $10 billion essentially in assets under management, $610 billion for the year. So what do you think is going on here? Most of the inflows this year though seem to be in tech. So even though there are other parts of the markets that did very well in August. So what would it take to get consistent influence?

into other sectors, like real estate, for example, or consumer staples or financials? Well, first of all, just to add some context, as you showed, the annual record for ETF inflows is nearly $910 billion. That mark was set back in 2021. And if you look this year, inflows have already exceeded the whole year inflows from 2020 in 2023. And if you look at the last two months, so July and August, we had nearly $200 billion. come in and just those two months. And so with four months to go here in 2024, I don't think the math is very difficult. We can certainly easily eclipse the annual inflow record.

And I don't think a trillion dollars in inflows is entirely out of the question. Now, to what Matt was saying, I agree, you know, the biggest key here is obviously the stock market's performance over the remainder of the year. There's going to be a lot for investors to digest between Fed rate cuts and the Fed's messaging overall. with the economic data slowing a bit. There's obviously the upcoming election. We do still have elevated valuations. There are several geopolitical issues to keep an eye on.

So I think there's a lot for investors to consider, but assuming stocks don't experience a massive pullback, I think investors will continue to allocate here in ETF inflows can break that record. So I think as we look at the remainder of the year, Bob, I continue to see or expect to see flows into those large mega cap ETFs and that growth bias. But you agree with, and Matt was sort of hinting at this,

that flows follow prices. So the price has moved up in August like real estate and consumer staples, but we didn't see much in the way of any flows there. If that continues though, we could assume, if price continue to improve, we can assume that there will be flows eventually, right? I mean, it is a sort of people are trend followers, right?

For sure. I think if you look at real estate ETFs, Those are a perfect example because they've come on very strong recently with about $2.5 billion into REETs, such as the I shares and Vanguard real estate ETFs, certainly XLRE, the real estate sector spider ETF. And if you look at performance, to your point, it's been there. All of those ETFs are up around 17% over the past three months versus about 5% on the S&P 500.

So I think this expectation for lower rates is a big driver. here because that results in lower rates on financing costs, mortgage costs. I think investors are starting to think about yield. And if you think about real estate in particular, maybe investors are feeling a little bit better about a soft landing scenario, which that could help a number of different segments of the REIT. So I think that's a good example. If we get inflows into sectors like REITs, that could certainly boost the entire ETF market. Matt, you know, I like to look at the rest of the world. It seems like nobody else. does, but in equities, it's amazing. I'm using your numbers here. The complete dominance of the

United States as an investing vehicle. We see big inflows into U.S. equities this year, equity ETFs, generally flat to outflows everywhere else in the world, especially emerging market, maybe some modest inflows into developed countries. What's going on here? Well, I think when we look at it, it's hard to make a case in a more tactical manner to go overweight or really allocate in a concerted effort outside the U.S. When we look at it from our earnings growth expectation, earnings are stronger in the US. We look at it from economic growth perspective.

Economic growth is stronger in the U.S. relative to say Europe and Japan. And we also have monetary policy that's now easing. So we have an easing monetary policy in the U.S. Again, Japan, they're coming off of negative rates, but it's not as, it's going to be tightening. So I think the only really case that you have to invest outside the U.S. on a more tactical basis is this valuation case. And the valuation case has been there for years

and it really hasn't been rewarded. Because when we look at it in a return space, the US continues to dominate the rest of the world and returns. So you had said earlier, Bob, you know, flows follow returns and there's sort of price momentum chasing. And right now when you look at it and you stack it up, the US, Europe, Japan, emerging markets, China, the US is at top of that.

We see significant inflows into US equity exposures. to sort of, you know, position for both growth and returns, sort of absent of this idea that maybe valuations are stretched, because a case for valuations outside the U.S. has been there for a while, and we haven't seen that come to fruition in terms of, you know, positive returns. And a lot of the X-U.S. flows, that negativity is being felt within China. Look at rolling three-month flows for China-focused ETFs. It is at its lowest point in 15 years, and I think that says something about the sentiment towards

emerging markets and mainly emerging markets related to just China. Yeah, I think that's a good point. I want to move on and talk a little bit about tech here because I know you help manage the Spider semiconductor ETF, which is an equal weight ETF of about 30 of the big semiconductor stocks. It's flat this year. It's really underperformed the Van X semiconductors, which is sort of a rival, which is market cap weighted here. And it's up, you know, 25, 26 percent, because.

because Nvidia is such a big weighting in there. It's been such a big performer this year. This is a good chance to talk about equal versus market cap weighted, Matt. Under what circumstances should an investor consider investing in equal weight versus market cap weights? Well, we're speaking about industry funds. They tend to be very narrow, right?

You're only going to hold 30 to 50 stocks based on that industry. And when you're in a narrow space and you market cap weight, your exposure is going to be dominated by one single stock. Now, in this case, Navidia has gone on a phenomenal run that we haven't seen out of likes of a couple of securities in history. And that has been a benefit to having that concentrated exposure that has dominated your portfolio. And you're not really picking up so much of that industry trend, but you're picking up that effect from one single stock driving the performance of a narrow spaced ETF.

All else equal, when you're trying to allocate into an industry and you're making an industry reallocation thematically. Say, you think the upcoming election, whether who wins, there will be an increase in aerospace and defense spending, well, you know, you would probably want to make sure that your exposure is broadly diversified across aerospace and defense stocks, so not one is going to uniquely drive your risk in return. Therefore, in a narrow space, having a more modified, equal-weighted approach can pick up those industry trends, but without having a single stock dominated, and in a case within

the video, it was dominated it when a benefit. So in the last couple days, that benefit has turned against it as Navity has gone into a little bit of turbulence. So we always like to think about industry exposures, being diversified to the industry and not having one single stock disrupt your investment thesis. Either, again, this is how it moves positively, but we've seen many instances throughout history where negative corporate events, negative news events, all of a sudden those concentrated exposures can really sort of blow up your industry thesis in a more tactical manner.

Nate, weigh in on this. I mean, this is an endless debate here. There are times when equal weight outperforms, times when market cap outperforms. The standard argument on market cap weighting is that's the way the market has voted essentially. And you're going with the way the market is. Your thoughts on this whole equal versus market cap weight.

Because this is a good example with the semiconductor ETFs here. Well, again, as I was alluding to earlier, if you look at the ETFs taking in the most money so far this year, it's a lot of the broad base, and market cap-weighted products that are skewed towards megacap growth, or skewed towards tech. So these are ETS that track the S&P 500, the NASDAQ 100, large-cap growth ETS.

In my opinion, until performance meaningfully turns here, I would expect flows to continue into those products. But there's no question to what Matt was saying, I think we have a subset of investors that are making a concerted effort to diversify away from what is. is clearly a top heavy market. And you see that in products such as equal weight ETFs, which have seen fairly sizable in for the future here. You know, Nvidia, I think is the poster child here

for what's going on because there's a real dichotomy. If you look at investors, some will point to Nvidia as the bull case. This is why you want to be in Megatacowro. This is the artificial intelligence code. But then you'll have bearish investors point to Nvidia and say, look, this is the classic example of an over overvalued stock and they want to avoid it at all costs.

So that's going to be the, you know, sort of tug and pull we'll see in the markets the remainder of the year. Yeah. What about let's talk about another sector. We just talked about, Matt was talking about gold recently, Nate, but what about banks? These are economically sensitive stocks. We, you know, Matt wrote KBE and the KRE. Maybe we could put that up here. They've been performing better lately.

But again, I don't see much in the way. way of inflows here. And that's curious to me. Again, this probably goes back to the idea about flows follow prices. But you see you've had it generally better. And again, these are equal weight here. But any thoughts here, Matt, or Nate, either one of you. Yeah. I mean, I would say with banks, we did see some flows immediately after the Fed stress test results were released. And that, again, should help your sort of capital efficiency and capital within those banks and maybe spur some higher return on equity or what have you. And we did see some flows initially right after that.

Since then, as the market turned a little more volatile, it's been a little bit of a sideways market there. But overall, when we think about the economy, we might have lower rates on the horizon of the Fed cutting rates, but that should loosen up some lending standards and some overall loans to the broader market because the economy continues to remain quite healthy. So this idea of a soft landing could be helpful to banks and regional banks. And we have seen earnings come in quite strongly for broad-based financials. So I think there is still a case here for the sort of allocation into financials

and maybe more narrow space like banks and regional banks more specifically. Because you also do have that valuation component because of just financials trading and more conducive valuations historically. Yeah, Nate, Big Cap banks have been doing okay recently. some of the regionals have been doing better. I see this as a very positive sign. If investors thought there was an imminent recession, they wouldn't be bidding up banks at all.

Some of the insurance companies are doing well on top of that. But any thoughts on the fact that August was a decent month overall for banks? Yeah, I agree with the sentiment of Matt in that if we have a soft landing, I think clearly we would expect to see banks do well. If there's concern that the Fed has waited too long, we do have a recession, then financials may be something to steer clear of. I think just at a high level, when you do look at valuations, financials are a bit more attractive. And so if investors are moving out of, say, tech, I think financials are going to be an area of the market that they potentially move into. Yeah.

I want to move on and talk a little bit about fixed income. What impresses me most is the record inflows we're seeing is not just for equity ETFs, but fixed income as well. So we had record inflows in August, again, fixed income, record year to date. What's this about, Matt? Is this all about investors betting on a decline in rates and are the inflows evenly distributed between treasuries and corporates? I'm talking about fixed income now, Matt.

Yeah, so within fixed income, you know, like I said, you know, 33 billion of inflows in August. Right now we're at 190 billion. The record is $212 billion for a full year. So we're $22 billion away. And given the pace we've been on, I think we'll hit that new record in September. I think we'll have more than $22 billion of flows in fixed income ETFs. And they'll be at a full year record in just not through nine months. And what's been supporting it has been some depth across different strategy types,

which just to me illustrates expanding use cases. But a more tactical market-relevant manner, we saw roughly about $12 billion into long and intermediate duration government bond ETFs. As investors, we're starting to get ahead of the Fed in terms of lower interest rates in picking up some of that duration-induced price appreciation from long rates falling down. I mean, even today, we saw the yield curve disinvert for the second time this year. I think that is helpful for that positioning on the long end, which we have seen really pick up pay, over the last three months. The other part of the fixed income aspect is that credit strategies. Credit strategies have taken over $50 billion this year. That's high yield bank loans and investment grade credit combined together. So there's been this

idea of going a bit longer in duration to get those as those yields start to fall down, but picking up that credit because the market continues to be somewhat well behaved from an earnings perspective. Economic growth continues to be positive and sort of signaling this idea that may be a recession is really not close at all, and that you can take some risk within your fixed income, owning some credit, pick up some of that coupon, get ahead of the Fed, and start to position your portfolios in through the rest of the year. Yeah, what's interesting, Nate, here is if there was an imminent recession, you would think

there'd be a sell-off in the junk bond area, and we're not really seeing that. We did see it on Monday, but I don't see it overall. At least they're not seem to bet on that. And so we've got this strong trend since June. It appears ETF investors are trying to get ahead of the Fed and position portfolios for a lower rate world in the future. Nate? Well, two points I would make here. Yeah, going back to Matt's point on government bonds, it's interesting because there have been inflows really across the treasury curve. But if you look here more recently, there's clearly biased towards intermediate and longer duration bonds.

And I think the story here is very simple, which is interesting. investors are seeking to lock in higher rates. And obviously, if rates do come down, you also get the benefit of capital appreciation. Now, I will say I'm still a little bit skeptical of this trade because I'm not quite sure the risk reward is attractive enough yet here, especially in longer dated bonds. But I get why investors are doing this. You know, my skepticism is simply that we've seen investors try to top take rates for, you know, what, nearly two years now. And that hasn't exactly worked out so well.

The other point I'll make just on the credit side, we've seen fairly significant flows into actively managed extinct ETS. And I think what's happening is I think just with uncertainty over what the Fed's going to do and you look at the economic situation, I think investors are looking to active managers to have a hand at the wheel in guiding through both the great side of the equation and the liberation side of the equation and the credit side of the equation. And I think we'll continue to see flows there as well. Yeah. What about Matt, what do we have, $6 trillion still parked in money market funds? As the Fed cuts rates, could some of that find its way back into the stock and bond market? I know that's been an issue for a while, but it hasn't happened yet.

Oh, I mean, 100%. I mean, the one thing you can sort of guarantee a little bit is, you know, because money market funds earn the yield on short duration paper, ultra short duration. If that yield comes down, the return on money market funds should come down as well. We've seen that historically. So as rates fall, we should expect to see some of that capital that has been on the sidelines in cash when cash was sort of cool again, start to go back into the marketplace. I think that's also going to be helpful for ETFs to reach that $950 billion.

And as they said, even probably one trillion of flows just this year with a strong pace into 2025 as more of that capital gets deployed. And I think it probably starts to move a little further up the curve, you know, maybe go into that intermediate duration space, maybe find out some active managers to sort of structure your short duration portfolio to pick up more incremental yield and some total return. So I definitely see that money moving out of money market funds into the marketplace, whether it's within equities or certain higher yielding aspects of the fixed income marketplace. The problem I have with that is that this is proven to be remarkably sticky. And I am not

sure even if we, you know, go into the 3% area for money market, how much incremental, money is going to come out of there. Nate, let me give you the last word here. I wanted to ask you about real estate. We touched on it very quickly. Performance from the REITs have perked up recently. We've seen lower rates. That's supposedly going to help on the financing costs. We have that soft landing scenario you were talking about looking better. And investors seem to be seeking yield ahead of the rate cuts, at least with REITs and utilities. Yeah, all three of those drivers you just mentioned, I think, are going to be catalyst for the entire REITF market. Again, flows have picked up here over the past few months.

I think those are going to continue. And certainly, again, with the Fed cutting rates, you're going to have investors looking for yield. And I just have to say with that $6 trillion plus parked in money market funds, I do think that that is really the biggest wild part for the remainder of the year, whether it be flows into REATs or just the broader ETF market. That's going to be a real potential catalyst here to watch. Yeah. Okay, guys, great discussion as always. Remember, folks, records, record inflows overall, record into equities, record into fixed income as well, just the rest of the world. That's sort of not doing too much.

Now it's time to round out the conversation with some analysis and perspective to help you better understand ETFs. This is the Markets 102 portion of the podcast. Nate Geraci from the ETF store continues with us now. Nate, thanks for sticking around. And we didn't get to talk about actively managed ETFs. They've hit $1 trillion in management assets under management this year. I think that's a significant milestone. What is driving that? That's one of the big sectors we're seeing the biggest inflows, at least.

I think there are several drivers. I think number one, you have the largest names in asset management, all now pursuing a real ETF strategy. strategy. That wasn't the case several years ago. The other piece of that is these asset managers aren't just slowly wading into the water. They're offering up their best strategies and their best portfolio managers. And so what you have is a real deepening on the supply side of active ETFs. And investors are now noticing it. And it's almost as if that supply is driving demand because investors now have many more options at their disposal. And if you look, look, the market

market, you and I know it's always very difficult for active managers to outperform over the loan fund. All of the data shows that. However, we are in a very unique environment right now where there's a lot on investors' plates between the Fed, the economy, the upcoming election, again, geopolitical issues. And so some investors are saying, you know what, it might be good to have somebody else in the room with me to help manage both my equity and fixed income in a portfolio. Yeah. But it's all also a sell side issue. I mean, the low hanging fruit has all been picked. Most of the money is going into low-cost index ETFs. Those are the winner. So there's really not much left

for the industry to bring out. How do they keep growing is, well, I push active management. And I'm not, I don't have any problem with doing that, although as Jack Bogle used to point out, a mediocre active manager in a mutual fund wrapper is a mediocre active manager and an ETF wrapper as well. The way these things seem to be expanding is there's new definitions of active management. So is somebody who has a strategy that buys the S&P with an options overlay, is that really active management? I guess you could say it is to a certain extent, but you get my point here. That's how they're getting to this one trillion. It's not old-fashioned alpha generating stock picking necessarily, right?

You're 100% right. I mean, I look at this in three segments. So you have systematic active strategies. That's what we're seeing from firms such as dimensional and Pontus. I would put JP Morgan in that category. So these are very low cost active strategies that this isn't what you would think of as a traditional stock picker. So that's bucket number one. Bucket number two is the traditional active stock picker.

I think that's going to be a more difficult proposition. However, I think it's important to point out that because those managers are moving to the ETF wrapper, they have a lower hurdle to jump over in both costs because we know cost tend to be lower an ETF wrapper. And also, ETFs tend to be more tax efficient. And so if you look at those two factors, it's easier for them to generate outperformance over the long run. I would still expect the majority to underperform, but their job is a little bit easier in the ETF wrapper. And then to your point, that third bucket are options overlays and using derivatives. That's really exploded, but I don't see those strategies as really being used in the core of a portfolio.

I think those are more satellite. Those are holdings that you have on the edges. So I think we all agree then that it's a little tougher to get traditional active management as alpha-generating stock picking, But even in an ETF wrapper, it's preferable than in a mutual fund wrapper. Let me just move on and ask you about gold. That's a clear play, I think, on Fed rate cuts and a potentially declining dollar. We've had a strong year for gold. Are flows starting to reflect that at all?

Again, I get to this question. Price follows flows. Is there any indication that's happening with gold? Gold is absolutely fascinating to me because I'll tell you, you Bob, that over the past three years, I've been perplexed as to why there haven't been greater inflows of coal. What you're saying here recently, we are seeing flows pick up. So I show a net $1 billion has come into physical gold ETFs such as GLD and GLDM. And of course, as you were saying, gold has performed very well this year. It's up 21% in actually outpacing the S&P 500, which I think

might surprise some people. And I do think the idea here is very simple. And that that if the Fed does cut rates, that reduces the opportunity cost of owning gold. That might also result in a weaker caller, which could be beneficial for gold. And there are obviously still plenty of political and geopolitical concerns out there. All of that tends to bode well for gold. So I expect inflows to continue here. So I'm not perplexed any longer because to your point, we're seeing the flows follow performance. Finally.

Yeah, good point. All right. I'm going to leave it there, Nate. Thanks very much for joining us. That does it for the ETF Edge, the podcast this week. Thank you for listening. Join us again next week. And remember, you can see all of our shows,

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