ETF Edge - Dividend ETFs, Airline Stocks & ETF Basics

Episode Date: May 4, 2020

CNBC’s Bob Pisani speaks with Simeon Hyman of ProShares, Dave Nadig of ETF Trends and Chris Hempstead of IndexIQ to discuss dividend-based ETFs, the Federal Reserve’s impact on the bond ETF market and airline stocks. In the 'Markets 102' section, Bob discusses the fundamental importance of ETFs and how to use them. Hosted by Simplecast, an AdsWizz company. See pcm.adswizz.com for information about our collection and use of personal data for advertising.

Hello, everybody. Welcome to ETF Edge, the podcast. If you're looking to learn the latest insights on all things exchange traded funds, you're in the right place. Every week, we're bringing you compelling interviews, thoughtful market analysis, and breaking down what it all means for investors. I'm your host, Bob Bazani. Let's get into it. Today on the show, we discuss risks to the bond market and do a deep dive on dividends and dividend ETFs. With so many companies cutting payouts this earning season, what impact is it all having on dividend-oriented ETFs? Now, here's my conversation with Dave Naughtick, CIO, and Director of Research at ETF Trends, Chris Hempstead, Director of Institutional Business Development at IndexIQ, and Simeon Hyman, Global Investment Strategist at Pro Shares. Gentlemen, welcome. Let's start with the poor showing of these transport ETFs today. I've been mentioning Jets, that's the International Airline ETF, getting clobbered today. Dave, maybe you can weigh in on this.

What has been interesting to me is not that they're getting clobbered, obviously. Mr. Buffett said he was getting out as hurting them. But there's been a huge increase in the shares outstanding in this ETF in the last month and a half or show. Seems to me it's obviously because they're professional investors that are creating shares to essentially short them or to hedge with them. This is exactly what we saw with the oil ETFs a few weeks ago as well. Your thoughts on what's going on here, Dave? Yeah, I'm a little skeptical that this is all create to land. And what we've seen is a pattern of consistent $20, 30 million flows day after day, which is really not consistent with a big rise in shares being shorted.

We have seen that shares outstanding being shorted go up, but nowhere near as much as the money has come in. So in this case, I think what we're actually seeing is a lot of people trying to call the bottom. Remember, Jets is down something like 56% over the last three months. It's one of the only sectors of the market, one of the only ETFs affected. that never caught a bounce. It's still trading very close to its March lows. So I think a lot of people are hoping that there's a government bailout, which is going to sort of act as the Fed put in this case.

It's going to act as that buyer of last resort because there's no question. These are beleaguered and beaten up companies. My only argument with that is that's what a lot of people said about the oil ETFs, that a lot of people were trying to play the bottom. Now, I know there's a difference here. We're dealing with equities in the case of the airline ETF and with the oil ETF. We're dealing with oil future. which is a different kind of phenomenon, obviously. But address this issue about professionals going in and playing in these ETFs for the purposes of shorting them or hedging with them or retail investors coming in.

In the case of Jets, do you have any sense of where the proportions are there? Well, I think with respect to ETS structure, what we know is that the ETS themselves create additional liquidity beyond the individual shares. So that's kind of a good thing from a market construction. standpoint. The thing I would note also just from a more of a market look perspective is that we know in the downturn that correlations went sky, sky high. But now what we're seeing is that dispersion, that dispersion that's telling who, you know, who's going to be winners and who are

going to be losers and what's going to be in very idiosyncratic recovery, whether it's troubles for the airlines of the energy sector, benefits for, you know, more tech-oriented online retail, things like that. So we saw this coming out in the recovery in 2019 out of the more modest downturn in 2018, that dispersion went big, correlations dropped across the S&P 500. So I think we're starting to see that idiosyncratic risk started show up as well. Christian, I just wanted to get your thoughts on this. We were all just discussing the role of professional investors in ETFs, noting that in the case of Jets and the oil ETFs, the creation of new shares had gone through the roof in the last couple of months.

months. We were talking about where the breakdown is between retail and professional investors. In the case of Jets, I'm talking specifically. Any thoughts on this? You see active trading all the time. What do you see here? Yeah, I mean, look, there's a lot of attention on it, Bob, and I don't think I have anything too academic to add, other than the fact that a couple of things are in play when the price of an ETF or any security, really, but oftentimes an ETF drops to a very low number or something along those lines, we see day traders. if you will, jump in and start to trade millions and millions of shares. If you look at what happened with USA, yeah, I understand that, you know, oil was a top

headline, but I think part of that was also the ease of trading a lot of the security at a low price. It's almost like a, it almost seems like a gambling tactic sometimes. So I think with the airlines being so beat up, and I think there's a lot of people out there, retail, and probably some strategic investors, obviously not Warren Buffett, who might think there's an opportunity to get in here and take a share. shot. You know, I don't think, you know, it would be my place to say that the airlines are out of the woods, but an ETF like Jets might give people that opportunity to go in, try to buy low, and ride a rebound. Yeah, I want to move on. Talk a little bit about the Fed, because we got some

news about a little bit more details on maybe what the Fed's going to be doing buying corporate bond and the high-yield ETFs. This morning we got word they're going to begin buying in early made, not exactly clear what that means, but they'll be buying $75 billion worth, but they'll be able to leverage that between 7 to 1 and 10 to 1, not exactly clear how they're going to make that decision. So it's a very large amount of money they're going to be buying. And in a shot across the ballot, everybody who was trying to front run the Fed, essentially, they said they would not buy ETFs that are trading at a premium of 1% to the net asset value or even one standard deviation above the net asset value premium over the prior 52 weeks. And boy, was that a mouthful to get through

all at one time. Dave Naughtick, what do we make of this? This isn't far off from what we already know. It's good to know they're actually going to start buying because we actually didn't know anything about whether they were going to buy, and apparently they are. For all we know, they could have already started buying. So we've gotten confirmation that they haven't. The real news here is this definition of what too big a premium is. And there was a lot of speculation around this because we really don't have an instance where a government entity has come in and said what fair value looks like. So I think, you know, obviously this is important for this specific set of buying facilities. We now know what the playbook looks like. I think this is going to have longer term implications,

though, because now it's pretty easy to say, hey, what's too much of a premium or perhaps discount? Well, according to the Fed, it's 1% or one standard deviation more than the last year. I think that's a very reasonable way of thinking about that. The bond market, is not nearly as efficient as we see in equities. So a plus or minus 1% on what is being called the net asset value is actually a very reasonable number. I do think this might have the interesting consequence of everybody piling into these ETFs trying to get in before the Fed, and then the Fed maybe not even showing up because the persistent premiums. Yeah. Well, the premiums have collapsed, though. Simiway in on this, we went way above the

premium to net asset value a few weeks ago. But that premium has collapsed. I looked at it at the close on Friday for LQD. I didn't see much of a premium at all there, and I don't think I sold one for high yield as well. So 1% I agree with Dave. It sounds reasonable to me. What's your read on this? Look, it's a reasonable marker. I mean, the one thing that most agree on with regards to the pricing of fixed income ETFs is that a lot of times the ETFs are just marking things to market before the less liquid bonds do. So that's an important marker, but also with regards to specifically the Fed now entering the market, I would argue that a lot of this was already priced in because they said that they could do it. So we saw spreads come in dramatically

both in investment grade and high yield already, and even the mortgage market, which sort of had a minor kind of technical hiccup when this stuff first started, it started to calm down as well. So I think the medicine is working, and medicine already started to work, but it was good that they came out and told us a little bit more precisely what they were doing. And Chris, I just want you to pick up on Simeon's point there. I think he's right in this debate. Why did we get such a widespread here at premium? It's because the ETFs had it right, not that they had it wrong. It was the bond market that couldn't price these products. What do you see down the road that could prevent these costs? kinds of premiums and discounts occurring. Is there a more efficient way to price bonds? Do we need to go

to more electronic trading? What's the lessons we can learn out of this now that everybody's not pointing the finger at the ETF business is why that happened? We all agree it isn't. I think those of us that have spent the last 20 plus years pricing ETFs on underlying asset information that's tangible and within arm's reach would love to see a more reliable and real-time bond pricing mechanism. Absent that, I don't think there's much, you know, that we can do about it right now other than trust that the true liquidity providers and those who are taking risk fixed income, both on the actual bonds themselves or with the EPS, are standing firm, and this is where they value funds. Now, I would tell you, you know, with the spreads that we're monitoring

on a day-in-day-out basis, there's still, you know, in the EPS, the spreads are still a bit wide. You know, you're starting to see days where they'll be trading flat to nav or 50 pips up or 50 pips down. But more often than not, you're seeing days where they're, you know, they're pushing 100 base points over or 100 base points under. So I have a feeling, you know, that the bond market is not entirely, you know, out of the woods yet in terms of spreads collapsing to, you know, to the narrow levels that we have seen in the past, both in high yields and in investment grade. if the Fed comes in and starts buying these and, you know, they push it up to a 1% premium. And the presumption is that they're going to be using the published INAV. Of course, that may not be the case. Maybe BlackRock has their own view of what it's worth, and they'll only pay 1% above that.

If that's indeed who the Fed is hiring to do the bond buying. But the market is very wide right now. When they're sellers, the ETFs traded a discount, and when they're a buyers, they traded a premium. they're whipping around a little bit. It's definitely a wider market for taking liquidity. Not as wide as we saw in the height of March, but it's still wide. Well, I bring this up every week in the hopes that there's a little more of a microscope focused on this. And hopefully, I think it's clear where I stand a little less over-the-counter trading,

maybe more electronic trading will make it more efficient. At least we'll move the argument forward, and ETFs are not getting the blame. I want to move on here and talk about dividend ETS because a lot of companies are cutting their dividend here. I just want to point out today, 114 companies in the S&P 500 has suspended guidance, and we're only 60% through earnings season so far. That's a quarter of the S&P. 79 has suspended the buybacks, and 31 have cut or suspended the dividends. And most of them who've cut or suspended are consumer discretionary, like retailers and energy stocks.

So it is a particularly subsector of the market that's cutting the. dividends. But, Simeon, I want to weigh in because you run one of the big dividend ETFs. You run the dividend aristocrats' ETF symbol is N-O-B-L. I wonder, this is a little teaching moment to educate us because there's a number of different dividend ETFs out there. I wonder if you could tell us what goes into that, how you determine what goes into that, and how are these dividend cuts affecting something like N-O-B-L? I'll try to keep it relatively compact. But the key difference here is between ETFs that focus on dividend growth and those that focus on high yield. So Noble is absolutely in the dividend growth camp. And the rules for inclusion of the index, we follow the S&P 500 dividend

aristocrat index, is 25 years of uninterrupted dividend increases, and then the portfolio is equally weighted. This is a very high-quality portfolio, and that, I think, is much of the key here. You know, if you look at, as an example, take the S&P 500 by quintile by credit rating, half a Nobel's constituents are in that first quintile. If you look alternatively at a high dividend ETF, like a DVY, only 10 to 15 percent of its constituents are in the first quintile of credit rating. So that's really important because what we've seen is the high yielders with the lower credit rating have actually underperformed in this downturn, even though interest rates came down, which should have helped them out a little bit. Yeah, that's a great point. So Dave,

We've debated this for many, many years, and I think Simeon gave a very good summary there. Generally, if you're a dividend investor, you want to buy companies that are consistently growing their dividend over time, which is Noble, of course, versus just buying the highest yield. Now, under some circumstances, if the market's going up, that'll work fine. But in this circumstances, obviously a company, an ETF like Noble, matters here. Can you refine that a little for us? What observation would you make for dividend people? Yeah, so what we're seeing here is a real division in the market between winners and losers,

and I'm obviously not the first one to say that. And the winners here, I think dividend increases or at least dividend consistency is a pretty good quality proxy. If you actually look at people who've reported, what hasn't gotten reported very much is that folks like Apple and J&J and Costco and Newmont, they've all actually increased their dividend this quarter, which I think surprised a lot of people. Now, that's because of two reasons. One is these are companies that have the cash and cash flow to support it, but it also signals

management confidence in their ability to weather this storm. So obviously, there'll be some changes here. I would not be surprised to see some shifts even in something like Noble because not every one of those holdings is going to be able to keep this up. But regardless, I think that portfolio will continue to be a bit of a winners in this market portfolio because it is that proxy quality. So I agree. I think it's a terrible time to be chasing years.

yield, but it's a great time to be trying to find quality cash flow positive companies. Well, Chris, wait on this. We've been talking about the difference between dividend growth and those that have a more emphasis on higher yield in their ETF. How worry should we be about defaults going forward? How likely do you think they are? How much are we going to be dealing with that? I mean, well, I mean, the good news is, is a lot of the dividend ETFs are underweight energy and underweight, you know, some of the oil sectors that the concern for default is the highest. Look, at Mackay Shields, which is one of the York Vice Plutique, you know, high yield and investment grade and municipal managers, you know, we talk about these things often in our meaty products

and our high-yield products. The default concern right now is not incredibly high in certain parts of the high-yield universe. Obviously, if you look at, you know, state general obligation bonds and, and, and, you know, and utilities, sewer and water, and things like that, it would be much lower, lower risk. But if you look at, you know, retirement facilities and things like that, the risk might be a little bit higher, Bob. So it really depends on what the funds are holding and what the active manager is going into, you know, to qualify that answer. And Simeon, apropos of what you were saying here, if you want to chase high dividends, you do end up with generally more energy stocks, as Chris was saying. So I'm looking at ETFs that have energy sector concentration.

The I-share's core dividend, the symbol is HDV. 20% of their shares outstanding are energy stocks. Noble has only, it says here 2.8%. I don't know if you know that off the top of your head, but pro-share, the Noble let you control only 2.8%. So there's a very wide range of what you can hold in terms of high dividend in some of these stocks. Simi? No, I think that's right, Bobby.

You see more energy, the more you're stretching for yield. So Noble just having a small amount. The other thing I wanted to note, because this is the ETF show, is one of the key advantages of owning a basket like this in an ETF like Noble, which is, you know, at the day's point, yeah, are a couple of names going to cut? Sure, but guess what? When you own the ETF and you're following the index, if a company gets cut, then, and by the way, you want it to be cut from the index

because a cutter typically underperform. So when it gets cut, the proceeds are then invested pro rata across the other constituents. So as an example, if you go back to 2008 and you look at the S&P 500 dividend aristocrat index, it lost names in 08, but the dividend actually went up. You could try to do that yourself. You're going to have to, it's a little cumbersome. You're going to have to sell it, and you're going to have to move your proceeds around, but owning it and an ETF takes care of that logistical issue for you, and it's another piece of the problem.

Is that going to happen now? Is that going to happen now? Have you lost any names? Is the dividend going up? Are we having a 2008 moment here with that? There haven't been any names cut so far from the S&P 500 dividend aristocrats so far. So obviously we monitor that, and we think there'll be far fewer cuts than in the broader market. But just as that extra layer of belt and suspenders, if there is a name cut, you could actually see the dividend go up.

It might stay flat. It probably won't change too much because you're automatically reinvesting across the rest of the portfolio. So it's kind of two layers of protection. Fewer will actually cut their dividends. And even for the small amount that would, you're redeploying those assets seamlessly in the ETF. Okay. Thanks, of course, to Dave and to Chris and to Simeon for joining us. Now it's time to round out the conversation with some thoughtful, in-depth analysis and perspective

to help you better understand ETFs and put it in the context of today's markets. This is our Markets 102 portion of the podcast. Today we'll be discussing the fundamental importance of ETFs and how we use them. Let's start today with a couple of the most commonly. asked questions. Here's one. What are ETFs and why are they so appealing to investors? This is the broadest kind of question you can ask and it's the right kind of question. So ETFs are essentially just baskets of stocks, bonds, or commodities. They are usually but not always tied to an index like the S&P 500 or the Russell 2000. Sometimes they can be tied to various sectors or sometimes

they can be tied to various themes like companies that are increasing their dividends. But the important thing is that it provides you diversification. You don't own a single stock here. You hold a basket of assets, stocks, bonds, or commodities. The other thing that's characteristic about them that's different from a mutual fund, for example, is that they trade on an exchange and they trade on an intraday basis. Mutual funds don't trade in the middle of the day. Essentially, when you buy a mutual fund, you get the price, the net asset value of that mutual fund at the end of the day.

With an exchange traded fund, almost invariably, it trades in the middle of the day. So you'll know at any one moment whether or not you want to buy into it if you're interested in doing that in the middle of the day and what the net asset value is. And again, most of these track a very specific index. So it usually tracks very close to the underlying value, what's called the net asset value. Sometimes that'll diverge. I'll address that in the next question. Another advantage is generally lower costs. A price for a mutual fund is typically higher than a price for an exchange traded fund.

Largely, this is because they often track indexes that don't require a lot of the manual work that actively managed funds have. You also get things like tax efficiency. So, for example, most ETFs are not actively managed. Therefore, they're much more tax efficient overall here. You get liquidity as well. If you get a certain amount of buying interest in that ETF, it's very easy to get. in or out of it. Finally, I think the thing that's most interesting is the ability to invest in a lot of different kinds of sectors as well as theme. There's an entire sub-industry in the ETF business

called thematic investing where you can buy into, for example, dividend appreciation sectors, or you can buy into stocks that are value or growth, or you can buy into sectors that have momentum or that are increasing their earnings. There's almost an infinite way you can slice and dice this depending upon your various choices. So it's very simple. For most people, not all, but most people, investing in cheap, low-cost index funds long-term is the best way to go. This does not mean there aren't such a thing as active managers that do well. There are. However, there's not a lot of them. And this is very, very well-known now. This has been closely studied for decades. Jack Bogle at Vanguard, based.

an entire career out of noting that most fund managers never outperform their benchmarks. This is just a fact. If you can find some, and by the way, Vanguard had some and still do, very good active managers, good. Stick to them. But for a lot of people, the high cost of those actively managed funds often negates any outperformance that they have. This was another one of Jack Bogle's central insights. That fund management, managers, the few that do succeed generally charge fees that are so high that the fees that they charge basically blows out any of the outperformance. Well, why would you want that? So for that and several other reasons, I have been a big backer of ETFs for more than 20 years. Let's talk another

question here. A number of people wrote in asking about why ETFs sometimes diverge from their benchmarks. And this does happen. It doesn't happen very often, but occasionally it does happen. I'll give you two recent examples. China ETFs. China was closed for the Chinese New Year. This was around the February period. This happens every year, so it's certainly a well-known phenomenon. But during this period, the Chinese stock market is closed. But there are ETFs that trade in the United States that are China ETFs. These ETFs hold China stocks in them. Now, here's an interesting phenomenon. China's closed, but the China ETFs keep trading. How could that? that be? Because in theory, these stocks are based upon, excuse me, these ETFs are based upon

the movements of the underlying stocks. But the stocks are not trading. How do you do this? Well, it turns out, you could call it the wisdom of crowds. There's a little bit of pixie dust involved in this, but traders are very good if you get a sufficiently large number in figuring out the direction of these stocks and even the underlying ETFs. So the point I'm getting at is while the Chinese stock market was closed, Chinese ETFs here in the United States traded, even though there wasn't a good comparison, and very accurately reflected the underlying direction of the stocks when they reopened themselves. Now, there's another more recent example where there was actually trading of the underlying investments as well as the ETFs, and that's in bond ETFs. So a few weeks ago,

we saw some real divergences between the corporate bond ETFs, and the biggest one is symbol LQD, as well as some high yield ETSs, including JNK there. And what had happened was there was those ETS were trading at premiums to the net asset value. So the net asset value is simple. The total value of all of the portfolio that's in there, divided by the shares outstanding, essentially. And so you've got a big portfolio of corporate bonds, for example, investment-gray corporate bonds in the case of LQD. In this situation, the reason for this outperformance, why on earth would investors pay more for the ETF than the value of the underlying bonds themselves was very simple. It was because the Federal Reserve announced a program of buying investment-grade bond ETFs, including ETFs associated with investment-grade bonds, the biggest of which is LQD.

So essentially what happened here was the average investor decided to front run the Federal Reserve by going out and buying this ETF. Now, wait a minute, there's all of these bonds underneath. So in theory, these bonds should also be moving as well. But because bond pricing is sometimes very difficult, that a very large part of the U.S. bond market doesn't even trade certain bonds. There are literally tens of thousands of different, they're called CUSIPs, different bonds that track different kinds of investments. And a good part of the bond market doesn't trade at all on a daily basis. There's only a small part of the U.S. bond market that's truly really liquid that trades actively. So when all of a sudden you have this huge demand, people piling into these ETS, the people underneath it have to go and create new shares.

They're called redemptions. And to do that, you have to go out and buy bonds. to create the shares because there's got to be something behind them, obviously. And yet these prices of these bonds, it turns out to be very difficult to price when there's so much demand because they don't trade that often. You see the problem? So who's right? Are the ETFs right?

Because the prices were higher than the underlying value of the bonds or the bonds right. And it's these damn ETF people that are screwing things up. Well, I guess you can guess where I'm going on this. It's the ETFs that are right. The problem is in we need a better way to do quicker, more accurate bond pricing. This has been known for years. Most bonds still trade what's called OTC, over-the-counter, where a dealer will call another dealer and say,

I got a bond I want to sell it, make me an offer here. And that's called over-to-see, literally on the phone, essentially, over-the-counter. And that's a very slow, cumbersome way to trade bonds. There have been attempts to make bond trading more electronic. There are organizations out there that do this already, but it's still very small. It's probably less than 30% of bonds are traded electronically for sure. So the question now is what can be done? How do we sort of drag bond trading into the 21st century?

Stocks don't have this problem, by the way. Stocks trade electronic. There's a floor of the New York Stock Exchange. But most trading in stocks happens electronically. There is a very small over-the-counter market for stocks, but it trades electronically, essentially. Well, why can't the bond market do that? And people have objected that there's too many bond, individual bonds that trade, but they're chipping away at it. So the bottom line to answer to this question is you can trade at some time discounts, ETFs can trade at discounts or premiums

to the market. And recently, a good part of this time, the ETFs have correctly guessed where things are going. That's it for today. I'm Bob Bizani. Thank you for listening. And make sure you tune in next week. And in the meantime, you can tweet us your questions or topic ideas at ETF Edge, CNBC.