ETF Edge - ESG Explosion & Thematic ETFs Tumble

Episode Date: May 3, 2021

CNBC's Bob Pisani spoke with Sal Bruno, CIO of Index I-Q, Armando Senra, Head of i-Shares Americas and Todd Rosenbluth, Senior Director of ETF and Mutual Fund Research at CFRA. They discussed the hottest trends of the year – including ESG – the boom behind BlackRock’s two recent launches and what’s driving the red-hot flows into that space. Plus, what was hot in 2020, not looking so hot in 2021? Why bets on thematic trends like cloud computing, cybersecurity and 3-D printing appear to have fallen out of favor so far this year. In the ‘markets 102’ portion of the podcast, Bob continues the conversation about all things ESG with Armando Senra from iShares. 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. 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 and market analysis, and we're going to break down what it all means for investors. I'm your host, Bob Pisani. Today we're diving right into the hottest trends of the year. That's ESG, environmental, social, and governance.

and the boom behind Black Rock's two recent launches and what's driving that red-hot inflows into that particular space. Plus, what's hot in 2020? Not looking so hot in 2021? There are some of them out there, believe it or not. Why bets on thematic trends like cloud computing, cybersecurity, 3D printing appear to have fallen out of favor so far this year. Here's my conversation with Sal Bruno, CIO of Index IQ, Armando Senra, the head of I-Shares,

Americas, and Todd Rosablooth, senior director. of ETF and Mutual Fund Research at CFRA. Armando, I've got used to saying amazing inflows into ETFs, but amazing inflows into ESG again this year. I'm looking at ESG inflows in the first quarter of the year, 21 billion in inflows into ESG funds. There was $21 billion in all of 2019. So we've already done, the first quarter of this year,

it's already have the same flows as 2019. I know we keep saying, well, there's a new generation of investors and they're interested in climate change, is that really it? Does that explain this avalanche of money coming into ESG? Or is there something we're sort of missing? Look at these numbers here going up every single year, every single quarter. Yes, Bob, and great to be here. Let me just say that I don't think is that. I think that it's the realization that investment risk and investment performance, that's what ESG is about. It's not about compromising performance and it's not just about values. So is that convergence of values with the realization of investment risk and investment performance.

So what you see is more investors incorporating sustainability into their portfolios, thinking about how ESG-related risks may have an impact on their portfolio, and therefore on that's the pricing. I think that that's why you see this massive increasing flows. And by the way, we think that we're just at the very beginning. Yes, in I shares, we just crossed 100 billion in sustainable ETB. EFs globally. Half of that coming from the US, so this is no longer a European story. This is a global story. We see the same thing all around the world. But the reality is we believe the category will be a trillion dollars by 2030. So we're just at the beginning. How does that happen? You see here in the U.S. you see a lot of model portfolios in the wealth segment incorporating ESG into the model portfolios, not only in sustainable models, but also in traditional models. So beginning to incorporate sustainability in their traditional models. And you also see it, as we talked before, with large asset owners around the world,

incorporating sustainable in their portfolios, like in the case of LCTU, we talk about costers. So that's what's driving the growth, and we're just at the beginning. Yeah, Sal, you also run an ESGETF, the IQ ESGETF, the symbol is IQSU. You've been outperforming this year, also big inflows, and maybe pick up on what Armando was talking about there, not just climate change, but there's gender equality issues. There's the whole stakeholder versus shareholder issue. This is sort of that perfect confluence, as well as, of course, a younger generation of people that are interested in this. But pick up on what Armando was talking about there and why we keep talking about ESG is the moment that it's having right now.

For us, you know, we think that this is really is the acceleration and continuation of the trend that we had seen basically going on for several years. But if you even go all the way back, you know, 15, 20 years ago, if you think about ESG investing was back then, it was really only about excluding certain types of companies. And that has evolved so much more so that it's really more of a comprehensive or a holistic view of your right to stake. And that's why we've partnered with Candium, who's one of our sister boutiques under the New York Life from over in Europe, to try to find best in class companies that cut across ES&G. And to us, you know, I think an important part of this evolution,

is the fact that ESG investing went from being an investment strategy to much more of a, and we're seeing a lot more investors using it, and they're cooking for things like very competitive fees, lower tracking error, competitive performance, is really those days of the question of, should I have to saccharacter on? We're seeing these types of strategies with lower tracking, competitive, very low fees. Yeah, Todd, you see what's in this ETF, the main holdings, and this is something you and I have talked about many times, you probably open the door of most of these big ESGs, and their top holdings tend to be big cap tech, or at least high-quality big-cap tech names, like Johnson and Johnson

shows up all the time. Can you help explain that to me? And maybe Armando could step in, too. I've asked him about it, but it does bother me a little bit, and people keep messaging me saying, Bob, is this all anybody can think of to put in their ESG funds? Is Big Cap Tech? Why do they keep going in, passing the test going in, and is there anything else that anybody can include there? So these are broadly diversified ETS for the most part, and as Sao just touched on, their goal, is to have relatively low tracking error, meaning they're going to perform relatively in line with the broader market. In this case, we've actually seen these two ETS that we're talking about outperforming within the past year. You tend to have less exposure to energy or slightly less

exposure to energy, you tend to have slightly more exposure to some of the more growth-oriented sectors like technology and like consumer discretionary. But it's more what you find not in these portfolios as opposed to what is in there. These are still market cap weighted in nature. So you're going to be heavily weighted towards the apples, the Microsofts, the Alphabets. But you often don't find Facebook within some of these portfolios in South product in IQSU. you don't find JPMorgan or Facebook within the portfolio. So there are certainly companies that you won't find that would be in your broader core portfolio. Yeah.

So, Armando, why don't you explain what's in your newest ESG fund, the Carbon Transition Readiness Fund? You just launched it two weeks ago. You've got $1.3 billion in this. How do you decide what goes in this? What's the criteria? I mean, it's $1.3 billion for two weeks is a pretty impressive. of inflows. So somebody wants in on this thing. How do you decide what's that? Yeah, and I would just emphasize first what both Todd and SAD indicated, which is that when I mentioned the growth is coming

from large asset owners and model portfolios incorporating sustainable, this is not just a niche allocation in the portfolio. These are broad exposures that provide a core allocation in the portfolio. So you have to look at your whole portfolio. Are you overweight large caps? That's a consideration, but you should not look for sustainable as if it's a different part of the portfolio that will play in a different space. So in the case of LCTU, which is the low carbon transition portfolio that you were referring to, that was the largest active ETF. That's actually an active EF offering, but with a low tracking error, given investors exposure to the RASO 1000. So you have exposure to the RASO 1000, but with 50% lower carbon intensity. So that's the key.

will still have a lot of those names. What do we do in the portfolio? We have about 350 holdings. We look at the holdings in the RASO 1000. We put it through a framework to analyze how those companies are doing in the transition to a low carbon economy. We have a proprietary framework that we use. We give different scores and we overweight and underweight based on that. But you still get exposure to the RASO 1000. So again, is that broad exposure that you're looking for, RASO 1,000, with 50% lower carbon intensity. So that's the simple answer. When people keep asking me,

why are tech names showing up in these ESG funds so much, and particularly something like a low carbon? The answer is, well, they tend to be companies that have the lowest carbon footprint. I mean, they're not actually producing anything. Well, they're producing chips. So the next question I usually get asked, Armando, or anybody on this, Sal, or Todd, is,

do you occasionally, for the fact that, for example, Apple produces chips that are, of course, have carbon impact as well. Is there something down the food chain that is also considered when including these companies? I get asked this question all the time. Yeah, we look across the value chain. We look at the company, at all these companies across all their activities, across the materials that they use, the use of natural resources, and that's how we come across with different metrics. Yeah, we look at, you know, the whole value chain and how it comes to the –

And with our companies, actually large-cap companies like Netflix, actually, one of the big reasons are actually not an hour strategy is that they have a significant negative impact on the data service. So just, you know, a concrete example of something for its environmental impact. You know, Todd mentioned names like Facebook. Amazon actually is one that we don't know. That's a very large holding in many of the others. The S and the kind of the work issues that they have, we also would happen with the unionization vote down in Alabama. So, you know, we do try to look across all ESNG to try to identify companies.

companies. Yeah, you know, one thing that's very interesting just to move on on this is it seems ESG is growing so fast that sometimes just managing the flows are an issue. So Armando is looking at ISHAres' global clean energy that you guys run. This is a huge fund that's a real darling of the ESG crowd. And the benchmark, I believe S&P ran this, did the benchmark for this. They had to increase it from 30 stocks. It was a very concentrated fund, which I think is terrific.

to 100 just because there was so much money flowing in, they had to be careful about, you know, reducing clustering, essentially. So you're sort of a victim of your own success here, aren't you? I mean, here's a very concrete example where ICLN had to expand the number of companies that are actually in there to accommodate all the people who want it in on it. Well, I would say is that EIClean is a very specific, thematic type of ETF. It's very different from the exposures that we talked about before. when you look at the LCTU, RASO 1000, when you look at the ESGU, large cut, mid-cut, those are broad exposures where there's no issues in terms of the flows.

In the case of ICLEN, also, index providers are just, we're still in the early days. They're working in their methodology, and that's improving. That's been updated constantly to accommodate for the growing asset class that we have. But again, when you look at the category, we think that this is going to be a $1 trillion dollar category by 2030. So we are still in the very early days. Yeah, I think what we started to see, too, the broadening out. I mean, we were talking a lot about kind of core holdings and lower tracking error products,

and now we're talking a little bit more of satellite-type products where you're looking at some more thematic type investments that maybe involve some ESG investing. So, for example, you know, we brought out a strategy in February as the IQ Healthy Heart ETF, the ticker is H-A-R-T, and it really, it overlays the ESG screens for the criteria. area, but it's very much oriented towards a specific theme. In this case, it's promoting healthy lifestyles. We're looking at companies that are lineups of more healthy alternatives in their food, as well as companies that are involved in fitness.

I think what we're talking about here is actually transitioning and broadening out the product, blending thematic. Yeah, thank you, Sal. And, Todd, let me just turn to you. I want to move on to another subject. So the two topics I get hit all the time by investors at CNBC on this is one, why is there so many tech stocks in it? We talked about that.

The other is the lack of standards that are developed for ESG that bothers a lot of people that they don't quite, they have to be very careful at looking at what these ETF funds actually are investing in in terms of what they define as ESG. Todd, has there been any advancement in defining what ESG actually is and what it actually is doing? I know there's some groups out there like the Global Sustainability Standards Board that are out there, but are we any close to an agreement on what ESG actually is. is, or should we not have an agreement? Should everyone have their own definition? So I don't think we're that much closer. You're right. There are groups that are trying to have standardization, but I'm not sure this is any different than we have index providers

that are behind this that classify companies as either growth or value. And often they'll agree with one another, but often they will not. And so a stock will be in the Russell 1,000 growth and it will be in the S&P 500 value because there's the day. There's the day data looks different, even though they've got different criteria behind it. This just comes back to you need to understand what's inside the portfolio. If what you want is a core product that's closely aligned to the broader market and you're comfortable that the five largest stocks are the same five largest stocks in the S&P 500, but there's a lot of stocks that are not further down, then there's some great products.

If you want more of an exclusionary product where it's much more narrowly focused, you know, For example, Ishare's has an advanced series of products. What's inside those ETS and what's inside the aware ones like the SGU are quite different. Yeah. Another thing I've noticed, and I'll throw this out to anybody, Armando, maybe you can handle it first, is what's sort of not hot this year? Yes, G remains hot. Last year, everyone was falling all over themselves for thematic tech ETFs,

not just clean energy, but 3D printing. cybersecurity, solar, cloud computing, for example. This year, not so much. Maybe it's because the prices went up rather dramatically and rates went up in February. But I noticed that other hot area, besides ESU, thematic tech in general, is not so hot. Is there any reason for that? Or will that change? They're off of their lows, but will that change this year at all?

Because that was investors really – I got a lot of emails. not that last year. They love investing thematically. Yeah, we are very bullish on thematic investing and the growth of our platform that we call megatrends in within thematic investing, both index and active. And there's great offerings. I mean, you had tremendous performance from some of our exposures last year. I drive was close to 100%. For instance, I cleaned that you mentioned early, 150%. I think that, yes, you may have a little bit of a pullback in performance. but we continue to see the flows. And about 80% of the flows that we are seeing this year

are not necessarily in technology type of exposure. So the IFRA, our infrastructure offering, very timely given all the talk around an infrastructure plan in the U.S. Big flows, strong performance. I drive, that's another area of the market where we are continuing to see strong flows. So again, I think that in thematics, We believe thematics is a long-term growth story for us and for the industry.

And a lot of the things that we create, we liken to be long-term things in anyone's portfolio. We're not just chasing one-year themes. We're looking for 10-year themes. Megatrends is supposed to be about the big trends that are changing society and the economy for the next 10 years. Yeah, we agree that, you know, we think that the thematics are a really great growth opportunity, a great opportunity for investors. I think, Bobby, touched on some of the key points. I think some of the thematics that did really well last year, but not quite so well this year,

I think, took up to that, I think, has to do with the dimension. So, you know, I think some of that is kind of cyclical, and you can't divorce these thematic strategies from, but we do think that the opportunity set in thematics is big. You know, we talked about the Healthy Hearts, the IQ Healthy Hearts. We think there are a number of other ESG and thematic, as well as, quite honestly, a dual impact. So for Hart, we have a lot of.

actually make a donation to the American Heart Association. We want investors to know that their dollars are doing well for their portfolios, but also doing good for society as a whole. We think that concept applies to a number of other areas, especially there are these opportunities to create these types of unique strategies. You know, Todd, the other big area, of course, was factor investing, what we call broadly investing by value or quality or momentum or size. A lot of these or I shares, ETFs that are out there, the bigger ones. We pay attention to these that are rebalancing that are big out there. Momentum, MTFUM, which Armando runs, is going to be, rebalances twice a year.

And, of course, last year it was big tech names. Now it may be a little bit different. You were talking, and I were talking about this last week. What kind of changes might be seeing something like some of these momentum ETS, particularly MTF? Right. So momentum, the momentum ETF from I Shares, MTCUM is the one of those five factor products that are U.S. focus that does not have any sector bans or any sector constraints. So it can go where the factor is strongest.

Currently, the factor is strongest the way the portfolio was positioned with technology and consumer discretionary and healthcare being heavily weighted. The last six months have been really strong for financials, which is little to no exposure. within the M-TU-M-N energy where there is no exposure. So the research that we at CFRA did, we believe that we're going to see an increased exposure in financials, and we're going to see a reinitiation of energy companies. And some of the growth stocks, Amazon, for example, is potentially going to be falling out of this index. And then we're also just watching what's happening within the value ETF, VLUE, which has sector neutrality. So it's looking for the value-oriented stocks within each sector.

And we saw, for example, in technology, some of the more deeper value stocks have risen, and we've seen a rotation. Some of the higher growth stocks have fallen. So we could actually see VLUE owning more of the traditional growth stocks within the technology sector, among other sectors. Yeah. And M-TUM rebalances twice a year, Todd, right? So when's the rebalance is supposed to occur now? The end of May?

The rebalance for all five of the factor ETS for I shares takes place at the end of May. The reason we're talking about this one, and we wrote about it at CFRA, is that the momentum ETF, it focuses on the six-month period ended April. It throws out that last month in the momentum part of it. So the data is now, in theory, available to try to figure out where the relative strength was, but, of course, there's an algorithm that constructs this. All right. And Armando, of course, just last question very quickly because we've got to go. But you ever give thoughts instead of doing this every six months, every three months,

rebalancing this, given that momentum moves very quickly now? No, I mean, momentum, by the way. I mean, Todd knows that. I mean, there's high turnover in that portfolio. So investors are aware of that. I think that what is really interesting, Bob, is in factors, which lately they don't get a lot of attention. We're seeing some of the strongest flows on the back of the reopening trade into our value. new portfolio and other single factor offerings that we have. So, I mean, factors is something that investors are really utilizing in 2021. We didn't see a lot of flow in 2020.

That is also changing in 2021. Yeah. Okay, guys, I appreciate the help. That's it for this week's ETF Edge. And my thanks to Armando, of course, and Sal, and of course Todd. Now it's time to round out the conversation with some analysis and perspective to help you better understand ETFs. This is the Marcus 102 portion of.

the podcast today. I'm going to continue the conversation about all things ESG with Armando Senra from iShares. Armando, we were talking about that new carbon readiness ETF. You launched LCTU, 1.3 billion in inflows in just about two weeks. That's a very impressive move to the inside here. And we were talking about the reason for it. And this whole interest in ESG, besides the new class of investors and concerns about climate change and gender equality and stakeholders versus shareholders, which I think is a wonderful discussion to have. I can't help but think there's another sort of point here that I like, which is that ESG, by its very nature, kind of shifts the focus from a shorter-term emphasis on just what the earnings are to a longer

term focus on sustainability, shareholder, versus stakeholder. Is that a good thing to have? Is it about time we shifted the emphasis a little bit away from just giving guidance? and how much can you beat earnings, you know, on that quarter? Yes, Bob, great to be here. I think it's a combination, right? I think it begins with the idea that investing in ESG is about investment risk and investment performance. And therefore, you know, when you're building a portfolio,

you have to think of ESG related risks and the impact that they're going to have to asset pricing and also capital allocation. So I think it begins with that. So it moves away from values. and it's about performance and risk. And then I think a lot of that, as you analyze companies and you try to understand what impact ESG factors will have on a specific company,

of course you have to look at the long term. I mean, we all the time talk about a black rock cow. We are long-term investors. We like long-term investors. So I think that there's an element of long-termism that is hugely important in good performance in a portfolio. but I think that the reason you see the flows going into ESG

is because of the realization that this is about investment risk and investment performance. And just like with any other risk, you have to consider that in your portfolio so you're building a portfolio. Yeah. We also talked on the show a little bit about the biggest complaint, the second biggest complaint,

the biggest complaint is there's too many tech stocks in these and you, I think, explain why that happens. But the other issue is just developing standards and whether we need to develop more standards. The SEC actually went as so far to issue a risk alert in April that I covered, warning about what they call a lack of policies and procedures related to ESG investing. I'm wondering what your thoughts are on that. Is BlackRock doing anything itself to assist in the standardization of ESG?

Or is that even desirable at this point? Absolutely. I would say that we are big proponents for regulation that helps create more consistent standards and increases the transparency of what sustainable portfolios are about. So number one, big proponents of regulation and standards across the industry. But number two, while that is happening,

our job is to double down on education to help advisors and investors, large institutional investors, how do they incorporate sustainable in their portfolios? And for that, we do a lot of work in our analytics and technology and education to be able to talk to investors and help him in that journey. Yeah. You know, I know you're in this business and I am too, but aren't you a little bit amazed at the money that's going in here in ESG? I used to say in 2018 and 2019, it was hot topic, but I used to say, where's the money?

Everybody, who's against, you know, a cleaner environment? I'm not. I'm in favor of a cleaner environment. And yet, where's the money? There wasn't any money at all in the ESG business in 2018 and 2019, $2,000, $2,000, $2,000, $21 billion, $20,000, all of a sudden now there's $50 billion. And then in 2021, just the first quarter of this $21 billion, we have as much money coming in in the first quarter of 2021 as came in the whole 2019 at this point. So the world is sort of woken up. Now, I don't know if it's, COVID helped. I don't know if all of a sudden a new string of younger investors came in. I don't know maybe it just hit a point. It's always been bigger in Europe than here that it came in. But it's really remarkable to see what a piece of the pie. And not only a piece of the investing pie,

a piece of the ETF pie is. They're a significant part of the whole ETF flows themselves at this point. Yeah, ESG growth in our I Shores platform has crossed 100 billion. and globally. About half of that is coming in from the U.S., as I mentioned earlier. So this is no longer a European story. But also, I think that the most important point is what we discussed earlier on, which is that this is not about a small niche allocation in a portfolio. What you are seeing is big substitutions of broad exposures for sustainable equivalents. So when you mention ESU in I-Shires, that's a broad exposure. So you're

not with a lot tracking error. So that's replacing a different core holding. So again, what we are discussing here, we are just in the early days. When we say we are in the early days, a hundred billion sounds like a lot, but we do believe the category will reach one trillion by 2030. Again, one trillion by 2030. So we are at the very beginning, and it's because of that incorporating sustainable into all portfolios. And that's going to be the core of the portfolio. Of course, there's going to be some thematics around the age that also play in sustainable. We mentioned I clean earlier on. That's not going to be a core holding.

That's going to be a satellite in the portfolio. But exposures like ESU or even LCTU that you mentioned, which is a Russell 1000 exposure active ETF, that's going to be a core portfolio. Yeah. I wonder if you could just comment in general on the ETF flows. So we're going to hit $7 trillion in overall. ETF's asset under management in the U.S. It was $5 trillion a year ago.

I guess of that $7 trillion, maybe $5 trillion is equities. Total equity market today is probably $40 trillion in the U.S. So $5 trillion to $40 trillion is still pretty small. It's 12% of the whole U.S. equities market, but it's growing really fast. Can you comment on how ETF investing and the money flowing in has sort of changed investing in general? We know, of course, about the lower cost, the better tax treatment that you get under it.

But is it truly changing investor behavior now, the fact that there's so much money continuing year after year to go back to go into ETFs? So the short answer is yes. First of all, let me just, it's just incredible the start of the year. This is the strongest start of the year in the history of ISHERS with over $100 billion in net flows. here in the US alone is $60 billion. Earlier in the year, we crossed $2 trillion in assets. A little bit less than four years ago, we crossed $1 trillion.

So we double assets in less than four years. Just remarkable growth. And the whole industry, incredible growth with over $400 billion in flows year to date globally again. But I think that what really matters is what you said second, which is that the success of the ETF is really how it is becoming the vehicle of choice for more and more investors around the world, whether it's to replace equities,

whether it's to replace bonds, a lot of the growth that we saw in fixed income ETFs is not replacing active fixed income managers. The growth is really coming from active managers using fixed income ETFs, replacing bonds, because there are more efficient ways to gain exposure to the same type of segments of the fixed income market. So it's really how the ETF is transforming the investment world

and how we think of building portfolios. I think that that, to me, is what is remarkable, and also why we think that, again, you know, this growth will continue. Yeah, and most happy for me that I'm happy to see is the ETF tail wagging the dog. By that, I mean, the last refuge of the ETF haters was, oh, these ETFs are going to get into areas of the market

that are not very liquid. Wait till they try to, you know, get into brokered loans or some obscure area of the market, like high yield. Remember that story, 10 years? ago, and boy, if there's an exit, no one's going to be able to sell these bonds. And it turns out the opposite is true. ETFs found a way to price the bonds more efficiently. And we saw this with Chinese equities. We saw this with bonds in times of high volatility. People can actually price these, and it's leading to more efficient pricing in things like bonds and leading to more

electronic trading in bonds. That's right. I mean, I think last year, March was just such an incredible example of the utility of the ETF, right? When you couldn't get liquidity or you couldn't really understand the pricing of bonds, the ETF was giving you that transparency and was giving you that liquidity. ETFs like LQD back in March was trading 30,000 times on exchange. If you look at the top five holdings, we're trading around 30 times. So the ETF was giving you an actual view of what was the price at that moment in time of the end of. line securities and was allowing you to trade. If you think of the importance, if you're running a portfolio as an asset, let's say a pension plan or you're running a portfolio as an asset manager,

the ability to, in a very efficient way, rebalance your portfolio, get in and out of risk, gain liquidity. That's just an incredible utility that the ETAF prove to be able to do last year in March. Right. So the simple answer to the ETF haters who said, wait till this thing, everything kind of blows up and everybody wants to exit for the doors nobody's going to be able to sell this thing because there's no liquidity. The answer, what actually happened was

the ETFs themselves created the liquidity for it. There were people who had stuff. They had to move in and out, redemptions and creations. That created liquidity itself and they were able to price it. The whole premise was wrong that everything was going to blow up and there was no pricing. The ETFs helped

create the pricing. That is what people didn't seem to ever get or understand about it. Armando, I appreciate you taking the time out. I know you're a busy guy. I want to remind everyone, this is the guy he runs the biggest ETF fund family in the world, I-Shairs. And also runs the biggest ESG suite of funds here. So he's given us an hour of his time.

And Armando, I really do appreciate. Armando is the head of iShares, America. Thanks very much, Armando, for joining us. And everybody, have a healthy, happy, and safe trading weeks. InvestcoQQQQ believes new innovations create new opportunities. Here's the greater possibilities together. Learn more at Invesco.com slash QQQ, Invesco Distributors, Inc.