ETF Edge - ETF Inflows & Coronavirus Impact

Episode Date: May 11, 2020

CNBC’s Bob Pisani speaks with Matthew Bartolini, head of SPDR Americas Research at State Street Global Advisors, and Kevin O’Leary, chairman of O’Shares ETFs, to discuss the divergence of the stock market from the economy and recent exchange-traded fund inflows. In the 'Markets 102' section, Bob discusses the growing dominance of ETFs and key mechanisms behind them. Hosted by Simplecast, an AdsWizz company. See pcm.adswizz.com for information about our collection and use of personal data for advertising.

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 Pazani, so let's get into it. Today on the show, we discuss what recent flows are telling us about the top trends in the ETF space and why the winners just seem to keep on winning. The NASDAQ 100 just hit $100 billion in assets, something old. only four other ETFs have ever done. So here's my conversation with Kevin O'Leary, Shark Tank co-hosts and O'Shares chairman,

as well as Matt Bartolini, head of Spider America's research at State Street Global Advisors. A lot of people over the weekend, I get these emails, I call them four exclamation point emails, people who are baffled and a little bit angry about the rally in the markets, only, what, 12% from the S&P highs at a time when we're near depression levels on the economic data. Can you just help square this for us? Let me just take this whole thing up with you, Matt. I mean, you're a big watcher here. I wanted to talk about ETF flows recently.

But what I've been watching here is I think two trends are really interesting in what's going on with ETFs. And it may be related to coronavirus. The first thing that we've been seeing is more ETF closures than openings this year. I don't remember when that's ever happened. Some of these are these leverage and inverse ETFs that are closing because of unusual activity that's going on there. But also I notice we're still getting money coming in. There's still overall inflows. Dollar amounts are still positive.

But most of the money is still going to those mega-cap S&P 500 funds, including your own fund, the S&P index fund, the IVV, that we're getting inflows there. AGG, the biggest bond fund that you run as well, I shares a bond fund, still getting inflows. What do you make of these flows and the closures? And do you think some of this might be related to the coronavirus and how it's impacted the ETF investing? Yeah, I mean, as far as closures versus launches, I think it's more about openings have slowed. If you're looking to start to launch a product, say sometime mid-February, it's becoming very hard. And then in March, became nearly impossible, given two aspects.

Seed capital was more difficult to come by, given the constraints on balance sheets, both from institutions and banks. secondarily, mobilizing the team to go and have discussions with investors about a new product during a pandemic. It's extremely difficult, but also unlikely to yield any results, given what we're doing with everyone was working from home. You're really more concerned about how to actually get through your day than maybe thinking about a new investment strategy. So for a lot of firms, the decision was to postpone. So I'd expect actually a ramp up of launches that are sitting on the shelf that will come out in the second half of the year. hopefully as those two variables I discussed earlier, change as our society begins to reopen and get back something close to normal. Closers are not a surprise.

I mean, if you're planning on closing a poor performing fund before this, the events over the last few months made it extremely easier, and it became just an operational experience. With respect to fund flows, every major asset class category monitored has had inflows in April, which to me is just a sign of steadfast usage of ETS and the desire by investors to allocate capital. across a variety of asset classes so it's not to miss out, is any gain that the global capital markets rallied. But is that really what's going on, Matt? I mean, it seems to me like the money flows are going into the biggest cap names,

basically S&P 500 funds like yours, IVV, Vanguard total stock still getting big inflows, triple Qs still getting inflows. That's where most of the money is going. If you look at there, there's like 15 funds that had the vast majority of the inflows. Investors still seem to be, my point is, they're still buying in to the idea of indexing as the way to go. And so the bigger ones are getting bigger and bigger, and the smaller ones still aren't really partaking in any bigger part of the pie. Yeah, I mean, the bigger funds, they're more liquid, right? So, Spy, R.S&P 500 ETF, they have garnered a significant amount of assets during this pandemic as it started.

February, investors sought out liquid vehicles to allocate capital. But even in April last month, while some broad beta products did have inflows, I would actually say, you know, I would argue that investors actually be more selective in picking their spots on how to buy back this rally because you saw $15 billion of inflows into sector ETS in April with basically healthcare and tech, so XLV, XLK, those funds having the most flows on record in a given month because investors were indiscriminately picking out areas of the market that would perform best during a period of the sluggish earnings. Earnings growth, also economic growth, where those firms' products and services are likely to be sought after. Yeah. Speaking of picking your spots, I continue to watch in amazements the gold

funds, including yours, the Spider Gold shares, the IAU there is the symbol there, as well as GLD or competitor, the money just keeps going into these funds. What I find interesting is gold for investment purposes, I want to own gold,

and I want to have an ETF, you know, keeping it in the vault somewhere. Gold for investment purposes is way up, and yet gold demand for jewelry in India and China is way down. The World Gold Council acknowledged that. So it's kind of strange. You've got the doom and gloom crowd out there saying, okay, I want to hold gold as a bulwark against uncertain times.

But jewelry demand, which is the other really major part of this whole equation, is way down. Can you square that for us, too? Yeah, so, I mean, our product, GLD, had significant influence. as well as its sister fund, GLBM, but the broader category had $7 billion of inflows in April. That's really large, and I think it's worth pointed out that gold ETS, AUM as a share of global ETF assets, is still below its peak of 90%. So there's been strong investment demand as a result of a supporter of macro environment,

given that real interest rates are low, extremely low and potentially negative based on what variable you're looking at, but also macro risk is high. Now, how do you sort of correlate that with the demand from jewelry? It is obviously waned. It's unclear whether jewelry demands lost during COVID is lost or simply delayed to the end of 2020. If jewelry weakness persists for a longer term as opposed to a short shock, that may weigh on gold over the long run. However, that's not our base case outlook. The macro forces at play, as discussed earlier, are still supportive for gold.

And I think broadly speaking, we look at historically investment demand. has somewhat outweighed jewelry demand as a sort of a driver of price, just giving the macro forces at play. Yeah. And sorry, I mixed that up there. GLD, obviously, is your fund and IAU, the other one there. Sorry, mixed that up there. Kevin, you think that the market is correctly looking ahead to reopening and do better days ahead. Well, institutional demand for equities is unprecedented, given there's very few choices. The average boge of a ticket, CalPERS, they've already gone public this year saying they're boggy 7 percent. Sovereign funds in Dubai or Riyadh, 6%. So if you think about how you're going to do that, your fixed income option of government bonds from the U.S. used to be something you'd even consider. That's no longer an option

at 60 to 70 basis points for a 10 year. That's not really going to be very useful. And so if you could find a company, and certainly there's many now that are yielding 2.5 to 3.5% div yield, large cap, liquid securities, you know, that's a very attractive place to park money for the next 24 months and you're seeing a tremendous demand for it across the board. It's not the retail investor that's driving this market. It's institutional. I speak to them every day. And they're saying, what other choice do I have if my bogey over the next 12 months is 6%. There is no other choice, Bob. It's that easy. Yeah. You know, the other thing that I've noticed, I want to talk about one of your funds,

I've noticed these big inflows into the mega cap funds here, Vanguard, mega cap growth, some of these other ones that are out there, S&P 500, the S&P 100, ETF. A lot of this seems to be the interest in Big Cap that I was talking with Matt about, but there's also seems to be a lot of interest just in buying into the Internet stocks that are going to really do well in this environment. Obviously, we've seen Amazon and Apple and Facebook do well. You've got one, OGIG, one of the O'S shares, the global internet giant. I was just looking at the inflows the other day, quite phenomenal in the last couple months. What do you think is going on with that? And tell us how that fund is doing. Well, what that fund does is realize that the fangs are not unique to our own domestic market.

There are companies all around the world, over 50 of them, that are experiencing tremendous growth as a result of what this whole pandemic has done to global retail changes. I mean, people's propensity to buy online is not just domestic anymore. We went into this at 16.2% online sales pre-pandemic, I think we're coming out at probably 24. So O-GIG is not market-cap-weighted. So the trouble with a lot of different indices is their market-cap-weighted. So the fangs represent 40-44 percent. But the fangs are not the fast-growing Internet stocks anymore. You can find all kinds of companies like Zoom, like DocuSign, like JD, all kinds globally. And that's what's captured inside of OGIG. It's up 21 percent year-to-date, Bob. It's our best-performing

index, but it's captured the theme that I think is going to stay intact for the next three years. People are going to keep buying online, and these are the global internet giants encapsulated inside of OGIG, and not market cap weighted. So you get lots of all of the stocks that are performing well, not just the fangs, which are included in OGGIG, but they're not 44% of it. Yeah. Yeah, this is a debate that's been going on for many, many years. Sometimes you get lucky, like if you look at the, look at the biotech stocks today, you see the two biotech ETFs, IBB and XBI. One is market cap weighted. The other is basically equal weighted, and they're both at new highs, but that doesn't happen a lot. Usually equal weight or market

cap weight does a little bit better. And recently market cap weighted in tech has done a lot better. So that's a very good point, Kevin. Thank you. Matt, there's a lot of bottom fishers out there. I never ceases to amaze me. We were talking last week about the influx. into jets. This is the global airline ETF. It's essentially a basket of U.S. Airlines. There are some international ones in there. But the inflows have been titanic in the last few weeks. Inflows into XLE, which is the energy ETFs. You think people would realize now picking a bottom, and this is a fool's game. And yet we're still seeing it. The urge to pick a bottom does not go away. And you can see it very clearly in the behavior of some of these ETFs recently.

trying to pick a bottom in energy stocks requires a steel stomach. And we are seeing basically that play out right now. I mean, that's what the flowchamps are telling us. In February and March, we saw strong inflows in energy sector ETFs, but those flows were from investors wanting to go short. Short interest on XLE climbed to around 20% of its assets. But here's where the bottom calling comes in. Short interest has declined since then, and it is now just around 11%.

But the inflows into energy sector ETFs haven't stopped. There was about $1.1 billion April, right at the sector rallied 30%. We were seeing some of the same trends within those airline and energy commodity EPS, you mentioned as well. Those strong flows alongside declining short interest point to bullish optimism on some of the more beaten up spaces like energy. And as we said earlier, you take those trends along with inflows in the sectors with strong earnings like health care and tech. And to me, it shows that investors are picking their spots and buying the rally. Yeah. Kevin, other than internet stocks, I know OGI is very involved in that. Is there anything else you're particularly enthusiastic about? Give us some guidance of what you're thinking is. Let's look six, eight months down the road towards Christmas. What's the sectors that are going to outperform this year?

Well, people that are trying to second guess the S&P 500 towards which companies are going to cut or reduce dividends. I mean, if you're an institution, and as we talked earlier, looking for a 6% bogey, you want at least 50% of that coming from the distribution of capital. So now quality really matters. Now you really care to cherry pick, and this is what I love about the actively managed ETS sector, which everybody poo-pooed only three years ago. Now it's actually doing its work very well because in the case of OUSA, the one I'm going to talk about, that I own, that's 130 plus of the S&P, but the highest quality balance sheets, which generally speaking are higher and more unlike. likely to cut dividends. So if you're using OUSA as a dividend play, which many people are doing right now, with north of 3 percent dividend yield, it's a very good place to hide in the weeds if you're trying to be an institution making 6 percent. This is a time to use actively managed ETSs that focus on things like quality if you're worried about companies that are going to fail or at least

reduce dividend yields. And there's going to be plenty of them, Bob. You've been covering it now for weeks. And I think there are sectors that are going to come out of this much better, obviously, than others. Virus stocks versus non-virus stocks. I'm not loving Disney right now for obvious reasons, but there's lots of companies that have actually done much better inside of the S&P 500 that aren't as worried about the effects of long-term concern to the virus. Yeah, I think that's a very good point. It's hard picking the winners and losers, and that's generally thematic stocks are a little bit fattish to me, but the concept of quality in this environment, strong balance sheet, unlikely to cut the dividends, that makes imminent sense. That's a, that's perfectly rational investment ideology

if you, if you understand what's going on there. Thank you, Kevin. That's a good point. Another noticeable trend to me, Matt, is sort of into America and out of the rest of the world here. There have been outflows in the largest European ETFs recently and some of the large emerging market ETFs. Is this like a lot of the world? a permanent trend out of foreign investments and more into the U.S. in terms of flows? It's not so much a permanent trend, but it is more recent. We've seen those outflows pick up, basically non-U.S. equity focused ETFs lost about $19 billion over the last three months. Meanwhile, $57 billion had been deposited into U.S. targeted strategies, leading to a differential

of $80 billion, which is extremely high and is one of the highest differentials we've seen in quite some time. It was really driven by the outflows into the non-U.S. equity into out of the European-focused ETFs, like you had mentioned, but also into some of the broad ephos strategies as well. I think basically what investors are doing here are ostensibly following Warren Buffett's advice and just buying America. There's really no preference from investors to express a risk on view overseas, given that the economic and fundamental foundations are not as strong if they are in the U.S. but, you know, weak performance, the constructive relative valuations of non-U.S. equity markets and low levels of position, however, set up international to be a big contrarian call right now. But unfortunately, that was the same call for the last few years and have yet to pan out. I think investors do want to sort of step into that market.

And based upon the conversation we're just having on Kevin, they're just focusing on firms with higher quality balance sheets that do trade in expense evaluations, maybe worth a flyer just because they might have some more fundamental rigor to withstand any, degradation and earnings and economic growth. Yeah, it seems to me, Matt, what's going on here is we've got two of the oldest games in the book. Investors are bottom fishing, that's an old game, and let the winners run, momentum playing, as Kevin noted with the internet names, which have been winners for so long. Guys, thanks very much.

Now it's time to round out the conversation with some in-depth analysis and perspective to help you better understand ETFs and put them in the context of today's markets. This is our Market's 102 portion of the podcast. Today we'll be discussing the growing dominance of ETFs and key mechanisms behind them. And this time, I'll be joined by my producer, Kirsten Chang. Just a quick disclaimer. With many of us working from home these days, our audio may sound a little different as we're adopting to the times and have to record on a cell phone speaker. So please bear with us.

I'm a producer Kirsten Chang here with Bob Bizani. And Bob, I want to ask you more generally about the market share of ETS because a lot of people may not realize that for all the attention we devote to ETS on a daily basis, there's still a very small percentage of the overall stock market. We did with something like 11% last year. Will we see that number go up? Yeah, it's been going up. So a lot of this depends on how you slice and dice the numbers, whether you deal with shares traded or dollar volume. But just look at it this way. There's about 2,300 ETFs in the United States, and they've got about $4 trillion in market value. That sounds like a lot of money, and it certainly is, but it's a tiny part of the equity in the bond market. The value of

the U.S. equity market has been all over the place this year, but it's probably about $30 trillion right now, somewhere around there. So think about this. And the value of the bond market is higher. Again, it's been all over the place this year, but it's probably close to $50 trillion. So think about this. The equity market is $30 trillion. The bond market might be $50, somewhere around there. And the ETF market is $4 trillion. So that is not very big. compared to the total amount of stocks and bonds that are out there. It's fairly tiny, but it's growing. A slightly different way to look at this is it's a more important part of the trading

on a daily basis than it is the actual market capitalization of market weight. So, for example, there's about, oh, I'd say two and a half, three billion shares that were traded on a daily basis in ETFs in the first quarter, somewhere around there. We had very heavy volume in the first quarter. So I would bet that all equity trading is close to averaging 10 billion shares a day. So ETF trading may be a quarter of all equity trading in terms of shares traded. Dollar amount might be even higher. So the New York Stock Exchange reported that the average daily value of ETF transactions in the first quarter was $165 billion.

I don't know what the average daily transactions of the stock market was. but I would bet it would probably be close to $400 billion. No, $165 divided by $400 billion. You know, you're getting into north of 30% of the dollar volume of trading. So my point is the actual amount of dollar value in ETFs is very small, but it's become a more important part of the trading activity because a lot of professional traders use ETFs on a daily basis to get in and out of the market. Getting to the heart of how ETFs work,

can you briefly explain that central mechanism behind buying and selling, a process of creations and redemptions? Well, this is a little bit complicated, but simply put, you have a sponsor, you know, an I shares or a Vanguard, somebody like that, and they want to create and say a fund that mimics the S&P 500.

They would have to go out and create an initial fund with a certain amount of money initially, obviously, and buy the S&P 500 stocks underneath it. They would have a trustee that would hold those stocks. And then they would bring in authorized participants. They're APs, they're called, but they're essentially market makers. So if somebody wants to come by and say, I want to buy this S&P 500 fund, they can buy it. But if you get suddenly a lot of people, and there's more people who want to buy it, more shares that are around than are available, the participants, the authorized participants, these market makers are authorized to create new shares.

Now, they don't create them out of nothing. They also have to, of course, the buying process of buying the underlying shares and, you know, putting them with the trust. But they have the power to create new shares and make them available. The other thing that happens, of course, is the authorized participants are people who can balance out any disparities between the underlying price of the stocks, the net asset value, as it's called, and what the actual ETF is trading for. at that moment. And sometimes they get a little out of whack, and that's what these people do.

There's an arbitrage of possibility because obviously it's buy low, sell high, so you can buy the underlying or sell the underlying and buy the ETF or sell the ETF to make everything balance out. And that's one way the whole ETF business works. So the real key to the whole thing is the what's called the APs, these authorized participants that are able to create and redeem shares on demand and it makes the whole business very flexible and very dynamic. 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.