ETF Edge - Fixed income, variable outcomes 2/2/26

Episode Date: February 2, 2026

From Fed nominees to overall risk-tolerances, the macro picture is changing rapidly. A new approach to fixed income tools could smooth out what is likely to be a volatile 2026. 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'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, Dominic Chu. Now, the income may be back in fixed income, but investors should be critical of what they add. to their portfolios. Here's my conversation with Joanna Gallegos, the co-founder and COO of Bond Blocks, alongside Todd Sohn, technical strategist over its strategic security. I'm going to start a little bit with you, Joanna, just about what the state of the market is like in your mind, given the fact that we have a new Fed share nominee, we have interest rates behaving somewhat well over the course of the last few weeks and even months at this point, and the market that seems

to be trying to figure out where the next step is going to be. What exactly do you make of all of this in confluence with each other, Joanna? Well, I think we still see resilient economy. We're seeing through earnings reporting that companies are still faring well. The fundamentals on their balance sheet still strong. Interest rates, the yield curve, looks like it's steepening, behaving appropriately with rates on the long end being higher than the rates on the shorter end. So that feels like a lot of normalization, but the markets are highly, highly responsive right now to all the news that's coming out. I think there was a waiting period in January to understand exactly what the direction was going to be with the new Fed chair. But so for a year to date, there's some really strong

performance in fixed income. Surprisingly, the best performing area in fixed income year to date, and also last year was emerging market. So it tells you a lot about investment and looking outside the U.S. for other opportunities, too. Joanna, how much of that trade is based upon, not just the idea of diversification or mean reversion because they have been underperforming other parts of the credit market and overall rates market for a while. And how much of that is this kind of feeling that there is a de-dollarization or some kind of a movement away from dollar denominated assets because of what's happening here in the U.S. not just from a policy perspective, but from a sentiment perspective as well.

Well, the U.S. trade is not going away in terms of issuance across the board, corporate, government. the U.S. has the strongest fixed-income market. It's the biggest opportunity set for the world to continue to invest in. It represents a lot of stability and a lot of known quantity in terms of the way corporations and the government are able to be available to everyone. But the opportunity set outside the U.S. is also very important. And so I think there could be the dynamic of the dollar putting pressure, the dollar pressure putting more of a view on non-U.S. assets.

But the truth is, I think people, are just seeing the returns from last year and looking for a way to take advantage of those opportunities more so than anything else. Todd, do you feel the same way about this idea that we could start seeing a little bit more of a move away from some of these kind of U.S.-centric assets towards other parts of the market? And how much of that do you think is being driven by sentiment from a flow perspective? Are you seeing that play out on your side? We are.

And I think this has a lot to do with the way U.S. indices are currently constructed, right? it's no secret that you have a little bit of a concentration problem in the United States. Now, yes, some foreign equity markets are more concentrated at the top than they are for the United States. But think how much money tracks U.S. assets. So that's a lot of wealth tracking a small quarter of names. So I think you're seeing this diversifying away from the U.S., not necessarily selling U.S., but going back into emerging markets.

Like Johanna mentioned, there's a lot of good risk return there, whether it's an equity or debt. because frankly, those assets really have not worked for about a decade. So I think investors are getting smarter. They're sticking with the U.S. They're going to E.M. They're surrounding with themes and all the myriad ways to play income in the ETF world. So the flow is definitely back up this idea of looking abroad, looking at all the alternative ways to keep portfolio returns going.

Todd, where exactly from a flow perspective and an ETF perspective are you seeing some more of this activity when it comes to the income orientation? Is it still kind of in that traditional dividend-paying stock type thing? Are more flows going towards bond-based ETFs? Are you seeing more of these alternatively, I guess actively managed alternative income instruments that are meant to spin-off income? How exactly are people playing that kind of a trade? There's a really interesting dynamic that's happening.

Over the last three years, flows to option-income ETFs, right? the ones that sell covered, they sell covered calls, the generate income and try to keep some upside on the equity sleeve. They've outnumbered flows compared to dividend ETFs, right? And dividend ETFs were great in the QE era when fixed income rates were depressed. And so you had to reach for yield. Now you can get that yield from a lot of these different options strategies. And so they're about 25% of dividend ETF assets. And I think investors like that, that they're getting some upside.

They're getting the option premium. There's different tax consequences for that. And then I also would throw down the fixed income space that money market funds have dominated flows for the last few years. You now have rates dripping lower. We'll see if we get two or three cuts this year. And I'll leave that to Joanna and her team what they think. But that's a significant amount of money that's sitting in money market funds, $8 trillion in assets. We believe that as cuts come, that money is going to get deployed to fixed income products, whether it's active, whether it's out on the duration curve or different types of credit, massive opportunity to fix income, ETFs to continue to take share.

All right, so those, Joanna, because we are since Todd broached the subject, we are going to defer to you to this one here. Those bond-based funds, whether they be mutual funds or ETFs, have long been investor instruments and vehicles that people have turned to for that kind of regular paycheck, whether it be on a monthly or a quarterly or a yearly basis. Where exactly then are you seeing some of the best opportunities within that fixed income space, traditionally speaking? We can talk about derivatives and structured products like Todd is saying for some of these

other strategies, but traditional bond funds, whether they're in emerging market or otherwise, are now places that people maybe have more relative comfort. So where exactly do you feel that there are opportunities within that relative comfort of bond funds? Yeah, I hope they feel very comfortable with the income that's back in fixed income since 2022. You know, people were reaching for yield and looking for income to offset volatility for almost two decades once rates sort of went back to zero after GFC. So that advent of, you know, more income back in fixed income has been really important than the last four or five years. So the places that we think investors should be focusing on is credit, you know, in particular investment grade credit, but to be

smart about how to use that, you should be moving yourself out on the rate spectrum to triple B because there's a yield advantage to going out to triple B with basically the same default risk of investment grade, which investors have come to expect rarely, if ever, defaults. So in terms of that safety, locking in or getting exposure to that income dynamic is where we would say you should be, and to be an intermediate right now, because the expectation is, well, we had to zoom up in rates, which is great for income to offset the volatility in your portfolio, we do think rates are going to come down. So now the price appreciation of your bond portfolio is going to come into play versus what people experience was the interest rate,

exposure before. So as interest rates come down this year, intermediate, we think, is a great place to be. It was in the fourth quarter, you know, the intermediate space outperformed most of the other categories across the spectrum of fixed income. So intermediate credit is where we start with. We also like high quality private credit. We think that for what exactly investors are trying to do, they're trying to reach for yield, but they don't want to take on as much risk. So if you're transitioning from that money market space, yet you want to get as much yield as possible, we think you should be looking at private credit. So our product in private credit is right now it's yielding close to 7% with a duration of almost less than a month

and a credit rating in that portfolio of average of A. So it's really important to utilize some of these products that are in the market now. They really can be powerful. I think people like to use some of the derivative products to offset their equity risk, but we want to remind them that the income is back and fixed income. And bonds are not just necessarily the safety part of your portfolio, but also the opportunity and the income set as well. Todd, I mean, some of the stuff that's kind of resonated with what Joanna is saying

has been with investors in ETFs who are trying to figure out ways to enhance that yield. Have you seen any signs of stress in your mind with regard to maybe possibilities for concern down the line because of deteriorating credit quality? Is the economy flashing some signs that maybe things are slowing down a little bit? How exactly does the macro picture shape up, given what we are seeing in terms of a tilt towards income strategies? And do those income strategies then have to be a little bit more closely scrutinized because of some of the macro factors at play right now?

Yeah, I don't necessarily see stress. I mean, credit spreads are still on multi-decade lows, whether it's high yield or investment grade. Financial stocks, specifically the banks and some of the capital market names still are okay, right? You look at big bank ETFs. That's a pretty good barometer of how the market might reflect the economy. I think the one stress point that stands out are private capital stocks, right? The public PE and private credit type names seem to be having some trouble. And there are headlines that are out there of private credit funds being marked down recently, which is where I think the ETF like PCMM that Joanna has comes in handy where it's transparent.

You can figure out what the holdings and the ingredients are in this thing. They're all properly rated. And so I think if you're going to see any further stress, maybe it shows up there, but so far, that's okay. It looks a little bit more, I don't want to use the word contained, but that seems to be the stress point right now is these private capital type names and the less liquid vehicles that are out there as opposed to say in the ETF space. If you wanted to see in the derivatives what's going on there, I would kind of pay attention

of what some of these metal names are going on. How long do they trade it a premium or discount for going forward? Because that's where the action is. But that's completely unrelated to what's going on here for what that's worth. Sure, Joanna, I mean, the private credit side of things has been focused on for a couple years now. But it's been around for a long time before that. It's only recently in the last few years that it's come to the forefront because people have been able to invest in it through fund formats or through ETFs. Is there in your mind an education or knowledge gap with regards to people who are investing in traditional bond funds, whether they be on the rate side of things or investment grade corporate, and then kind of making that move

to reach for a little bit more yield in private credit, are there things that you feel as though maybe aren't being appreciated about what you need to understand about private credit investing that some investors don't know, and all they see is the higher yield that they might get. Yeah, I think the yield is attractive, and that's a good reason to look at private credit. The reality is that more companies are private than they used to be. So 20 years ago, even 25 years ago, there were maybe 8,000 publicly listed companies. Now that's down to 4,000. It just means that the full opportunity set isn't available to you unless you look over the fence into private equity

and to private credit of all of the American companies that you're able to invest in. So that's an important thing. That's why you should look. The yields are very attractive. But one thing that I think people need to understand about the structures in something like PCMM is, you know, it's a very well-diversified exposure to private credit.

So it holds CLOs that are bonds that hold, that underlying loans of direct loans to companies. But what it's in there is there's also multiple managers. So what you're seeing in the press is you're seeing maybe a fund of one manager and one manager's assets being marked down, and that's going to happen. There may be a concentration in that manager's approach or in the loans in the companies that are in their fund. In something like PCM, because of the way it's structured,

you're getting exposure to almost over 7,000 of those loans. And there's 27 different managers in that portfolio. So the immense diversification, it seems to be the right approach in an ETF. It gives you a pure play to private credit, because 80% of the exposure in that product is private credit. And I think there's been a lot of discussion about other vehicles and UTIPs that may not be 100% private credit.

So if you're really looking to get the full opportunity set, reach for those yields with the risk characteristics I described, I think that it's important to start engaging with private credit and not be so trepidious about what you're seeing in the headlines because you should be looking for something that gives you access. to the whole broader exposure. All right, Todd, with that in mind, given everything that we've now seen, we talked earlier at the top of this program about this idea that we have a changing Fed

landscape coming up, interest rates, you know, I'm not going to say that the forecasts are all over the board, but, you know, they've kind of tightened up a little bit and maybe gotten a little bit more clarity with Kevin Warsh being named as the nominee for Fed share. I wonder from your perspective how you think the investing land. landscape for you is either changing, shifting, or evolving over the course of the next few months, given this idea that the Fed is going to be a little bit more variable, I guess, is the best way to put it over the course of the next several months. Yeah, I think from the equity landscape, I would expect more volatility, right?

So you're going to have a new Fed share. It's also a midterm election year, and both of those historically bring volatility. It's just how markets play out, right? There's a lot of different variables at play. So I would definitely be looking for volatility. I would think low-volve-straties might actually make a comeback here. And those have seen pretty good outflows in the last few years as there's been other replacements in those portfolios.

So I think if you're looking in the equity sleeve of your portfolio, take a look at low-vol to help ride the storm out. And then in fixed income, Joanna says, and she's right, the income is back in fixed income, whether it's the two-year, the 10-year, and yeah, the shorter end is dripping lower. but you can start to move out on the duration scale, and you're still going to get a pretty good return there without any sort of credit blobs, I think, that are out there. So I think investors should just realize,

hey, if you're too much in the short end, consider moving out on the fixing of the space, you can capture that yield and look to say, how can I hedge myself throughout what is expected to be a pretty volatile year, given all the policy variables that are out there going forward. All right. And Joanna, because you are the bond. manager on this panel right now from a from a bond manager's perspective what exactly are you thinking

mentality wise or construct wise about how you're going to approach the balance of this year knowing that you know to Todd's point this is a midterm election year knowing that we have a new fed chair coming in whether that's Kevin Warsh the nominee or some other strange development down the line do you have to kind of change the way that you look at fixed income markets given all of these potential catalysts or is this more of a business as you use environment until you see evidence of something actually happening. I think if you've been steeped in fixed income as we are every day, you do see the bouts of volatility, do you see the uncertainty coming through in the appointment of the Fed chair.

But what we see is a lot of consistency. So for 2026, our outlook isn't much different, but what we do, which is sort of very much a bond blocks way, is we just help you get more precise during a year like this year. So we still see that credit fundamentals are very strong. Spreads are tight, which also means that you can just really means that the economy is strong. There's still really attractive yields and income, as Todd mentioned. So you should be using more fixed income. We like credit.

We do like the international exposure this year to help, you know, move people towards, you know, a more diversified portfolio, but also capture some of the attractive yields that are developing there. As we mentioned, like it's important to look at the full opportunity set, So private credit, so public and private credit is something we want people to look at. So I wouldn't say that we haven't seen defaults. That's been very consistent. The resiliency, the strength of the economy and the income, we've been telling that story in 2023, 2024, 2025.

The mix is a little different, but there's a lot there still for opportunity. And Todd, before we let you go, the one thing that could derail what's happening in the markets right now in your mind in the next couple of quarters, what would you be watching out for? A credit event. If any of this private credit in the illiquid space starts to leak into other areas of the financial system, I don't have any edge on that, but that would be my, you know, kind of the glaring sign of risk. I think that's out there, quite frankly. Everything else so far seems all right, right? Credit spreads are still okay.

Banks are still okay. The consumer seems all right. But I think it would be some sort of credit event out of left field that leaks into other. areas that we're not maybe focused on. And Joanna, same question to you. What exactly would you be keying in on from a data perspective, a macro perspective, or anything else with regard to whether or not something does maybe happen badly down the line? I think we have our eye on credit events. I think we also think about, as I mentioned, you know, the diversification. It's hard to say, we had a huge credit event with a bank failure two or three years ago, and this economy absorbed

that. So I don't know that a credit event would be on our top list. I think we want people to be paying attention to the risk in their portfolio and adding as much income as possible. I think on the side that we've seen investors take probably too precariously time and time again is going too far out on the curve into the 20 year too fast because they think that, you know, rates are going to come down very quickly. That can be not the best trade and it's been really volatile for investors time and time again in the last four years. Or just piling back into to equity. Equity risk seems to be, you know, a huge appetite for the U.S. investor and not offsetting that risk. Once you get through, you know, some comfort level, there's a dip or

there's a market volatility. We see investors just go all the way back in. So not being more balanced there and diversifying your risk is what I actually think is the risk, not necessarily in a bet. Now it's time to round out the conversation with some thoughtful analysis and perspective to help you better understand ETFs with our Markets 102 portion of the podcast. Todd Sone, technical strategist at Stratica Securities, continues with us now. Todd, I'd like to focus in on something that you mentioned during the ETF Ed show that I kind of want to dive into a little bit more. And that's this notion that there's an evolution, if you will,

of income generating investments when it comes to the types of products people get into. Bond funds are bond funds, and they've been kind of like that. way they've evolved a little bit. But the equity side of things has typically been tilted towards things like dividend paying sectors, right? Utilities funds or consumer staples funds for those income elements, maybe even those so-called dividend aristocrat type ETFs that kind of focus in a little bit more of that dividend equity strategy. But you make a case that these days, there are a lot more elements and a lot more instruments out there that are trying to also replicate income for investors. What exactly are you seeing in terms of how, at least some investors are getting their exposure

in the equity income side of things? It's a great question, Dom. And I think this is part of the beauty of ETFs. They are constantly involving and you're seeing issues constantly bring different types of exposure. So if you think back to the massive growth of ETFs from, say, 2009 of 2022, right? Almost the QE error, so to speak. Depressed rates, very hard to generate yield on the fixed income side, so investors resorted to dividend funds. I think staples, utilities, some of the discretionary names out there, insurance type names, to reach for that three to four percent yield. Fast forward, we have hiking cycle, and we also have changes that allow for much more derivative use in ETFs, and we have seen an absolute explosion in the amount of

of ETFs, they're now using options to generate premium income, right? They're selling calls against the whole basket of stocks in order to generate income, and that can go up and down depending on volatility. But that is now taking share of what you would get from dividend ETFs. So, for example, there's about $500 billion in assets of dividend ETFs, and there's about $100 and some odd billion in option income ETFs, and that has rapidly risen over the last three years. So they are taking share away from the dividend-type product.

investors are seeking yield elsewhere. You see it in the flows over the last three years. So I think a lot of investors are saying, you know what? I want S&P exposure with an option strategy on top of it rather than saying I'm going to go out and buy very boring utility or dividend type funds going forward. How exactly then, what exactly do you have to make the distinction with with regard to those different types of instruments and investments? I mean, when I think of options or derivatives, I automatically think, oh, it's got to be really complicated. I don't know, should I even be involved in these things? I know what bonds kind of are. I know what coupon clipping is. I know what the income is supposed to be like. And then I kind of know what utilities

pay because they're cash cow type companies, AI, you know, notwithstanding, but they generate a lot of cash and they pay these things out, generally speaking, in heftier dividend payments. But what exactly do you have to be wary of or understand more of with regard to, say, index strategies with options overlays to generate income versus those traditional income paying sectors or instruments? Well, first it comes down to the exposure of the underlying basket, right? If you are doing the S&P or the NASDAQ, you're technically adding more equity that you probably already have exposure to, right? You likely own a large cap passive fund. So then if you're buying another large cap pass full option income, that's more of the same stocks. That's just one thing to keep in mind. There are tax

differences and how options can be tax versus say qualified dividends, you know, consult your tax experts on that. And of course, the, I mean, just like dividends, the option income can vary. If it's a low-volve-environment, those premiums aren't going to be high. If it's a high-volve-environment, those premiums can be higher. And then of course, one of the, you know, the main difference here is you're talking about a strategy that's going to be actively managed with the options component here. And you're going to want to have a manager who knows what you're doing in the options market because it's very complicated. versus a dividend or yield strategy that is likely just kind of quantitative base and it's built

and tested over time. So as long as you're comfortable with having an active manager at the helm for that option component, then I think it makes sense for investors. But obviously these are parts of the due diligence you need to do when things get much more complex, which is the error we are in for ETFs now. We are definitely in a complexity error as opposed to say simplicity like the first 15 to 20 years of the industry. How much, Todd, from an ETF strategist standpoint, do you have to kind of adjust the way that you construct portfolios for income outcomes, right? How much do you have to now do the homework or do some of that kind of portfolio construction legwork on your own to kind of understand just what the risks and rewards are

of using all of these new different types of strategies to kind of achieve that monthly or quarterly income profile that you want to target? Yeah. Yeah. I think at first it comes down to what you know what's your demographic how old are you because we have plenty of investors now from whether they're 15 years old to 75 years old who have all these different goals and it can and can swim in these types of products so figuring out what's the income you need and then secondly having an understanding of what else is in your portfolio because I think one of the problems facing ETFs right now is if you own large cap blend if you own large cap growth even quality and momentum there's a lot of overlap among some of those names atop those indices

So you just have to be careful of making sure you're not overloaded on certain types of names. Maybe it's AI, which clearly has benefit investors, but maybe it's being questioned a little bit now. So when you're constructing these portfolios, know what is my exposure to top of the indices. And then when I'm adding the income component, where's it coming from? Is it again now overlapping or is it completely different side, right? Is that where fixed income comes in? Or am I getting income from, say, gold now, right? There are covered called gold funds that are generating massive premiums because of the volatility in the metals market.

So there's all sorts of different ways you can go. But I think it comes down to demographics of what is in your portfolio before you even start adding the derivative area. And Todd, one final question before we let you go here. If you look at the way things are shaping up with regard to some of these income-type investments that are really starting to percolate a lot more in active ETFs, what would you be watching out for in terms of the next big step when it comes to income investing? Do you feel as though something is due to happen later on this year?

Is there a product evolution that you're kind of maybe looking the most forward to? What do you think is going to be that thing that really gets your interest in income investing for the rest of the year? You're seeing a lot of newer products shorten the intervals between distributions, right? So, you know, back originally it was quarterly or monthly. Now you're getting down to weekly and on single stocks too, which is kind of interesting. And then in some cases more than, you know, twice a week. I think is a very nascent product that's out there. So the frequency of distributions is changing.

The one thing you have to be very careful of is when you get higher distributions, are they actually income or is a return of capital? That turns into a whole tax scenario. Basically, are you getting the money you invested right back in your pocket and actually not really make anything? That's where it gets very tricky with some of these options strategies. So make sure you understand the underlying asset, how volatile it is, and also the frequency of distributions.

Is it something you want weekly or are you good with monthly and quarterly, like how they used to always do it? I'm pretty sure it's going to take hours to figure out what the tax implications are from that kind of a policy perspective. So Todd for another time. Todd Sone is Stratigas. Thank you so much. We appreciate it. Thank you, Dom. All right.

That does it for ETF Edge, the podcast. Thanks for listening. Join us again next week or just head over to etfedge.cnbc.com. Over the last few decades, technology. has transformed our world in amazing ways. Through it all, InvescoQQQETF has connected investors to the forefront of innovation. Access the future today with InvescoQQQ. Let's rethink possibility.

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