ETF Edge - Inside Scoop with Invesco – What the Flows Are Saying 10/24/22

Episode Date: October 24, 2022

CNBC’s Bob Pisani spoke with Anna Paglia, Global Head of ETFs and Indexed Strategies, and Dave Nadig, Financial Futurist at VettaFi. They did a deep dive into fruitful yields and the future of growth stocks. Invesco offers a suite of products that track senior loans issued by banks to corporations, as well as the largest tech-oriented ETF out there, the Invesco QQQ. They discussed what the flows are saying about investors’ appetite for growth and for risk – and how to best handle the market’s many twists and turns heading into year-end. In the Markets ‘102’ portion of the podcast, Bob continues the conversation with Dave Nadig from VettaFi. Hosted by Simplecast, an AdsWizz company. See https://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 interviews, market analysis, breaking down what it means for investors. I'm your host, Bob Pizzani. Today on the show, we're doing a dive on fruitful yields in the future of growth stocks with two of the best minds in the ETF business.

Investco offers a suite of products that track senior loans issued by banks, the corporations, as well as the largest tech-oriented ETF. That's the all-powerful triple-Q. the NASDAQ 100. We get an update on what the flows are telling us about investors' appetite for growth and for risk. And how investors can handle the market's many twists and turns heading into the end of the year. Here's my conversation with Annapalia, global head of ETFs and index strategies at Investco, along with Dave Noddick. He's the financial futurist at VETI.

Anna, you run the largest tech ETF that's out there, the triple Qs. We talk about it all the time. It's the NASDAQ 100. We're down 31% this year. and yet I see no outflows. It shares outstanding are near 17-year highs, and S&P tech sector, Kathy Woods, ARC fund, not appreciable outflows so far this year.

Why tech investors so loyal to the markets? Why aren't they fleeing? Well, they are not loyal to the market. They are loyal to the idea of growth. You do not assess growth companies based on what's happening today, what's going to happen next month. You assess growth on what you think is going to happen in the next five years. or 10 years. So you have to look at the entire cycle, and I'm not surprised to see so much

loyalty on the QQQ. We actually piled on the QQQ with new products over the last few years because of that. I want to talk about that, but Dave, I look at these leverage and inverse bets on the triple Q that's a gigantic industry. Highest volumes every day. Every day, these pro shares ultra-pro pro-share's ultra-short QQQQs, the biggest thing. Why is that? How are they used? And given the... reset every day. I'm amazed at the success of it. I mean, it's speculation, right? And I think we have to put two things together. One is that the cues have been used as the proxy for tech growth in the United States since the 90s. And that has only become stronger over time. So when people look at the

shorter, the leveraged versions of that, what they're really doing is using the benchmark proxy for tech and growth in their day trading strategies, right? We talk about spy being a proxy for sort of generic large cap and all of the derivatives activity that happens around that in the queues, while there's a little bit less activity in some of the more obscure derivatives markets in the ETF space, boy, those short and leveraged products have just been stalwart for volume ever since they launched. Yeah, you know, Anna, we have talked, Dave and I have spoken often about the increased complexification, if you want to call it that, of the ETF structure. Have ETS gone too far with these leveraged and inverse products?

I mean, you run a big family of funds. What's your opinion on this? So, Bob, you can call me old school here. I'm a purist. I believe that the ETFs should deliver the results that investors expect from them. And if you think about ETFs, the first thing that comes to mind is

easy of access, diversification, cost effectiveness, and efficiency. Now, if you take that away and you add the level of complexity, now you are directing your offering to a subset of the point, that is not really buying the ETFs for diversification and ease of access. So I am a purest when you think about ETFs.

I like the traditional diversified portfolio better. Can you make an argument for why we need these? I always say they're leveraged inverse of 2% of the volume, 98% of the problems. Clearly the headlines. Do we need, is there an argument to be made that why we need them? Yeah, absolutely. And we can turn to the cues as a perfect example here. The people who are trading short cues and leverage cues are not doing that

because they're looking for a more efficient beta for their retirement plan. They're doing that because they're making a call on tech earnings season, one way or the other, maybe even tech earnings announcements today. That's where those products have a real place. Now, is that investors? No. Those are speculators and day traders looking to put large amounts of money to work quickly in a well-tracking, highly liquid vehicle.

ETFs really do check that box. Now, I agree this is not really where ETFs have found their foothold, which is really with buy and hold long-term investors and advisors. But there is a market for these more traded tools. Now, whether they should be as accessible and whether there should be gates against some of those, you know, sharper tools, I think that's a reasonable conversation. Kenzler's talked about the idea of should people be required to have exams,

for example, for these complex products. And there's something to be said about that. I mean, you do have to sign off saying you understand the risks of trading options. Yeah. Right? Well, any, you know, any miner could buy ETS. I'm exaggerating, but it does hide the risk. Not that wrong.

Like my mom and her, you know, IRA can go buy triple leveraged oil if she really wants it. Should she be able to without acknowledging she understands those risks? Probably not. Yeah. And Bob, this is why it's scary because there is a derivatives market that exists just for that type of investment. Those sophisticated investors have access to the derivatives market. So should they have easy access through an ETF? That's a different type of investor that maybe don't really want that type.

I can imagine a guy who wants to trade options, you know, and they trade saying, well, hey, this is fabulous. I don't have to have a margin account. I have to do anything with an ETF. It's sort of a backdoor way of getting what they want without having, you know, to put up. And on the short side, you never have to worry about getting a margin call because all you can lose is all your money, which always strikes me as an odd selling point. Yeah, it is a great way to say it. And these Triple Cube products have done very well.

have done very well. You had the next generation 100 ETF that launched a couple of years ago. I call it the NASDAQ 200, but it's sort of the 100 non-financial stocks that are next eligible for the 100. I guess that's the way to say it. It's like I call it the NASDAQ 200, essentially. There's been some modest outflows this year, but considering these companies tend to support relatively high valuations, it's still a lot of loyalty from investors, even in what you could call arguably the second tier of tech companies that are out there. Indeed, so two years ago, Bob, you may recall that we launched an innovation suite. So we created the 40-active version of the QQQQQ and the QQQJ, which is the next generation of a

QQQ, NASDA-listed companies. In the last two years, these products have collected something like $6 billion of net new assets. And that really shows the investor loyalty to this type of concept. And we just launched a third addition to the family, QQQQQS. S for small cap that gives investor access to the entire journey of a growth company. Yeah, you know, the distinction here with the Kathy Woods Arc Fund may be that most of these companies do make money in the NASDAQ 200, I mean, even if they have high valuations that are out there. So I'm just astonished at how loyal everybody seems to be.

Well, I mean, there is an index methodology, and I think that that gives people some solace, right? They know that they're not going to have to worry about whether this is in or out tomorrow because there's a methodology, and that tends to smooth out that ride. It's not surprising to me with the franchise that the Q's has in terms of a brand, that people are trusting that brand to look further into the market. So it doesn't surprise me at all. Yeah, so I want to talk about your new product here. You've got a new QQQQQQ.

There's a whole suite of products that are launching around this thing. QQQQS, you mentioned. This tracks an equal weight of 200 NASDAQ stocks based on the value of patent portfolios. Here's a very interesting concept, and yet the way you keep explaining it to me is the Patents at the heart of why famous companies have been successful in the past. Explain what this is about now? Sure. So if you put the concept of innovation to work, we look at how much money companies spend

in research and development. And the money in research and development translates into patent findings. Now, if you go back in time and think about the big tech companies, or even outside of tech, think about Amazon, think about Tesla. These are companies that invested a significant amount of assets in research and development. Amazon 10 years ago, 15 years ago, was the place where you could buy books online. Today is much more than that because of all the developments in tech. Tesla, if this fund existed in 2011, Tesla would have been in the fund back in 2011.

And we know that Tesla has been promoted into the big QQQ. So for us, patents are an indication of innovation, and QQQQS, which includes small-cap tech companies, give access to that growth journey that translates into the J and into the M. This makes some sense what she's saying. I mean, I look at the companies on this list. They're small, prithina, fibrigen, series therapeutics, paratech pharmaceuticals, but I can see how all of them are going to depend on some kind of patent to make their bones. This is a page right out of the active management playbook from the 90s and 2000s, right?

Going after companies with strong intellectual property has been catnip for active investors, stock pickers for a long time. This is taking that with a systematic approach, right? We have so much better data than we had 20 years ago, not just about what patents have been filed by what companies, but on how to value those patents, how they match against other things in the market, how unique and marketable they are. All that can now bake into a methodology that on the surface looks very simple, but is actually covering up what was 30 or 40 years of active management prowess, really trying to understand what companies were building.

It really highlights the wonderfulness of ETS because the methodology enables you, and here's what you're listing some of the companies here, to essentially troll for the companies that have valuable patents, put it into an ETF. So what would have taken a big research team and a mutual fund that would have charged you 2%? 20 years ago, you'd now buy an ETF. Another advertisement for the ETF business. Well, simple and rule-based.

That's right. Rule-based. Good idea. Good point there. I want to, I know we've been talking about tech a lot. I want to move on to another hot topic, and that's the search for yields. We've been doing this several times. Investco, and it runs Invesco, okay, the ETF end of Invesco. Senior loan ETF, B-KLN. This tracks a market value-weighted index of senior bank loans. These are issued by banks to corporations most of the time. After seeing a good outflow for, you know, part of 2020, too. We're seeing inflows. What do we have a 3.7% yield here? That's got to be part of it. But what's the attraction here? What are you getting with a bank loan first off? And how is it different than, say, a treasury bond to explain it to somebody? Sure. So, BKLN gives you access to the 100 most liquid loans that are offered in the marketplace. And that's powerful because when you think about the loans, the first concern that you have is about liquidity. Now, this fund really wraps the most. the liquid loans. The yields are in excess of 3% now. So we have seen incredibly healthy

flows from clients looking for income, looking for yield, and those clients that are worried about inflation, interest rate hikes. So we have seen outflows at the beginning of the year, which have turned around in the summer. And now it seems like clients are really looking at the yield story. And this fund is the perfect vehicle for them. And maturities for these loans are typically what, range five years, six or seven years? Yeah, fairly short, often with a variable interest component as well. So they can give you a yield that you might not just expect to see if you look at liquid corporate bonds, right?

It is a different structure of financing. But this hunt for yield, it's up and down the product line. We've seen flows into traditional short-term bond funds, but we've also seen a lot interest. I know in your bullet shares products, particularly in the corporate side, you know, some of those that are, you know, have a yield of maturity of only a couple years now are paying five, six, 7% on the high yield versions. That's catnip, right?

That's for an advisor that's been hunting for yield for the last seven or eight years, being able to see a 5, 6, 7 handle on a potential yield for a short-term bond fund. Even a big uptick and ultra-short duration. Yeah, well, absolutely. And the ultra-short side is probably more of a cash management issue. We've seen, I think, in this downturn, instead of a huge increase in money market mutual fund in cash sweep vehicles, we've seen a huge increase in super short-term. term bond funds up and down the spectrum.

Super short for you is one to three months? Yeah, one to three months, under six months, right? You get out towards six months and now you're talking about products that are really more like actively managed short income funds. Yeah. So what we have here, Dave, suddenly, has got a whole raft of products which have real yield now. That's quite amazing.

I mean, how do you think about that in your bond allocation? Well, I think there's a really interesting stuff going on in the sort of portfolio management academic sphere around do we now need to rethink what we meant by the efficient markets hypothesis, right? Do we believe a 7% yield when we're also pairing that with, say, 7, 8, 9% inflation and what we know is going on in the capital structure inside companies? I think a lot of those pieces are moving parts. You talk to very sophisticated advisors who run model portfolios and they're not claiming they have that's all figured out either. They're really trying to understand all of these new betas that are coming to market and how they're really going to interact

in the rate environment that we can project for the next year. So I guess the question is, I'm trying to give practical advice to viewers who are watching here, where does it fit in in your portfolio? We had the fellow who was doing single bond ETFs last week on. I mean, viewers literally wrote it and said, this 4.2% on the four year, excuse me, on the two year, where do I get this? Because on my bond funds, I don't have it. I said, well, that's the problem of bond funds.

They own old bonds. So here these guys, they do an on-the-run, you know, bond. They literally sell the auctions are every month. They sell the last auction, buy the new one. And it turns out to be cheaper than doing it at Treasury Direct. Well, that's what they claim. It really does. Well, they say that.

I don't know. I've talked to a lot of advisors who are using those types of products, and the reason they have traction is because most advisors can't log into Treasury Direct and go buy 400 bonds for their 400 clients. They have to go through a desk somewhere. The friction in that desk ends up being more than the cost of just buying one of these cheaper beta funds. Yeah, yeah. Commodities continue to be a big diversifier out there.

Whether you're owning commodity stocks or a basket of commodity futures, DBB, for example. This is one of the favorites out there. It's basically copper and aluminum futures, I think. We're DBA. This is the agricultural futures contract. So we've seen geopolitics. cause price fluctuations in agriculture this year. Look what's going on with the Russia-Ukraine

and how that's messing with wheat. Industrial metals are being driven up by potential bands on aluminum, drawdowns in copper. It's been a crazy year for that. How are these funds trading? Well, the commodities, I mean, let's look at the asset class to begin away. Commodities have been performing much better

than equity in bonds, which it's obvious. It has been obvious throughout the entire year, even if during the summer they gave up some of the upside. We have seen very healthy flows in products like PDBC. You know, Baba, when you think about commodities, you think about precious metals, gold, but PDBC offers a diversified portfolio, which is what investors really like. So you will find in their energy, but also agriculture, industrial metals. So you have access to a portfolio of commodities that is very diversified. I want you to explain the title here because it's optimum yield is the PDBC.

What is it what does optimum yield mean? How do you? So it's based on an index methodology that really selects the best yielding contract at the end of the month. So it doesn't go necessarily from month to month. This fund invest in futures, so let's not forget that. So the secret behind this portfolio really stands behind the optimal yield methodology that is not just, just rolling a future from month to month. So we look at value for our investors

in how these future contracts trade. Is there indications that investing, this is a managed fund in a sense, that it's a rules-based fund, but is there evidence that that would be a superior way than just mechanically rolling over? Okay, we've got 6% and copper and 12%. You can do the math in your head, right?

If the futures curve for oil is like this, you don't want to be rolling into that contango month after fund. It's going to cost you, right? So somewhere that could cost you, right? So somewhere that curve rolls over where it's still sensitive enough to the price of oil, but you're no longer paying a two or three or four percent monthly cost to keep rolling. That methodology basically finds that spot on the curve where you're either making money from backwardation

or you're minimizing the loss from contango. It's been out for ages. That methodology has been out for ages and ages, and it's been very successful. It's absolutely the default for most financial advisors, PDBC. So that's a very good example, then, of an actively managed rules-based fund, where it actually changes month by month, right? So at one point, you might have a certain amount of money in oil futures, and the next month it changes, right?

Well, there's reset periods, but mostly what it's doing is picking the month, right? Are you in June oil or are you in August oil? That tends to be a pretty big determinant of the difference between different commodities funds. Yeah. What else are we seeing and flows into in commodities? Anything? I mean, is the commodity trade over? I know you're not a strategist.

I don't think it's over. I don't think it's over. I think it's going to take some time for the commodity trade to be over. The geopolitical risk is not going to go away anytime soon. And we see how politics have really played in the price of commodities. DBA, the Agriculture Fund, has been a fund where we have seen very positive flows at the beginning of the year. And then clients came to us and said, we don't like to have a K-1 at the end of the year. Can you do something about it?

And we created the 40-acted version of that fund, which is PDB. B-A. And we have seen very positive flows in there. So I don't think the commodity place over is going to take a while for that. That's an important point about getting the K-1 and make that distinction there. What funds do you get a K-1 in? What funds do you not get a K-1 in? Yeah, so, I mean, usually they say no K-1 on them in the fund name, which is the thing that you want to look for. It's important to point out that the K-1 is mostly a hassle. It's not that you necessarily make less money when you get a K-1. Just your accountant makes a little more money because he has to do a little more work at the end of the year filling out your paperwork.

But the no K-1 versions of these would sort of use a little bit of a trickery would be the wrong word. They use some mechanics to get around some of the problems in the 40 Act in terms of how commodities get taxed, all totally above board. It's become how most commodity investing gets done now is in these no K-1 vehicles, like PDBC or PDBF. What's amazing to me this year is to watch this debate because as an asset class, we always talked about stocks, bonds, commodities, and maybe real estate as a separate asset class, but nobody paid attention to bonds or commodities as an asset class in the last few years.

And all of a sudden, instead of there is no alternative, Tina, determined that there are alternatives. And some of them have done well. Some of them have really done well. So to me, you know, the Jack Bogum, he says, oh, there's mean reversion, you know, eventually. It's about time, actually. because if you think about it, what we just saw in the last 10 years, that's weird. Not what we have now. Four year, 4% yields on a 10 year is not weird.

No, it's pretty normal. What's happened before it was weird in the last 10 years. So as painful as it is, it is nice to see some normality. It is nice to have your mother call and say, Robert, I saw the CDs at the bank. They're offering more. I said, no, mom, the CDs are still terrible. But even my mother noticed. Right.

Right. Well, you put inflation into that mix. And I think that's the part that a lot of people haven't quite, even advisors I'm talking to, they're hunting for yield, they're looking at dividend funds, they're researching the stuff like crazy. But in the back of their head, they should have that voice that says, but in an 8% environment, 4% still losing me 4% real a year. And that's, I think, the part that a lot of folks are really rethinking their portfolio allocations because of that. Yeah, do we, I guess the question is, can we bring it down and still stay at 4% and finally get some, you know, real returns on the whole thing?

We don't know, folks, but that's what makes it fun and interest. And remember, there's ETFs for all of that. Now it's time to round out the conversation with some analysis and perspective to help you better understand ETFs. This is the market's 102 portion of the podcast, and we're continuing the conversation with Dave Noddick from VETI. Dave, one of the things that we talk about often and you talk about is the rise of active management. That seems to be another theme this year. It's still a small minority of assets under management, but what's the major trend you're seeing? Yeah, so the big deal here is that a lot of the betas that seem interesting are actually not boring old beta anymore.

They're interesting because they're being well run by active managers. And you and I both know this whole industry was really built on the back of passive funds, low-cost indexing, the bogal effect. That's really what drove things. This year we've seen just a couple of examples. First of all, the arc complex. Despite pretty significant underperformance to the baseline indexes, flows have either been positive or stayed-stead. I think that really attest to the power of a good story behind a fund. And I don't mean that in a pejorative way.

It's a story that is true. It's a story about how they manage money and they've stuck to those rules, those ways of managing money. And investors have stuck with them. At the same time, we look where money really has flowed. Two examples come to mind. The JP Morgan Equity Income Fund, JEPI, has just had constant flows for the last year and a half. It's done extraordinarily well, and that's kind of a one-stop shop. It's equity exposure, but with dividends and with other ways of generating income,

like using options overlays, all with an active manager. Hamilton, I'm going to get it wrong. But he's been running that fund for quite some time and has a bit of a track record behind it. So what do you call these equity income funds? I mean, is it sort of like the everything in one package, ETF? It's exactly what it is, right? And I think if you think about where a lot of advisors have been in the last couple years, they've been in this market where, well, they had to stay in U.S. equities.

There was no alternative. Bonds were garbage. There was nothing to do there. They weren't really even diversifying very well. And they were looking for alternative income streams and options-based products and buy-right strategies and junk bonds anywhere they could. Funds like Jetby are now putting that into one package with this idea of having somebody minding the store.

And what we've learned is things change very quickly. having somebody minding the store can be a real help. Yeah. And yet, these kinds of mixed funds have been around for years. I mean, the Wellington Fund is one of the oldest funds in existence. It's a stock and bond fund, essentially. Yeah. What's different? What's different is the environment, I think, more than anything,

and also what we expect out of an active manager. Like, if you think back to the 90s, right, the active managers of that era were sort of rock stars, right? We looked at people like a Jeff Vinnick, right? And we thought of... Peter Lynch, yeah. We thought of them as sort of being the masters of their own little universe. Just not the case anymore.

What's different now is we've got interest rates up 4% in however long it's been 16 months. We've got the commodities complex whipsawing with commodities data, with global GDP data, with what's going on on China. The markets are now moving so much faster than they used to that I think having some human interaction that pay attention to that's important because methodologies tend to be fairly slow. If you've got a 200-day moving average strategy and the world changes on day 101, well, guess what? You're not going to respond quickly enough.

So I'm not backing up the truck on active managers. Most of my money is still completely passively managed and low-cost beta, and that's probably the right call for most people's assets. But we're seeing this rise of targeted asset managers in specific areas where active seems to be working. And yet, over time, we still see active management in general underperform. Underperforming. There's a chapter in my new book, which is out this week where I talk about how difficult it is and the unknowability of the future. And remember, the active guys always say in a volatile year, this is the year they're going to outperform. Which it hasn't been forever. How many decades have we heard this for?

Right. So some can this year is not terribly shocking. No, but here's the thing. I'm not suggesting that the average stock picker is going to start beating the index. The math is just never going to make that work. But you take something like DBMF, which is the managed futures fund. It's a CTA-style fund absolutely on the deep end of the pool for most investors' exposures. But there again, you've got an active manager deciding to be short the yen in long gold or short gold and long the euro. Whether he's going to get that right or not, I think that's a reasonable question. But we're starting to see some track records really get put down.

All right, Dave, we're going to have to leave it there. Dave Naug, my old buddy, Financial Futurist at Vettify. And everybody, thank you to watch me, Tf Edge Podcast.