ETF Edge - Kicking off Q2: Bond ETF Bonanza Going Strong? 4/3/23

Episode Date: April 3, 2023

CNBC’s Bob Pisani spoke with Chris Concannon, CEO of MarketAxess – along with Alex Morris, President and CEO of f/m Investments, and Tom Lydon, Vice Chairman of VettaFi. They discussed the top ETF trends to look forward to in the second quarter. Will the tidal wave of money pouring into Treasury ETFs continue? Markets are already undergoing some important sectoral shifts bubbling below the surface, so will technology plays take more of a backseat in favor of consumer- and cyclical-focused ETFs, or should investors expect more of the same? In the “Markets 102” portion, Bob continued the conversation with Tom Lydon from VettaFi. 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 InvescoQQQQ, 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 breaking down what it all means for investors. I'm your host, Bob Pisani. As Wall Street kicks off a new month and a new quarter, today on the show, we'll discuss the top ETF trends to look forward to in the second quarter. reporter, particularly will the tidal wave of money pouring into Treasury ETFs continue?

We've already witnessed some important sectoral shifts taking place, so will technology plays take more of a backseat in favor of consumer and cyclical focused ETFs? So should investors expect more of the same? Here's my conversation with Chris Canaan, CEO of Market Access, along with Alex Morris, president and CEO of FM Investments, and Tom Lighten, Vice Chairman of Vetify. Okay, Chris, so Treasury ETFs. $45 billion of inflows in the first quarter. I got, wow, I don't know when the last time I saw $45 billion in treasuries.

Corporate and high-yield funds had outflows. Oceans of money is going into these treasury bonds and treasury ETFs. It's unusual to see all this money. What are the challenges of investing all this money? Is there an issue for the market handling this inflow? If this was a stock thing, we'd be debating, like, how are they going to handle? Where are they going to be putting all of this money? What happens now?

Well, I think, first of all, thanks for having me on the show today. I'm excited about what's ahead because I do think investors have rediscovered bonds, given the rate of return that we're seeing from the bond market, given rates that the Fed has adjusted upward. So I'm super excited of what's ahead for the bond market. But the bond market can consume all this AUM. Over the last couple of years, electronic trading and the bond market has grown dramatically. It's now a third of the market. It's now a third of the market. market access is about 20% of the overall U.S. corporate market, and it's fully electronic and easily can consume that kind of AUM coming into the market. I want to talk more about electronic trading and your role in that coming up. But Alex, we had you on a few months ago. You become a regular here. You hit the right spirit, the right ETF at the right moment. You were talking about your suite of on the run single Treasury ETS.

You added five new ETFs last week to complete your suite of offerings. We have to have the viewers understand what you're doing here. So explain how these single treasury ETFs work, and what advantages are there in buying them over, say, buying treasuries directly? Sure. So first of all, buying treasuries directly can be very hard. Go to Treasury Direct.gov and try it for yourself. It's confusing.

There's a lot of issues. And unlike, say, a stock, which is evergreen, and you can buy the stock and you're done, bonds will eventually make their way to maturity. So a two-year on-the-run bond today is not the same bond in 30 days or in 60 days or in 90 days. So there's inherently more trading action required to just hold on to the thing you thought you bought. And most investors don't want to put in that effort or it's expensive to it requires professional skill to make that happen. So we launched these to replace the need to do that. So now, as opposed to creating a ladder, waiting for everything to come to the bottom of the line,

ladder. You can just set the ladder and it will stay exactly where you want it to be. We take care of all the trading for you and we do that in professional scale. And it's just to explain to people, on the run, when you buy a one-year treasury, you hold it to maturity, you get exactly the yield that you're buying. But in here, you're buying on-the-run treasury. So you're rolling over, one-years have auctions every month. Correct. Right? So you're rolling over every month into the new one. So you're not necessarily going to get the same yield every single time that when you're rolling over into a new one. That's right. You'll see some price action based on what the one year is trading at today,

what you see printed on CNBC with some regularity. And the upside there is you're constantly getting that same exposure. So if you bought a one year and you're really happy with its yield today, and you wait a year, what do you do with that money? Now here you can choose that one year. You can also move up and down the spectrum now that we've launched all 10 of the key benchmark tenors. It's 15 basis points. 15 basis points. And as opposed to some of the multi-bond funds that you'll see, which perform a different function, same. price, but now much more surgical access to what you see on TV and what exposures you want to put in your portfolio.

Tom, I look at the quarterly numbers, which you provide, VETIFI provides me, $3 billion in outflows from U.S. equities last quarter, $45 billion in inflows into Treasury ETS. We just talked about this. Your thoughts on this. Are we going to continue this tidal wave of money going into the second quarter? Well, the great thing, Bob, as you point out, you're finally getting paid for being invested in fixed income, where it's a lot different than a year ago. And when the six month is actually paying close to 5%, and the 10 year is paying 3.5, it doesn't pay to take that added risk. So kind of what these gentlemen are talking about right now, it's worth getting paid.

The other thing is we've seen almost $5 trillion now in money market funds. you're starting to get paid a little bit for that as well. But with the Fed balancing the risk between fighting inflation and the banking conundrum we've got, along with trying to keep us out of recession, there's this tenuous period right now where a lot of people are kind of risk off. Hence, we've seen flows into ETFs that we haven't seen in a long, long time. And you know, you point out money going out of equities and into areas like treasuries. or into areas like international funds that we haven't seen those types of flows in a long time, because valuations are there, and guess what?

People are looking for good value. Yeah, I suppose I should highlight the fact that while we have $3 billion in outflows from U.S. equities, there was $29 billion in inflows into international equities. So here's two anomalies. We haven't seen notable inflows in international in ages more than a decade, and we haven't seen these kinds of inflows into treasury bonds in a long time. I gather people looked at the United States and said, maybe incorrectly, the chance of recession very high here, and maybe we should spread the money around a little bit that accounts for this inflow into international equities.

Yeah, I mean, I think you're dead on right. I mean, and when you look at, for example, the top holdings in the S&P, you've got Apple and Microsoft that are 13% of the overall. overall weighting, they were up 27 and 20%. You factor that in, and that was a lion's share of the S&P gain that we saw in the first quarter. International markets are off to a really good start off of the October lows and also year-to-date. So the pendulum may start have swung here a little bit, Bob, and that's actually really good for investors, and it's really good for ETFs as well. So I noticed, Tom, total ETF flows, everything, was $77 billion for the first quarter.

At this time, this is well below the historic average, the Q1 average. We were doing north of $200 billion this time last year. And here's the numbers that we have. You gave you these numbers. Where's the rest of the inflows gone? And you mentioned everybody hiding out in money market funds. Maybe that kind of accounts for this. but it's rather noticeable after years of kind of steady inflows,

we had this little brief hiccup. I guess the question is, is this going to continue? And is it right what you were saying here? It's all in money market funds right now. Well, there's a lot in money market funds, and also in the last year, we've seen a lot of advisors take a little bit off the table, both in the equity side and the fixed income side.

We've talked about the problems with the 6040. And when you look historically, I mean, last year, we had $600 billion in new money in ETFs. In 2021, it was $900 billion. We're at a clip for, we'd be lucky if we make $350 billion at this point. So to the point of flows here, it may not mean that we see huge flows because they're all alternatives. People might be buying individual issues in the bond market. And this is a great subject to talk about now.

They may be going to money market funds and for the first time, years actually getting paid to be there. So safety is key until we start to see confidence that the Fed really has some handle on inflation and stability in the marketplace. And, you know, we're really at a tenuous time right now. Yeah, Chris, you run a firm that specializes in electronic trading of bonds. Is this massive increase in trading in bonds and bond ETFs? Is that accelerated bond trading, electronic bond trading? Well, it's interesting. Rick McVeigh, our founder, had this idea 20 years ago

that bonds would trade electronically. And here today, we're seeing the result of all that work. And with the rise of the fixed income ETF, we're seeing higher levels of electronic trading and bonds, both corporate bonds and treasury bonds. And why is that? Is this just what makes electronic trading accelerate during this kind of volatility?

Is it just easier? It's a better way to trade than over the counter? If you look at how ETFs, fixed income ETFs trade, they trade fully electronically on all the markets across the equity market. Market makers that support those ETFs provide price every day. They want to trade and hedge in the underlying corporate bond market rapidly as well. So there's hedging involved as well.

A lot of hedging. So we see the benefits of the growth. of ETF, fixed income ETFs. We see that electronic trading is, in fact, accelerating as more and more people adopt fixed income ETFs. Overall bond trading is about a third electronic now? Is that right? It's about a third of the overall market is electronic. Isn't it remarkable, and I'm addressing this to everybody, including Tom, remember the haters 10 years ago or so would say, oh, this stuff, wait till it starts getting volatile out there. Where do you see what happens to bank loan ETFs where the underlying don't trade that often? The minute you hit any volatility, the whole thing is going to blow up on us.

And what's happened was the opposite. I call it really a miracle because the ETF tail is wagging the dog. It turns out people traded the ETFs instantaneously. The bonds were trading slower. And it was the ETFs that set the prices for the bonds, not the other way around. This really is a miracle to me. Well, if you look back at March 2020, that, that's when the fixed income ETF was truly tested.

That market, we saw super high volatility in both the equity market and the underlying corporate bond market. And all of those fixed income ETF sustained all of that volatility. Yeah. Tom, a riff on this for a minute. We have discussed this numerous times over the years, you and I, but it really is quite remarkable and somewhat counterintuitive when it is the ETF that really sets the underlying prices Although when you think about it, ETFs trade instantaneously, the bond prices

have to have some kind of delay behind them, I'm quite sure. And I don't know if that is the reason that you actually get this, the ETFs are able to lead and lead the underlying bonds. Exactly. If you think about how ETFs trade in the fully electronic equity market, that's real time. Prices are disseminated real time.

Bonds take a little bit longer to update price. And so the underlying corporate bond market is actually following that ETF market. Tom, you want to refund this for a minute? Give your thought. Yeah, I think, you know, what you're pointing out, Bob, is early on, we weren't really sure. And Chris, to your point, the fact that today, ETFs have actually helped with fixed income liquidity, they've helped with price discovery, and there's an embrace among the fixed income marketplace of ETFs. And Bob, as far as what you're saying, look, this market has been tested, and it's come out pretty well. It's really, really high marks. So as ETF investors continue to evolve and now we start to see more money

going into fixed income ETFs, I think investors and advisors and institutions are doing that with confidence. Yeah. Alex, I want to turn back to you. I often note, Tom and I joke about this, the new ETF offerings start out strong, but they fade because they buy at the top and when the things are hot and they fade over time. But your first five Treasury ETFs that you have, have raised more than a billion dollars, right? Which is not bad for Treasury ETF. Are you expecting, tell us what's happened the last week with your new suite of offerings?

Sure, so we hope we're not going to fade. So far, average daily volume is up every day, and I think investors have embraced the tool set we offer. And as a result, they demanded that we launched the rest of the key benchmark tenors. So we started off with the smattering, trying to figure out where did folks want to find yield? Where were they comfortable buying treasuries?

And they came to us and said, we want to buy middle of the curve. We want to buy the long bonds. We want more duration. Maybe not today, but we know we're going to want it later this year. Chris, I'm trying to look into the future because people are messaging me saying, okay, is this going to continue? Should I keep buying, you know, Treasury ETFs?

And I always joked about my mother a month ago called me from the bank saying, Robert, I'm getting 4% on my, she was rolling over a one-year CD. She was getting 4%. She was astonished. It was the first time in a decade. She'd gotten anything close and she was amazed. And the bank tellers were giving her advice on, you know, yields and things. like that. My mother's become a bond maven now. That's the top of the yield market,

if there ever was one. But it's a good question. My mother's paying attention now. And so is it reasonable to assume that one-year Treasury is not going to go back to 1%? That seems highly unlikely at this point. That's the question. My mother wants to know, Barbara, is it reasonable, you know, but we're going to get 4% or 5%. Well, I think we're about to see what I'd call bond renaissance. Bonds are suddenly very attractive. The stock market is having its own challenges. We've had a banking crisis, and I think that's some of the drive to the Treasury market and the growth in inflows in Treasury ETS. I think your mom should start looking at some corporate bond ETFs in the market because some of the yield

that we're seeing in those products. But truly, we're going to continue to see inflows. I think rates are going to remain quite high. We haven't gone through this cycle fully yet, and the Fed is still taking action. bond yields overall to remain relatively high and attractive, and the stock market to have its own set of challenges. Corporate bonds haven't performed exactly the same way as high yields, rather treasuries, though, Alex. Is there, obviously people were concerned about corporates, corporations in a recessionary environment, bank bonds in a banking crisis.

I mean, there's issues there that are sort of separate from that, corporate-wise. Can we make a distinction? You threw out the corporate bond things. I'm just riffing on you there, Chris. Well, we clearly had challenges around the bank bonds that were in the corporate bond market. But if you look at the more liquid ETFs out on the market, we have Vanguard and State Street and I shares with some highly liquid ETFs. We worked with State Street in launching a new ETF, LQIG, which is 400 of the most liquid corporate bonds in the U.S.

And the liquidity matters in this market. Tom, you run Vetify. I often say Vetify does many things, but you're really an educational site for registered investment advisors and offer educational programs on what they should be looking at or advising their clients on or investing in. What are you hearing from the RIAs out there? I mean, these are the people that go out and buy these things

on a professional level, is the interest level continuing in bonds or just riff on what you've seen and trends in the second and third quarter for us? Yeah, we're surveying advisors all the time, Bob, as you know, and a couple of things. Those that had maybe stuck with the 60-40 allocation have gone through some pain, but they're also feeling a little bit more confident, as many are feeling that yields and rates are not going to be, they're going to be lower 12 months from now. So not only you're going to have less opportunity for yield, but you're actually, if you're invested now, some opportunity for appreciation. There are a lot of advisors who took money off the sidelines, put money on the sidelines. They diversified a little bit.

And kind of what Chris is saying, they're starting to move back in, not just into treasuries, but into corporates and high yields with the idea that we may be able to lock in longer duration and longer. payment for those higher rates with the idea that we're not going to see higher rates a year from now. And that's, I think, key and critical. I think finally, to what Alex is talking about, being able to be in treasuries and get paid for it is great. You know, Alex, briefly, with that role, you're also susceptible to the appreciation and depreciation based on the ups and downs of the markets as well. So you're not holding that to maturity and getting and safely giving that yield, you do have some market exposure as well, right? You do. When things go in your favor, rates come down. There's appreciation. We can roll it tax-free

through ETF mechanisms, which is great for investors. But you do have some tail-end risk, and obviously to lower the duration, the lower that risk profile. That's why we've seen a lot of action into the short end of the curve. But now, if you want to get paid long-term, and there'll still be material yield in treasuries. I mean, we're looking at a very long-term, stock bull market where folks just forgot bonds existed. Allocations were often 80, 90 percent stocks, which doesn't make a lot of sense. But there's still a material yield to be had there and some duration risk to manage. I would just point out, Tom, at the ETF conference that you run last year, not this

year's conference, but the 6040 portfolio was declared dead, completely dead at that conference. And this year, the RIAs were scrambling to sort of re-expose themselves. to a certain extent. February was a little early. It was before this banking crisis. But this goes to the Jack Bogle and me about having a long-term plan. Nobody could foresee these kinds of rate rises, but having a long-term plan. Now, you mentioned lower yields a year from now. You'd have my mother's attention because she called me, thank you, Mom. I'm bringing it up again. Robert, should I get roll over my one year? She was rolling it over, or should I make it two years? I said, the problem with the one-year,

mom, is you have another risk. You have reinvestment risk. Now, you don't, know you're going to get that money back. You don't know what the rates are going to be. Personally, I find 4%, 4.5% for a 1 and 2 years, even if a 2 years a little lower, very attractive. Why don't you just consider getting a 2-year CD? She said, oh, well, you know, maybe I'll do that. And she was waiting. This was a week and a half ago. For the yields to go back up again, she was hopeful, again, playing that. But that's a good question now. The people who now have these advantages of, oh, my gosh, I've got a 4%. Should I, what kind of, what kind of, what What kind of maturity should I be playing with at this point?

Well, first of all, Bob, you've got to get your mom back on the show. Yeah, I know. No, she's going to start giving you advice, Tom. No, we're going to, and you're not putting her on VETify either. We're not going to turn my mother. Then next thing, there'll be a TikTok video for my mother. No, we're not doing that. Go ahead.

I do love that your mom is arbing the fixed income market. She's arbing the CD market. She has another bank teller at another bank who is going to call her too. She has two bank tellers at two different banks giving her advice on when you get built. There's so many tools available right now to invest in bonds. That's the beauty of all this. There's money market investments. There's direct investments.

But the ETF provide the simplest tool to access to full fixed income market. Lower yields, though. See, that's an interesting question. So you have a chance to make a little money. But people, you know, like my mother, they don't hold on. They hold the maturity people that are out there. Now it's time to round out the conversation with some analysis and perspective to help you better understand ETFs. This is the Markets 102 portion of the podcast.

We'll be continuing the conversation with Tom Leiden from Vettify. And Tom, I want to get your thought on second quarter, third quarter, fourth quarter flows. I made a joke on the show about my mother who was trying to top tick bond rates. She was rolling over a one-year Treasury CD and was hesitating to do it. under the hopes that yields what might be higher a week later. Now, when your mother tries to top-tick the bond market, something is going on here. And it seems like there's the same problem

of people trying to top-tick the stock market. Is there any signs that people are hopeful that yields will be higher and prices lower? What are your RIAs telling you about what they want to see happen to bonds in the second and third quarter? Well, first of all, happy for your mom, Bob, because she's finally getting paid on her CDs, which is great. Yeah. And your advice, I think, was right on where a year from now, and a lot of advisors that we survey agree that we're probably not going to see rates where they stand today a year from now.

They're probably going to be lower. When you think about the Fed and how they're signaling now as they're trying to battle inflation, at the same time, keep confidence in the banking sector and in the economy, not pushing us into a recession. We'll probably a year from now being a situation where rates will be lower. If that's the case, not only your mom is trying to top tick the bond market, but advisors are trying to do that as well. So they're doing that by not only going a little bit longer duration in corporates and high yields, it doesn't pay right now to do that in the Treasury side when you're getting close to 5% in a six-month, and you're only getting 3.5% on a 10-year, right? Yeah, it's a little bit inverted in the natural order of things.

That's for sure. But I wonder, I'm concerned about this consensus you think is developing, that rates are going to be lower a year for now because it's sort of like the consensus it develops in the stock market, and it's right until it's, until it's not right. So I'm only trying to point out the analogies with the stock market here, because people are now forming very strong opinions on where yields might be, and they're obviously hoping that they'll be lower, which means they'll make some money on holding their bonds. The prices will go up, yields will go down, right? But is there any reason to think that people making bets on

where the bond market is going or any better than people making bets on where the stock market is going? Yeah, you and I both, that our crystal balls don't work. However, if you think about the Fed's late fight of inflation and then cranking up what they've done in the last six months, but at the same time signaling and we're seeing, you know, month over month numbers that inflation is starting to cool down a bit, which is great. One of the best things that probably happened as far as the antidote to higher rates was the uncertainty that we've seen in the banking market. You can't have a Fed that's going to continue to tighten at that rate when you've got uncertainty in the banking

market where at one point in time, the elixir may be lower rates because those bonds that are underwater on the bank books actually are repriced to better levels. So that's another thing to consider. And then, look, everybody's sniffing around about recession. You know, there are a lot of periods of time, Bob. One thing you and I know from living long enough that there are people. periods of time when the market does quite fine during recession, and it can weather that. And we can also go into an extended period of inflation, not at six or seven percent,

but three to four percent, which isn't that painful. We can live through that. Yeah. Let me ask you about all this money going. The only two trends that are really remarkable for the first quarter is huge money going into Treasury ETFs and huge money going into international equity u s equity had outflows international big inflows uh... and i'm wondering you could explain that given look for example at europe uh... is got its own issues and yet it europe bounce back and develop markets i i don't know what what's the rationale for going into developed markets in such a uh...

uh... in such a big way or or even uh... even emerging markets what what's the rationale for out of u.s into international Well, coming out of the great financial crisis, we've had a huge home country bias. It was really tough and has been tough to beat the S&P. And a big chunk of that performance was Fang stocks or the like. So that has, to some degree, continued so far this year. If you look at the S&P being up almost 7%, but the two top holdings in the S&P, Apple and Microsoft,

are up 27 and 20%, respectively. back those out, you know, you've got an S-A-P that's up 2%, where across the board, we've seen the top two ETFs, the Vanguard-F-F-E-Developed Markets, ETF VEA, up over 8%, and same with the I-Shears core MSCI, EFI, up 8.5%. We also saw that in the fourth quarter coming off of the October lows. So, look, maybe it's the time where the pendulum starting to swing. you're able to buy these ETFs on a discount. You know, the P.E's on those two ETFs around 11 or 12,

where you're still paying 20 on the S&P. So eventually things balance out. And then when you look at small caps, Bob, they've been stinkers for a long period of time. But historically, small caps outperform large caps. PE on the I shares Russell 2000, IWM, is 11. So almost half of what you're paying for the S&P 500. Yeah, it is true historically small caps, but almost not in our lifetime.

It's been pretty rare since the great financial crisis. I mean, come on, we all know what the long-term evidence is that small caps outperform big caps and, you know, value outperforms growth, except since the financial crisis by and large. Now, there was some periods last year where that went back to the old mean reversion, but it's been a while, Tom. It has, Bob. And when you think about the average financial advisor that has diversified portfolios,

remember, their equity allocation, their 60 of the 6040 should be diversified almost equally between U.S. and international when you think about global market cap, they should have not just large cap, but also mid-cap and small-cap. They should have some growth.

They should have some value. And if they did all that, they drastically underperform the market because the S&P has been the place to be. So, however, those advisors that today have that allocation, other areas of the market starting to outperform the S&P has been really good for the advisors and the whole idea. Back to Jack Bogle, you've got to diversify. It is certainly good news to see some beaten up sectors. Even REITs did better last week. And it was one of the worst months for REITs I've seen in decades.

Tom, thank you very much. much. Tom Leighton is the vice chairman of VETI and everybody, thank you for listening to the ETF Edge podcast. Investco QQQ believes new innovations create new opportunities. Become an agent of innovation. InvescoQQQQQ, Invesco Distributors, Inc.