ETF Edge - Navigating the Global Slowdown

Episode Date: September 20, 2021

CNBC's Bob Pisani spoke with Arne Noack, Head of Systematic Investment Solutions at DWS Group and Dan Wiener, Chairman of Adviser Investment and editor of The Independent Adviser for Vanguard Investors. They discussed the factors fueling the sharp moves lower - Plus, no red flags coming out of China, everything from weaker retail data and tighter regulation to the fallout from Chinese property giant Evergande. In the 'markets 102' portion of the podcast, Bob continues the conversation with Dan Wiener from Adviser Investment Management. Hosted by Simplecast, an AdsWizz company. See https://pcm.adswizz.com for information about our collection and use of personal data for advertising.

The ETF Edge podcast is sponsored by InvescoQQQ, supporting the innovators changing the world. Investco Distributors, Inc. And 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, market analysis, and breaking down what it all means for investors. I'm your host, Bob Pisani. We've got a Monday market sell-off on our hands. Today on the show, we'll hone in on the factors fueling the sharp moves lower.

Plus, no red flags coming out of China. Everything from weaker retail data and tighter regulation to the fallout from Chinese property, giant Evergrand. How can investors navigate the global slowdown? Here's my conversation with Arnie Noak, head of systematic investment solutions at DWS Group, along with Dan Wiener, Chairman of Advisor Investment Management, and editor of the Independent Advisor for Vanguard investors. Arne, I'll start with you. How much is Evergrand a risk, a systemic risk to other problems?

property developers in China and to banks in general in China. It seems to be the big issue today. Yes, first of all, thank you for having me, Bob. Speaking with our CIO in APAC earlier this morning, we obviously take the issue very seriously. We look at all the facts very closely. Evergrand being one development company that is in trouble obviously is concerning to us, but we do not see this to be of broader systemic risk in China. And Dan, you run $7 billion in the U.S. You've been a big proponent of investing in international growth sectors outside the United States. Now, what are you telling your clients about this?

Should they be putting more money or less money into China right now? Well, first of all, I think you need to work with an active manager. I don't think you can index China right now. And our active managers have got 14 to 20 percent of their broadly diverse. foreign funds in China. But you have to look at what's going on with Evergrand and consider that it's just part of a bigger picture here. You know, China said they were going to have a new three-child policy in May.

Since then, we've had issues around tutoring, becoming more egalitarian, limits on computer gaming. They're trying to make housing more affordable. Look, if you're going to have three kids, you need a bigger house. It's more expensive to house three kids. three kids, now it is one. The homes are very expensive as it is right now. It's expensive to educate your kids. And then, you know, think about the issues around data. They are trying to protect what I'm calling intellectual property. The intellectual property is the data on 1.4 billion people. So, you know, at the same time, they're trying to get to be a part of the Trans-Pacific Partnership.

it's very important to have boots on the ground with your portfolio managers so that they can determine which are the right companies to invest in because this is a huge market just inside China, not even talking about the export market. Yeah, you know, Dad, this is the issue with China. We always have this problem when we talk about China as an investment. You can get a pure China fund like Arnie's runs, ASHR, exposure to mainland China, or you can get exposure in various international funds like Vanguard Growth.

I know you're a big proponent of that fund, but the exposure really varies tremendously. I guess what's the right level of exposure? I look at some of these I-share's emerging markets is 35% China. Vanguard international growth, which you've been talking about, 14% weighted towards China. Vanguard Total International, the whole world, XUS, is 10%. And on the I-Share's ACWI, all-world index, it's only 5%. So you can go all over the place on this, and this is the problem. we have when we ever address this China issue?

Well, the question is, are you going to make a bet in your portfolio on a China allocation? You know, are you going to bet on 14? Are you going to bet on 5? You're going to bet on 20, on 30? Or are you going to let someone who's got boots on the ground make that determination for you? I mean, the world is a big place. China is obviously a big market. and, you know, really glad to have some exposure there, but I'm glad to have exposure there through some very, very smart managers. The guys at Bailey Gifford here, it's really a terrific team.

And they, you know, they are running the bulk of the international growth fund, and they have a couple funds of their own. Yeah, Arnie, tell us a little bit more about ASHR, the fund you guys are running and what's in it. I know it's heavily weighted towards banks and insurance, but give us a sort of flavor about what you're owning when you buy that.

Yes, with pleasure, Bob. And I would agree with the previous speaker that it's actually very important to have a close eye on the China allocation. Also, when we speak about Chinese equities, it's very important to understand what type of Chinese equities. So, for example, ASHR is the largest ETF outside of China that provides exposure to domestic Chinese equity in the form of the CSI 300 Index, which essentially represents the 300 largest companies in China. And just for the arguments sake, the previously mentioned company Evergrand is not part of that index. So ASHR does not have any exposure to that particular company. Also, what I would say is when you look at the different China ETFs that exist here in the US,

but essentially all over the world, really do have a look at what are the underlying companies, what are the underlying indices and resulting sector exposures that you take into account. So as you already outlined Bob, So ASHR is heavily weighted towards financials, IT and consumer staples. The bottom sectors, in fact, of ASHR, energy, communications, and, of course, real estate. So it is very, very relevant, especially when we look at the real estate segment, then against the biggest competitor ETFs here in the US. ASHR has an underweight of roughly 2%.

So the sector deviation can really matter here. Yeah, so I guess, Arnie, I know this is a tough one to answer, but this is the question I keep getting from the viewers. Is China really investable right now? How should investors look at exposure to China, given all these regulatory risks that have appeared that look much higher than expected? Yes. From our perspective, China is very much investable. However, we would definitely caution that, you know, China should not be looked at as a, a market like the US or let's say most of Western Europe. China obviously as an economy is subject to much more stringent and severe regulation. The regulatory risk on individual sectors and individual companies is significantly heightened. So what we would on our side say you as an investor for all of our investment partners out there,

China is most definitely too large and too important for the world economy to be ignored. However, the current circumstances warrant and very much show us that it's a good time to have another look at what drives China and what drives the different China allocations that may, as you point out, Bob, already be in existence through various other vehicles. Yeah, you know, I want to just emphasize for everybody that even with a pure China fund, there is a lot of ways that you can slice and dice China ownership because there's three markets, essentially. So you're dealing with mainland China, you're dealing with Hong Kong, and then you have U.S. listed China shares like Alibaba. And you can see we put up some of these earlier in a full screen. You know, the ASHR tracks the 300 largest China mainland shares, but you've got a large cap fund like FXI, I shares. That's 50 Hong Kong listed stocks that behave a little differently.

MSCI China is sort of an amalgam of Hong Kong as well as China and mainland. as well as U.S. stocks. That's probably the broadest of them. But you can get others, too. Crane shares has the China Internet, KWEB, which is China Internet that includes U.S. listed shares as well. So you could slice and dice this a lot of ways, Dan. And if you actually put up China versus the U.S. markets this year, you know, the S&P 500 is up 16%. But, you know, the rest of it. Look here, it's all over the place. KWEB is down 39 percent. And, you know, aren't Arnie, your X-Trackers is down to about 8%. There's a lot of different ways that you can play this, Dan.

No matter how you slice it, though. China's been a dramatic underperformer, Dan. I guess that's what I'm getting across here. Yeah, Arne is exactly right. You have to look at the underlying. If you're going to do ETFs, you've got to look at the underlying index because they are all across the map. And that's why, I mean, I think he kind of makes the point for me

that an active manager can pick and choose and build. a portfolio based on their research as opposed to, you know, the, whoever it is that constructs these various indexes. So, you know, that is why we've been advising our clients forever to use active funds. If you want to make a weighted bet on one country, whether it's China, France, Italy, you know, Turkey was very popular last year, you can do it with ETFs, but you have to be very, very cautious. I mean, it's really a trading vehicle. It is not an investment vehicle. Yeah. Let me ask you about the Chinese consumer, Dan. Besides these issues with Evergrand that we're dealing with, we've also seen a notable slowing in retail sales in China around the Delta variant. So we've seen

big international luxury retailers last week, LVMH, for example, Rishmont. They all got hit on this concern. How do you feel about the prospects for the Chinese consumer? Because that's the main argument for investing there. This is the biggest consumer market in the world right now. Listen, it's an enormous market. It's an enormous country. You know, all you have to do is switch China for the U.S. and say, you know, how many times have we had a conversation you and I about it? What do you feel to the prospects for the U.S. consumer? Well, the Chinese consumer is going to continue to consume. And if some of these Chinese policies gain some traction, you may actually end up with more disposable income in the hands of those Chinese consumers.

I mean, look, if you're spending however much it is for private tutoring, and all of a sudden the country said, no, that's a non-profit business. Everybody should have access to tutoring. That's a little extra money in your pocket. Yeah. Arnie, a lot of U.S. investors write to me, and they're interested in investing overseas in bond markets, particularly high-eield, just like here in the U.S.,

they're reaching for yield. There are emerging market high yield funds that are out there. Right now, we don't see any particular contagion. Is there any thoughts that your company or organization has on how to approach this? I'm talking about U.S. investors who are going overseas, buying into emerging market high yield funds, for example. And there is a concern here about a contagion associated with that at all. Any thoughts on that? Yes. And in fact, I'm going to borrow a page out of Dan's book when it comes to active management.

I would want to say with regards to China equity indices in particular, as we said before, they are very investable. I'm very much a proponent of ETF-based investments there. However, when we look at emerging market high-year bonds in particular, it is a very valid statement to say, hey, do I not want to look at an active manager? Because there's several risk factors when it comes to fixed income that don't necessarily make the front page, so to speak, such as foreign exchange. If I buy a non-dollar denominated bond,

then I no longer have a fixed income instrument, but I have a variable income instrument because all of my coupon payments, as well as the principal repayment are subject to a fixed risk. On top of this, you have different jurisdictions in terms of the legislation that underlies those bonds. All of those relatively nuanced details

for me are very relevant from a U.S. standpoint to say, hey, if this is a segment that interests me, why don't I look at an active manager? However, I do want to very clearly state that in Chinese equity case, we're very much a proponent of ETF-based investment there. Yeah. And Arnie, just on a separate I know value guys out there. They have a very lazy-fair attitude about all these fundamentals

who are talking about regulatory risk or bank risk. They don't care. They buy China when it's cheap. So when it's under, I'm picking a number, 15 times forward earnings, they buy. And then they sell or they walk away when it's higher than that. Is that an equally valid way to play China at all on the technicals? I would say it can pay off, it can be a little bit dangerous too, though, because as we stated before, Bob, the regulatory risks in China are somewhat heightened, as proven by the current situation and by essentially the different scenarios we discuss on this call alone. So looking at the underlying fundamentals, looking at the analytics alone might not be sufficient. And we would very much encourage you to work with an asset manager or with essentially a partner that, as Dan was saying, has boots on the ground to get a good understanding and a good feel for what are essentially risks that may not necessarily be priced in or what might be a little bit of a forward-looking sentiment around those.

Yeah, I think so. Dan, you're in agreement with that? I mean, obviously your business is not technical analysis, but you get my point. There are guys who don't particularly care about all of the fundamentals. They're just looking for it when it gets cheap. Right. And those same guys are trading in and out. And by the time they make some money, if they make some money,

they're going to give half of it back to the IRS. So, you know, I'm loath to recommend a trading philosophy when you can be a long-term investor and make an awful lot of money in this market. And, you know, I think Arnie's exactly right. You know, Bob, you like Vanguard a lot, and I cover Vanguard. Vanguard's actively managed emerging markets bond index this year alone is doing quite a lot better and has done quite a lot better than its emerging markets bond index fund.

The active fund has done better than the index fund. Yeah, yeah. This year, for sure. Now it's time to round out the conversation with some analysis and perspective to help you better understand ETFs with our Markets 102 portion of the podcast. Today will be continuing the conversation. with Dan Weiner from advisor investment management. Dan, thanks for joining us. We've talked a lot about China today,

but I wanted to get your thoughts on the broader market. We're dealing with a lot of other things. Seasonal risk now, September and October, the debt ceiling, the delta variant, the Fed tapering. You managed $7 billion for clients. What are you telling your clients right now about the current investment climate? Well, do you have an hour?

I mean, basically, you know, you've hit a lot of the issues right there. But let's talk about seasonality for a moment. You know, a lot of people look at October and they say, oh, my God, October, you know, we've always had these big drops in October. In fact, the worst month in the market going back through the S&P history is September. But it's not that bad. You know, the average September return is negative 0.7%.

And it is the only month that has an average that is a negative. But we get through September, and then we're in the best quarter of the entire year. So even if we were to have a little bit of a drawdown, and we are having one so far this September, sets us up for a very good fourth quarter. But I'm not a timing guy, not really interested in quarter to quarter. What I'm more interested in is, frankly, earnings and interest rates. If we see growth in earnings, even if that earnings growth is slowing, and we see, you know, interest rates, rates low enough to give people the opportunity to borrow at low levels, even if they go up a little bit,

you know, we're still in a very easy interest rate environment. That's good for stocks. Yeah. And what are we seeing in terms of the earnings situation? We watch it microscopically here at CNBC. And what's been going on is overall earnings have been rising throughout the entire year, even to the third and fourth quarters. However, the last couple of weeks they've stopped. And I wonder if this is now that favor. mark at this point that a lot of investors have been anticipating for a while now? Well, I mean, first of all, look at the street's estimates, right? The street has been incredibly bullish, and yet they were outpaced by earnings in the second quarter. Now they've gotten even more bullish, but they're drawing back. So that, you know, that is the volatility in the

earnings estimate game. And I think what you have to do is, if you remember, prior to COVID, prior to the lockdown, we were in what we had advisor investments were calling a slow growth, not no growth economy. And I think once we get through the bounces of, you know, earnings going down and then earnings shooting back up, we will be back to a slow growth, not no growth economy. We still have a long way to go to catch up, say, on GDP, to where it would have been had we not had COVID at all. If we had just continued on that 2% or so annual growth rate, we still got a ways to go.

So I think the potential is there for stocks to continue going higher, but they're not going to go up at the rate they have been. And I don't think people should have expectations that they will. Yeah. Besides managing money, you also run an advisor newsletter for Vanguard investors. And you're a very interesting guy because you sit right at the crux of this whole debate of passive versus active. Vanguard, of course, has been extremely successful in passive management. Jack Bogle practically invented the concept more than 30 years ago, 40 years ago, really.

And yet Vanguard has always had actively managed funds that have done well. Very briefly, explain how you approach that, given that you're writing a newsletter for Vanguard investors. How do you approach that attitude of active versus passive? Right. Well, first of all, I write this newsletter independent to Vanguard. So I don't have to buy into the Vanguard dogma, which, you know, last year and the year before was about indexing. And this year, all of a sudden, they're getting very interested in promoting their active management.

So for 30 years now, I've been building portfolios in the newsletter that primarily access the best active talent that Vanguard has been able to bring in to its family. And they don't do much active management of equity portfolios in-house except through quant funds. They hire out. So we use managers running Vanguard funds like Bailey Gifford, like Don Kilbride at Wellington Management, like the prime cap team out in California. You put these different managers together, in a diversified portfolio, and our experience has been over the last 30 years, you will get market-beating performance. Yeah.

It's a very interesting question because Jack himself debated this whole concept. And as I said, he had active manager, the original Wellington team there was many active managers, still are. And yet he himself promoted that. Let me just move on here and ask you about an interesting news item that came out. There was a report over the weekend, I believe, on Friday, that was made that Invesco was considering a merger with State Street's asset management arm. Of course, they have very active ETF business here. This is a very interesting subject because the asset managers are in a very tough spot, it seems to me.

They need to get more and more assets under management because scale is what matters here. And generally, they've been successful doing that. And yet at the same time, they need to keep getting, they need what they are charging for, the fees keep dropping. There's constant pressure on them, so you have this pressure to merge. How do you look at this as a guy who's sort of watching this from the outside, but very much involved in something like fee structures? Well, the whole fee war thing, you know, we're already into fee war 2.0. The first fee war, 1.0, was Vanguard with its low, low fees and everybody else somewhere way above them in the universe.

A lot of companies, though, have begun to cut their fees. They're trying to bring them down to Vanguard's level. Some of them are actually lower than Vanguard's, and Vanguard's fees have stopped dropping. I mean, that's, that is the story that has not been reported, which is that Vanguard's fees are not dropping anymore. They are not finding a way to keep cutting them. And so their competitors are catching up on the fee, on the, you know, on the fee issue. The merger that you're talking about will create more competition primarily in the ETF arena.

And I think that's a good thing. I still believe that active management outperforms. But, you know, if you've got all these companies fighting over basis points in the ETF area, eventually it's going to migrate a bit and have an impact on actively managed funds as well. And, you know, as you well know, we're starting to see the development of more and more active ETS. And I think that's a good thing. Yeah. Well, that was just a report, of course, on Friday.

No confirmation on that at all. But Dan, I appreciate you joining us. As always, with your insight, Dan Weiner, Chairman of Advisor Investments. 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. InvescoQQQQ believes new innovations create new opportunities.

Here's the greater possibilities together. Learn more at investco.com slash QQ, Invesco Distributors, Inc.