ETF Edge - Schwab’s Dividend Darlings – ETF Edition 12/5/22

Episode Date: December 5, 2022

CNBC’s Bob Pisani spoke with D.J. Tierney, Senior Investment Portfolio Strategist at Schwab Asset Management – along with Dave Nadig, Financial Futurist at VettaFi. They dove deeper into how investors can make use of ETF to get in the game of tax-loss harvesting – selling securities at a loss to offset those losses against capital gains taxes on other securities. They also broke down Schwab’s top picks when it comes to playing defense and owning dividend darlings to fend off inflation and rising interest rates. 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.

The ETF Edge podcast is sponsored by InvescoQQQ, 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, market analysis and breaking down what it all means for investors. I'm your host Bob Pisani. Today on the show, we'll dive deeper into tax-lost harvesting. That is selling securities at a loss offset against capital.

gains taxes on other securities. How can investors use ETFs to play the game? Plus, dividend, VETFs have been beloved all year long. What are Schwab's top picks when it comes to playing defense and owning dividend darlands to fend inflation and rising interest rates? We'll talk to two of the best in the business. Here's my conversation with DJ Tierney. He's the senior investment portfolio strategist at Schwab Asset Management, along with Dave Notting, financial futurist at VETI. DJ, you're the face of Schwartz. to clients. Explain how some of them are using

ETFs for tax loss harvesting. Sure, Bob. We spoke earlier and I gave the example about an investor maybe selling a total return bond fund. Chances are if you've invested at a total return bond fund any time in the last five years in a taxable account, you're likely at a loss between 12 and 15%. So you have this opportunity before the end of the year to sell that fund, realize the loss,

stay invested by buying an aggregate bond ETF, and you can do two things. You can lower your tax obligations. You can also lower your expenses in your investment on an ongoing basis. So we're seeing that. Oh, yeah, go ahead, Bob. Continue, DJ. I'm sorry. I didn't mean you're up. So we're seeing that. We're seeing it across asset classes. You know, bond funds are one example. Emerging markets are another, you know, and then really any asset class. With emerging markets and bonds, chances are you're at a loss if you've invested over the last few years. With U.S. equities, the window gets a little bit more narrow, the purchase would have had to happen in the last 18 months or so for you to be at a

material loss. Yeah, so can you do this with, that's an interesting question here. Can you do this with ETFs? I mean, with equity ETFs. So suppose you have an S&P 500 fund. Yeah. It's down this year, right? Yeah, no, this is the perfect year to do this. One of the biggest problems with tax loss harvesting is we had such a great run that was hard to find that moment to actually book those losses. With ETFs, the only thing you really need to be careful of is you can't go exactly the same. So you can't sell your S&P 500 ETF to buy another S&P 500 ETF. You have to be able to sit there in front of some tax auditor who might actually question whether or not they're

identical exposures. If they're identical exposures, you need a period of time to pass or it's a wash sale. But you could absolutely sell your S&P 500 fund and say buy a Russell 1000 fund. You can get away with that all day long. And there is a limit to, it's the $3,000 limit here. Yeah, I mean, there's only a certain amount you're going to be able to do this. You can't book millions and millions of dollars of losses and then never pay taxes again. I'm doing this again this week because I got a lot of inquiries about this. Is there actual signs that this is really a phenomenon?

I mean, can we actually track that people are using the ETFs for tax? It's difficult to go apples to apples just because it's difficult to know that you're selling your shares of an ETF and I'm buying my shares. But what we can see is in aggregate, the moves out of big blocks of ETFs. For instance, we saw a lot of folks book their losses in value. We had big outflows in some of the value funds last week. We've seen big inflows into really core exposures like an IVV or a VOO. Those things, to me, smell like tax loss harvesting.

DJ, can we track this in any way? Can Schwab track this? Is there any signs that people are doing this? I think there is, because I'm getting inquiries about it. This implies that, you know, the interest level is pretty high in it, but I can't quantify it. Yeah, I agree with Dave, that you can't always look at flows and make absolute conclusions as to what's happening on.

The nature of the way ETFs trade on an exchange is we don't exactly know, but there are tell-tale signs that this is going on. One, in talking to advisors, I hear about them talking about this. We're getting questions on strategies and tactics and how to do it. And then in a macro level, if you look at the inflows into ETFs, and I know we may talk about that at some point, but the massive inflows into ETFs in aggregate compared to the outflows in mutual funds would suggest this may be happening. And so, and I do want to make a point, that $3,000 limitation, That's really only a limitation against offsetting ordinary income.

If you've got material gains that you've realized through some other investment this year, then the losses can offset them one for one and there is no limit. It could be hundreds of thousands of dollars. It could be millions of dollars if you had capital gains to offset. So the opportunities can be very significant. Again, as David said, the time is now.

It's a unique year where we've had these material losses. It's really a great time to engage with a divisor right now in the month of December. before the end of the year. Yeah, I bet you there's a lot of very heavy conversations going on for the first time in a long time. We just haven't had to deal with this in so many years. It's like amazing.

You know, I haven't done a story on tax laws harvesting, and I literally don't remember. Well, the other thing is we've seen huge dispersion in return. So for every, you know, Tesla that may be down 50 percent, there is something else that's up. We saw the rally in energy, et cetera. So it's not impossible that you might actually have some great trading gains that you want to offset with some of those longer-term positions. I want to move on and talk about another hot topic, dividend ETFs.

They've been investor darlings this year. DJ, your dividend equity ETF, SCHD is the symbol. This is your largest ETF. It's one of the top 25 ETFs by assets out there. I'm looking at the inflows, huge inflows this year, and it's only down 3%. So explain how this happened. This seems like a combination of growing dividends and defensive stocks. It's a very potent combination this year.

Yeah, SCHD has enjoyed very healthy inflows for the last few years. 2022, you know, the largest for sure. This space has done well. It seems advisors and investors that are looking for income that might have been wary about looking for that income in the bond market with rates rising and prices depreciating have found comfort in dividend strategies. It's the largest category to have inflows by factor. And then the Schwab U.S. dividend ETF has had a strong track record.

If you look at its performance characteristics over the last one year, three year, five year, 10 year, it compares very well in the category. And then it happens to also be the least expensive ETF dividend ETF in the space as well. So it's got a lot going for it. And it does pay. It's not like the dividends are that much amazingly different than the S&P 500. It's really you're in defensive sectors this year. Yeah, absolutely. The play here is it's kind of a combo play.

On the one hand, these are defensive equities. And for folks who are a little bit shell-shocked from this year, the move to defense has been very clear. At the same time, we have two million excess retirees from the pandemic. Those folks are restructuring their portfolios to generate income, something like a CHD, which is cheap and delivers all day long. So you have a poll here. This is one of the great things about being with VETify, which is Dave's with. They do polls all the time. So I can use these polls. 970 advisors at VETI-Fi. 62% said they're adding to dividend-paying strategies to combat inflation and interest rates. Yeah. So we asked them all the time,

what are you doing to portfolios? It's the number one question we ask. We ask, what are you doing to portfolios to deal with inflation and rising rates? The number one answer was adding to dividends. Number two, answer, looking for value stocks. Number three answer, short-term guvies, right? So you've definitely got a spread there in terms of risk and reward. Yeah. So are we still seeing, DJ? Is this going to be a story in 2023? I know it's hard to figure that out. If growth stocks make a a comeback. I mean, dividends are not going to be as popular because they're, it's a hard game to say here. This was the perfect year for the dividend play, right? Right. And so now the viewers are going to say to me, oh, that's nice, Bob. Good for you to review the history of 2022.

How about 2023? What's going to happen there? I'm not, I know you're not a strategist, DJ. I'm not trying to put you on the spot, but that's the question the viewers want to know. Yeah, that's okay. I point out that dividends and value, right, which are dividends are related to the value factor in some way, and that high dividend stocks tend to be more value-oriented. Growth trumped value, not just in 2021, but over the last decade, right? So there's a lot of catching up to do on valuations in the value space. And by the way, SCHD scores high in the value factor. So this is not a one-year, not likely to be a one-year phenomenon.

Look at the growth that the technology companies delivered to the U.S. indices over the last five to ten years. And companies in SCHD, which just have some information technology, but it also has a lot of financial services and consumer discretionary. So these companies have strong balance sheets and have a demonstrated history of growing and paying dividends. So this is not just a one-year story. The demographics of baby boomers in retirement where dividend strategies can be beneficial has a lot of legs to it. I certainly would like to see the value outperform for more than a single. You know, when you see energy of 3% of the S&P, all right, now it's 5% will be, that's kind of depressing, considering at one point it was close to 30% 30 years ago. I think that's part of why people look at dividends. I mean, 96% of dividend payers kept them flat or increased them in the third quarter.

Even while there's a lot of discussion about some shaky earnings, this is a statistic. This is a thing a company can do to keep investors interested in their stock, maintaining or increasing that dividend. Tough for a value company to do that out of the gate. Well, we saw this with energy stocks, right? I mean, look at the, there was a small group of exploration and production companies that were offering variable dividends this year, depending on the cash flow, which sounded fabulous. All of a sudden, they're getting 9, 10 percent dividend yields, but if the cash flow is dropped, it changes. Yeah, nobody likes it when the dividend gets cut, ever. Yeah, but they call it variable.

So they have a fixed dividend, and then a variable component on top of that. And you say, don't be mad at us. We're calling it a variable. If it's cash flow goes down, payout goes down. Well, I guess it's that or stock buybacks, right? the world we live in. Sure. So people are trying to figure out ways to return money to investors, so I certainly understand that. What happened to DJ to the inflation play? You know, everybody wanted inflation protected bonds, tips. It was the big thing last year. This time

last year, he and I were doing stories, Dave and I about tips. You have your own tips fund, S-C-H-P is the symbol, but there's been outflows all years in these funds. So what gives here, DJ, what's the right way to look at this as a hedge against inflation? Yeah, so 2019 and 2020, inflation started to really crop up as a concern for investors. And so we did see a massive inflow into TIPS in 2020. And so I think 2020, 2021 even, and so I think what you're seeing in 2022 is just a little bit of the pendulum swinging the other way. Is inflation as big a concern right now moving forward as it won as a year ago? Probably not. Investors might have made tactical allocations towards TIPs, and maybe they're pulling that back a little bit.

So that's how I would probably assess what we've seen in flows this year. We still think tips make a really good place to be in a tactical asset allocation plan for the long haul. And so there's still a place from it actually now with the rate move upward and inflation break-evens. They might make more sense right now than they did a year or two ago. So we still believe in them for the long haul. You messaged me that tips were driven more by sentiment than reality.

What does that mean? Tips are one of these things that are notoriously difficult for even really great traders to get right. I mean, the old adage is by the time you've decided to make a trade in tips, either in or out, you're probably wrong. It's over. It's over. And we're seeing that right now. We've had massive outflows and tips, but the break-even on the 10-year tip is 2.3%, which means you have to believe inflation's going to average less than 2.3% to choose a straight treasury over the 10-year tips. I think that's a pretty good bet right now, as DJ was saying, like, now might actually be the right.

time to get in, I think this is just one of those chronically missed time sectors in market. You have to get exactly right. Now, the second choice for advisors that you mentioned in your survey is value stocks this year. Now, of course, as DJ mentioned, this overlaps a little bit, but with the dividend story, but we're clearly back in the Tina but scared camp. Exactly. You know, Tina meanings there is no alternative, but we're scared. So in other words, be in equities, but be as safe as you possibly can. Yeah, and we've seen interest in values, dividends, all of those defined outcome products have done very well

in terms of gathering assets and terms of what they've delivered for investors, all the downside risk hedging varieties of which there's dozens and dozens. They've all pulled in decent assets. Most of them have done what they've said on the tin. The question is whether or not investors are going to get the timing right on those things as well. You have a value fund, DJ. What are you hearing in terms of him? I don't have any data on your fund.

in terms of flows this year. But what are you hearing from clients? Yeah, we've got a number of strategies that have the value factor, SCHD being one, SCHV for value being another, as well as the fundamental index approach, which tends to score high on the value factor. All of those have had relatively healthy inflows this year. So, you know, to us, it's just heartening that in the face of a very tough year, we're still seeing investors in aggregate utilize ETFs as a long-term investment vehicle. We've actually, By the way, the growth factor has actually seen decent inflows this year in the face of really, you know, brutal price depreciation in growth. So, you know, again, we're not as tactical and trying to call things on a month, quarter, a year.

But in terms of a long-term allocation, these things make a lot of sense. And that's really what we would conclude you see in the massive flows in the face of a really tough year, like 2022. It's remarkable, though. You're still seeing inflows this year, DJ. Is Schwab overall still seeing inflows, right? Yeah, so we have 29 ETFs, and 25 of them have had inflows. We've had outflows in four of the 29. So just like the rest of the industry, more inflows than outflows.

It's just remarkable, just continuing inflows, whether the market's up or the market's down. If there's any trend this year that is clear, though, it is that Vanguard keeps hoovering up assets. So we always talk about the top, the big five here, folks. and they are not far from overtaking, Vanguard, it's not far from overtaking BlackRock as the largest ETF issuers. What is it about Vanguard that keeps hoovering up assets? I mean, it's a couple of things.

I mean, first of all, they tend to be, you know, if not the cheapest, very cheap in every place that they're competing. So I think that's a big piece of it. The other thing, too, is I think people now are starting to understand the Vanguard story a little bit. They're understanding the idea of mutual ownership, and it's really hard to compete with a competitor who is essentially acting as a bit of a nonprofit. I mean, not technically, but they're really running that.

They're running the company and cost as best they can. Really tough to compete with. I think people are associating that brand value with safety, whether or not it should be or not. And I think that's really compelling. Yeah. So the top five, I want to put up that list again. We always talk about the big five. Black Rock is number one.

Vanguard is number two, but it's closing in on Black Rock State Street. Invesco. And Schwab's there, too. Yeah, Bob, we'd be number five there on that right after Investco, by the way. I'm going to make sure that $268 billion is what I have. I'm not forgetting about you, DJ. Your chances there to get in on that. And you've done a – Schwab's done an amazing job. In the last 10 years, remember, they were not a significant part of the ETF.

I had one of those, you know, ETF nerd bar bets when Schwab launched about how quickly they would reach $10 billion in assets. And even I was too pessimistic. I mean, they were absolutely rocketed. out of the gate. They deliver great products for the average Schwab customer. Of course, they've done well. And what do you attribute your success comparatively, DJ? Here's a softball question. If there was one, okay? So here's your chance to have the one softball question. Well, surprise you and say, I'll participate in that Vanguard discussion and say Vanguard does a lot

of things right, right? They like us, oftentimes, we just try and see the world through investors' eyes and offer low-cost investment strategies that do what they're supposed to do and track the index. So they do a good. They do a good. good job at that. I think the market looks at us as, you know, hey, it's a welcome alternative, right? Is it a healthy marketplace if you've got two providers that really overwhelm the entire industry in terms of asset growth? So I think that we're being welcomed as an alternative. We have scored really well in terms of inflows competitively for the last few years. I think we're number four year to date among over, you know, 200 ETF providers. So it's a very competitive

space. And I think that we've been able to, you know, do what Schwab's known for doing, which is look at the world through the investors' eyes and bring low-cost, diversified products that help investors achieve the long-term objectives. That's really all we do. It really helps to have a huge loyal distribution, you know, center. Doesn't hurt. Doesn't hurt. Just a famous brand name. Schwab is one of the real. I think those brands really do matter, right? I mean, when you think about names like Schwab and Vanguard, right, these have very positive brand associations. They're very storied older brands in the space, people look to those as signs of safety and comfort. Yeah, they're trusted.

Yeah. And beyond that, I would say, beyond our distribution channel, I would point out that a significant portion of our flows this year, last year, the last few years, have come from what we call off platform. In other words, having absolutely nothing to do with Schwab's distribution, branch network, or even advisors at custody. So we do have institutions that are now noticing our ETFs that are at scale, right, an average of over 10 billion each ETF, and they're utilizing them for liquidity. And again, as an alternative. If you want, low-cost index, you know, you're competitive up there, right? Your TIP fund is lower than TIP, right? I think your fee is lower than TIP, right? Yeah, not just a little. They followed the same index.

TIP's got a 19 basis point expense ratio, and SCHP's at four. So that's not really close. and they track the same index and take a look at the comparative returns. SCHP holds its own pretty well. I didn't actually plan that advertisement for the end of the day investors win, right? But there you go, folks. We're just stating out, laying out the facts here. 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. Today will be continuing the conversation with Dave Nautic from VETI. Dave, thanks for sticking with us. One of the things that's amazing to me is market up, ETFs have inflows. Mark it down. EPS have inflows. It's just remarkable.

So far I'm looking at, I have $550 billion. $560. $560. Thank you for correcting me. Year to date of inflows. And every year, this is the second biggest year? The second highest, I think 8-8-something, 880 last year was the highest we'd had. And for those of you're not tracking this in the nerdy way.

that Dave and I track it. There's about, what, $6.5 trillion? It's an asset? Seven, yeah, about $6.5 trillion. Close to $7 trillion. You know, it depends on the day. Okay. So every year there's another 10% more in overall flows

on top of whatever price movements there might be this. Yeah, so like my internal model still counts for, modeling 11% AUM growth over base X market move for the last nine or 10 years. It's kind of where we've been. So these numbers should, over, on average, keep getting bigger and bigger. I wouldn't be shocked that we,

don't face down a trillion dollar year next year. It could easily happen. And why is it happening? I mean, what I notice is we can play around the edges describing what's going on. There's inflows into value funds and outflows from growth stocks. But what you see year after year is plain vanilla ETFs continue to attract attention and vanguard above everybody else. Yeah, well, there are a couple things going on. One is that the mutual fund exodus is not over. So just this year, we're looking at about $850 billion. So more monies flowed out of mutual funds than flowed into ETFs. Where did the money go that's missing?

Either cash or individual securities. We have to assume that. So that's a huge shift. And that's been very consistent year after year, at least as much money comes out of mutual funds as ends up in ETFs. So that happened this year, too. Half a trillion dollars in bond mutual funds were sold this year already. And that's just a staggering amount.

of money for the pocket of the industry that mutual funds really had a lock on. Between Target Day funds and bonds, they've had the lock on those sectors for a long time. So that's still the continuing story. And when you get a down year like this, you get volatility like this, you create all sorts of opportunities for tax loss, harvesting, repositioning, and any way you want to be, there's an ETF. And that's going to help ETFs. Absolutely, right? So those of you don't know this, mutual funds still have a big advantage in terms of assets under what, $20 trillion and something like that in mutual funds,

$7 trillion in ETF, so there's a three to one difference, but it's narrowing. It's narrowed quickly. Yeah. And who knows? Five years, we could be at parity. Yeah, I think that's actually about the right answer. I think last time I ran the model, we're looking at like 2028,

which I guess is about five years. Yeah, so 2027, 2028 is about when we'll be parity. It's never going to go all one way. There are still some things mutual funds do better. Having fractional shares mean they'll be in 401 plans forever. Having 12B1 fees means they'll be in 401 plans forever. ETS are never going to completely kick them out of that space. So it's a horses per courses thing.

But if you are managing money in any kind of interesting, more dynamic way, chances are ETFs are the best vehicle for you to use. One other thing that strikes me as remarkable this year is the overall lack of panic. I have been with CNBC for 32 years. I have lived through all sorts of panics. When I was hired, the Gulf War was going on in 1990. That's how old I am. And I lived through the dot-com bust.

I lived through 9-11. There was a significant amount of panic. I would say, judging by emails, high levels of panic in March of 2000, around the dot-com bust. Then again, around 9-11. Then again, 2008 and 2009, with the great financial crisis. I would say that was the mother of all panics.

And then again, for COVID. Right at the beginning. At the very beginning, March and April, 2020. And yet this year, we have a year down at 1.20% or more. And yet other than, I would say June, I got, I could smell some panic by the viewers worrying that we're going to just completely you know, be down 50%. But other than that, we hit the bottom in October, again, lower than June. I didn't smell the patent. Vicks is at 19

on Friday. It's the most boring bare market in history. It really is. It's just, there doesn't... Why is this happening? Are viewers better educated? Can they actually look and say, you know what? We've had an amazing run the last 10 years. We're only down back to where we were two years ago. Which is the truth. Are they that logical? Or they're more

logical than they used to be? I think there's a piece of it that's that. But I also think that The reality is we have investors dealing with a market they've never had to see before. One with high inflation, rising interest rates, obviously all of the global political stuff, right? I mean, the phrase polycrisis gets kicked around, but there's a whole lot of stuff that's either broken or in the process of breaking in the global economy. And everybody knows it, which means that while you may feel like you should do something, it's very unclear what one would do. Do you sell everything and go to cash and throw away 5 to 10% a year to inflation? of course not. So this really is a Tina market, and Tina, in this case, stands for there's no

alternative to being invested, whatever that means. So when we talk to advisors, I haven't gotten any panic either. What I get is, okay, it's time to reposition. I've got some opportunity to make some changes because I'm going to rebalance. All these things moving around means the rebells are very real. So maybe people are just better educated about it. I mean, what's startling to me is it's not a major topic of conversation, the stock market, as opposed to what it was during the dot-com bust during even 9-11. Or even the beginning of COVID, right? Even COVID, when we had, everything just dropped like crazy, and the meme stop craze happened.

But we had that, remember, March was one of the worst years I've ever, worst months I've ever seen. Oh, yeah, horrific. We went straight down 35% in a few weeks. Yeah, absolutely horrific. So I think we've shaken out a lot of those investors. I think, you know, a year or two ago, we would have been talking about our Robin Hood investors selling this market. Now we don't really care, right?

We look at the volumes on screen. I mean, what used to talk about them. Yeah, exactly. So I think that retail sense of panic is gone largely because whoever's left in retail has find a way to live with it. Yeah. Well, let's hope they stay in. You know, one of the things that I really was happy about three years ago, four years ago, pre-COVID was when Robin Hood announced they had 20 million accounts. Never mind, they only had $5,000 in account.

That's all. This is peanuts compared to Schwab, which had $70 million. But 20 million knew it young people. I welcome that. I thought that was wonderful. And look, all those folks aren't going to go away. And honestly, look, I started investing in 1986. So you know what my first two years were like. And honestly, I'm very grateful that I had that experience of recognizing that markets can move around on you and you can be wrong.

I think we've got a whole generation of investors. We've learned that less over the last year and a half. I hope most of them stick around. Yeah, I hope so too. I said to somebody, and I forget who it was, a year ago, the central job, of a lot of financial advisors is to figure out a way to keep those young people those twenty million accounts from going away keep them from saying uh... it's all rigged everything you know the market was

up we were really smart and now it's down it's all rigged we keep those young people around even if they only have three thousand dollars in the account because my mistake my generation made and i'm older than you david was we didn't do anything we in the nineteen seventies when i was in my twenties we did not invest our generation the market was terrible that that that that

because, well, we had all sorts of issues with oil and inflation, but I didn't start investing at all until I came to CNBC in 1990, and that was way late. So as a result, I had to take more risk to put more money. And when I finally understood what was going on 30 years ago, I said, I'm in trouble. And I hope more people, young people, don't do the same stupid stuff the baby boomers did, way too long.

So let's hope that continues. Dave, thank you very much for being with. as always my friend, Dave Naughey is the financial futurist over at VETI. And thank you, everyone, for listening to the ETFAG podcast. InvescoQQQQ believes new innovations create new opportunities. Become an agent of innovation. Invesco QQQ, Invesco Distributors, Inc.