ETF Edge - The Best Bond Alternatives

Episode Date: April 25, 2022

CNBC's Bob Pisani spoke with Jon Maier, Global X CIO and Todd Rosenbluth, Director of Research at ETF Trends. They discussed attractive bond alternatives. With the age-old 60/40 stock and bond portfolio unraveling, investors are clamoring for alternative sources of yield as bond funds continue to bleed. Where else can they turn? Plus, they discuss Twitter as Tesla CEO Elon Musk edges closer to a deal to take over the social media giant ahead of its earnings. In the "Markets 102" portion of the podcast, Bob continues the conversation with Todd Rosenbluth from ETF Trends. 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, Invesco Distributors, Inc. Welcome to ETF Edge, the podcast. If you're looking to learn the latest insights on all things, exchange-traded funds, you're in the right place. Every week we're bringing you interviews and market analysis, breaking down what it all means for investors. I'm your host, Bob Pisani, and today on the show we'll discuss attractive bond alternatives with the age-old 60-40 stock and bond portfolio. UNRWAveling. Investors are clamoring for alternative sources of yield as bond funds continue to bleed. Where else can they turn? We'll discuss that. Plus, we'll talk a little about Twitter as Tesla CEO Elon Musk edges closer to a deal to take over the social media giant ahead of its earnings. Here's my conversation with John Mayer. He's the CEO of Global X, along with Todd Rosenbluth, Director of Research at ETF Trends. John, GlobalX has income equity portfolios that you say can report.

place bonds. I know we're going to get into a lot of complicated stuff, but just as an opener, tell us what these replacements look like. Sure. Thanks for having me on. When you look at an equity income portfolio, you're looking at a few sectors that are paying high dividends, quality dividends, dividends that coming from covered calls, as well as just generally high dividends, not necessarily quality dividends, and then you have some preferreds. Those sectors can provide a yield that's pretty significant, somewhere in the four to five percent range. And that's pretty meaningful, particularly in a market where we expect long-term rates to continue to rise. And obviously, the price of your bond is going to go down.

So it's a tough place to be on the fixed income side, much better on the equity income side from our point of view. Yeah. Now, Todd, John's got quite a list here of alternatives. Quality dividends, master limited partnerships, real estate investment trusts, covered calls, even preferreds are on this. Is there evidence that investors are buying into them? I mean, are there actually inflows into some of these ETFs that do these sort of odd corners of the market? We're seeing that. So when we look at the data that we have at ETF trends and ETF database, we're seeing demand for covered call related ETFs, ETFs like JEPI, which is JPM's covered call ETF.

John's QILD is popular. We're seeing some other ones that are gaining traction. We're also seeing popularity for dividend-oriented ETFs. So higher-quality dividend ETFs, as well as above-a-L-L-Dash. average yielding and lower risk dividend ETFs are gaining traction this year. Okay, so we're getting investor interest in them, but I want John and Todd to walk through a few of these alternatives in the specific manner. But first, I want to play an excerpt from the interview I did with Jeff Gunlock at the recent

ETF conference. Here's what he told the participants to do with their bond funds. The bond market was grossly mispriced thanks to the government's manipulation, and so everything's being repriced. I've been advising 25% commodities, 25% cash, 25% stocks, and 25% long-term treasury bonds, believe it or not, because they're so ridiculously valued, but that's your deflation hedge. And so if you actually have a 60-40 portfolio, 2020 is your worst year-to-date ever for 60-40. But if you had the 25-25-25-25, you'd be far better off. So, John, 25%, this is a pretty low weight for stocks, but you believe you have a much higher weighting in equities here.

And if you're in the right equities, the key seems to be low volatility, high dividends. Why are you emphasizing these, what we call quality dividends? Sure, first of all, some people's portfolios are constrained, so they can't necessarily go with Jeff Gunglack's suggested asset allocation. And many investors just need that yield. And the yield is coming from, first we can look at quality dividends. Dividends. Quality dividends are an area that I believe can, at least on a relative basis, benefit in the current environment. Typically, they're more value-oriented. The companies typically have strong cash flows, high dividends, and dividends that potentially can grow. And the market is rewarding that, at least on a relative basis. I think that's a more safe place to be than some of their sectors in the broad... Now, I want to get a little more specific. You have this breakdown of your equity portfolio here, and you specifically recommend.

and Vanguard high dividend yield, VYM, you have 16% of your portfolio, and I shares core dividend growth, that's 14%. What is it about these that you think is particularly attractive? Well, there's just a handful of high dividend-paying, quality dividend-paying ETFs out there. Now, with our portfolios, we take an open-architecture approach. We don't only use GlobalX ETFs.

So we believe these two ETFs have the ability, the companies within the ETF have the ability to have stable to growing, dividends and the companies have strong cash flows. We think it makes a lot of sense for that bucket, but that's just one of five buckets that we have in our equity income portfolio. Now, another interesting group here, we'll weigh in here, Todd. Another interesting group that he's bringing up is master limited partnerships. This always shows up when people want higher yield, and yet they've had problems. Years ago, they used to sell them on the ground and said,

well, if the market goes down, they own the pipelines, it won't get hurt. And we found out that wasn't true. There's also some tax issues. This gets very complicated, right, when you're dealing with something like master limit of partnership. It does. MLPs are different than traditional energy companies. They're often not found within the broader S&P 500. So if you were to look at AMLP, which is the Illyrian MLP, ETOF, the largest of that group, you're going to get exposure to companies that you wouldn't have traditionally within the S&P 500, above average dividend yielding companies that have relative stability that are going to have some bond-like characteristics, but also have that equity risk behind it.

And, of course, there's always this tax question. Every time we do this, the viewers write in, and you better tell the viewers, Bob, about what the tax structure is like. Can you explain what the difference is here? Sure. We have a couple MLPs funds, MLPA, which is a C-Corps. So the taxes are paid on the corporate level. So what many clients are concerned with, are they're going to get a K-1?

They're going to have to extend their tax returns. It's going to be an issue. It's all done on the corporate level. So that's one of the reasons that investors like the structure, the ETF structure with MLPs. Just one of the common on MLPs, MLPs are highly correlated to the movement in interest rates. So as interest rates go up, MLPs also potentially could go up. They also have some correlation to the energy market. They are seeing a pullback today because there has been a pullback in the overall energy market as well.

Yeah. Now, what's interesting when I was talking to you about this, you have exposure to many sectors, the market. But Gunlock was very big on commodity ownership directly. He was talking about 25% ownership commodities directly. I don't see any direct commodity exposure here. Is there a reason when you're dealing with this? Or you just wanted all equities? Well, it's all equities, but the MLPs do have some component of energy. And they are correlated to the energy market. So there'd be, I'm not trying to match Gunnlock's asset allocation, but you are getting some exposure there as well in terms of energy.

And we're also seeing another area, Todd, is REITs here. Now, why would REITs be advantageous in a rising rate environment? So what are we getting here when you get a REIT? With REITs, obviously you're getting equity exposure, dividend-paying companies. It's diversified. I saw some data recently from S&P that showed the exposure differences within the industry and now the sector group of REITs over the last 20 years. It's much more growth-oriented than it had been.

Exposure to data center companies like American Tower with VNQ, which is the Vanguard REITF, you're going to get broad exposure. You're going to get some retail reach. You're going to get some residential REITs, but you're also going to get exposure to more the growth-oriented companies that you find that can benefit from a strong economy through VNQ. So this is a good way, and it's actually been very popular in the past month. VNQ has been seeing some strong inflows. Yeah, and, of course, REITs have been one of the better performing sector.

I mean, investors have caught on at least this idea for months now. So we do have exposure to REITs within some of the ETS we have. DIV, which has a good amount of REIT exposure in it. Now, REITs can pass on higher costs of, you know, rents and whatnot, but they could be susceptible to the business cycle as well. So if there's economic slowdown, there's kind of a push and pull. So they can pass on higher costs, but if there's economic slowdown, perhaps people are renting less.

Perhaps people are renting stores much less or offices are being rented less. So there is some exposure, but very high yields, and there is inclusion in the portfolio. Now, I want to give another alternative, and I know we're throwing out a lot of ideas here, but that's the way it's evolving, and we're going to try to sort it out at the end here. But covered calls is another area that gets very trickly. Now, explain covered calls and how this can help in a rising rate environment. Sure. We have several cover call funds. One is QILD. It's our biggest fund. It's about $7 billion in assets. It has a yield of approximately 12%, very high yield. What does it do? The underlying components are the NASDAQ 100. And what we do is we write at the money option, index options, on the underlying portfolio. Now, when VALD is writing. Writing means selling, essentially. Yes. And then you're getting income. You're getting income. And we're passing on that income.

to the shareholder. Now, you're somewhat cushioned on the downside, depending on the volatility in the market. There's been some volatility in the market, so it does better than the overall market in this environment, but you're capped on the outside. Right. Selling a call obviously implies that you don't believe it's going to go higher than where it is right now. Right. The perfect... PS&P or the NASDAQ 100. You're making a trade-off. You're getting that income, and you're trading your upside for that income. A range-bound market is really the best market for covered call fund. We had covered call funds on the NASDAQ, the S&P 500, the Russell 2000.

So we think it makes a lot of sense if you believe the market's going to be rangebound, and you're looking for that very high income. And this has been one of the more popular areas within the ETF space, QILD being among them, but this shows the benefits of the ETF structure to buy individual companies and then sell calls as an individual investor, and to do that on an ongoing basis. Enormously complicated. Extremely complicated, but with QILD, with JEPI, which is JPMorgan's product, with DIVO, which is an Amplify product, these covered call-related ETFs getting a lot of traction. We're finding a lot of interest with our client price as well.

But it's not free. You're paying for this service to do. What's the cost of QILD? It's approximately 60 or so basis points, but you're still getting that very high income. Everything has been done for you in the structure. Right. And you mentioned 12% right now, yes, because the volatility is a little higher, so you're receiving higher income because of the volatility is related to the office. To sell that call, you can charge a premium essentially, yeah, at that point.

I mean, the average you were just hearing 12%, wow, like sign me up for that one. And so, but what's the risks? That doesn't mean you're going to get 12% going forward. You look at it from a total return perspective. So the upside is capped because you're selling your upside and receiving something for that. Now, the downside is somewhat cushioned. So if the S&P's down, say, 20%, this is down right now about half as much as the NASDAQ, about half as much as the NASDAQ, because we have elevated volatility. Now, potentially, if volatility is lower, you can get a little more downside. Yeah, potentially. Todd, preferred equities,

so we're also getting a lot of attention. What is the concept behind preferreds, and why might that be more interesting than owning common stock? So prefer to get some of the benefits through owning common stock and some of the benefits of owning fixed income. So you're getting income, you're getting higher up in the capital structure as a result of it. These primarily are financial institutions. So there is some sensitivity to the economy, some sensitivity to it. We're showing some of the Global X products on the screen here.

John can talk more about those products, but there's a number of products that are out there. I shares has PFF, which is another one of the products that are out there. These are also gaining as an alternative. You get some of the stock upside that you would get. And you get a higher yield. You get a higher yield than you would from the bonds as well. And yet, John, it doesn't mean you're going to outperform. PFFD has not been an outperformer this year particularly.

No, you have to think about what... I'm talking about your preferred ETF there. It's not just ours. It's all the preferred space. And if you look at what preferreds are, they're long duration instruments. So if rates go up, the long end of the curve goes up, inevitably these are going to go down in price. But the underlying credits are strong. 70% of the preferred market are financials.

Even during the financial crisis, there is no defaults. Some preferred stop dividends for a period of time than restarted. But the underlying credits are very good. But another way to play it is variable rate preferreds. We have a fund called PFFV, where it's short. duration than perpetual preferred. And while it's still down, it's not down as much as PFFD. But if you're looking at Gunlack's asset allocation, he's saying 25% long treasuries.

In that scenario, Perferds would do very well. Yeah. It's a little bit difficult to sort this all out, but I want to just chat a little bit about your broad sector. So remember, you have an equity portfolio that is an alternative to bonds, and you've got several big sector-specific bets here. Vanguard technology, 12%, health care, 9%, communication services, 3%, and even your infrastructure, PAV, which you own, which is an infrastructure play as well here. This is a pretty broad portfolio that you've got here, suggested, and

it's, I'm not sure I would call this defensive. I mean, you've got a fairly significant weight in technology, for example. So explain this, and where does that fit in with this concept? Sure. You're talking about. Is it alternative to bonds? Got it. So when I was constructing this portfolio, I took it as a complete portfolio. Now, when you're looking at income, equity income, it's confined to a few sectors, whether

for utilities and REITs and mortgage-backed securities. So if I wanted to build a complete portfolio, I wanted to add back a bucket that would correct for what you're missing in other portions of your portfolio. So whether it be technology or industrials or materials or health care, I felt like these were necessary components to put into your broad portfolio. Now, on a portfolio level, you're still getting about a four and a half percent yield. But if you want to buy this as a complete solution, in certain market environments, if you're just exposed to equity income, you're at a disadvantage. This provides a more rounded portfolio.

So you're trying to say, essentially, this is a complete portfolio in a certain way for an income investor. You're going to get higher income than if you would have just owned the S&P 500, for example. This is totally a complete portfolio. It's a more defensive portfolio. If you actually look at the performance, it's down about 3 or 4% relative to the S&P 500, relative to the NASDAQ, and you're still getting that 4.5% yield. Right. And the SEP is, what, 1.5% right now?

Right. So your 4.5 versus 1.5 is a more defensive portfolio. That makes a lot of sense to me. I'll tell you the problem I have, other than buying this as a pack. By the way, can you buy this as actually a complete package? The equity portfolio. Yes, the GlobalX equity income portfolio. It's available on InvestNet.

It's available on TD Model Marketplace, Geo Wealth, Orion. So if you just Google GlobalX equity portfolio. Yeah, on our website, GlobalX is its model portfolios at the top. People want more information. Sure. Can get it there. I'll tell you the problem I have. I've been doing this for 32 years with CNBC, and I always pity the viewer who's trying to understand this.

This is an awful lot of stuff to throw at the average investor. All they know is they're getting their quarterly statements, and their bond funds are down, and their stock funds are down, and they're going, what the, you know, what am I going to do here? So we've discussed today, quality dividends, master limited partnerships, reets, covered calls preferred. This is a lot to throw at the average investor. Todd, can you make sense of this for us? I mean, is the answer to try to consider just buying a portfolio like they have and it's all wrapped up in a nice, neat little bow? How should investors look at all of these choices? It's a little confusing.

It is confusing, and John can confirm this or not, but I don't think people should swap out their entire 40% of their fixed income portfolio into something that's equity income oriented because then you're taking on so much more risk. So, yes, you get some of that interest rate sensitivity, yes, you get some of that credit risk, but there is more downside in investing in stocks typically than investing in a bond portfolio. So you want to make sure that you understand each of these individual components, what you're getting, what you're not getting, and look at the individual ETFs, then do your homework on that to make sure you understand what a risk you're taking on, what that reward potential is, and the differences between a preferred and a covered call

and an MLP and a dividend strategy. notable differences within those four categories that we're talking about. Yeah, and I don't, I think you're probably not recommending also that you swap out your 40% in bonds necessarily with this whole portfolio. You have to think about what I do. I manage model portfolios. I did that when I was at Merrill Lynch for a long time. I do that at Global X.

So I build complete solutions. You could argue this is a complete solution, or it could be a sleeve. That this could not just replace the 40, this could replace your whole thing. In the current environment, it could replace your whole thing. in different environments. The yield right now on this portfolio that we just talked about with all of this stuff in it is 4.5% right now? Yeah, I think it's slightly below 4.5%.

And the S&B is 1.5. So you're getting 3 percentage points right there. Would you not agree, though, Todd, that all of this is nice. But if we actually go into a real slowdown, let's avoid using the recession word, the R word. But if we really go to a very serious slowdown, all of the stuff drops, it doesn't matter. It's like 2,000 again. and we're essentially everything. It's very hard to hide.

Exactly. So if you're looking to hide, you can look at ultra-short-oriented fixed-income ETFs. Those are cash-like with a little bit of income. And various providers offer those. You can have short-term corporate bond products. The equity exposure is a risk, and investors need to make sure they understand

what risk they're taking on. John, before I let you go, your social media ETF, SO-CL, has a very significant holding in, Twitter. It's 7% of the fund's assets. There's reports surfacing that Mr. Musk is in very serious negotiations with Twitter. They may be able to make a deal. They may not. But what's your thoughts on that as a significant shareholder in Twitter? Well, it has about a 7% allocation. And if Elon Musk takes it out at a higher price, it only benefits the shareholder. And then

Twitter gets removed from the portfolio once the acquisition is complete. So from a portfolio level from a shareholder point of view, it's a positive. Yeah. For SOCO, if Twitter gets taken out or taken private, you have to decide what replaces that, right? Well, it doesn't direct, something doesn't, it gets rebalanced in terms of weightings, but it doesn't get directly replaced. There will be new social media companies that come into the portfolio and go out of the portfolio based on the index methodology. So that just happens as a natural course of events. Okay, gentlemen, thank you very much for joining us. 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. Today we'll be continuing the conversation with Todd Rosenbluth from ETF trends. Todd, thanks for sticking around with us. I wonder if you could give us some thoughts on the recently concluded ETF conference. We had 2,100 people there. I was very impressed with the turnout. Bonds were the big concern, the RIAs, the registered independent advisors who attend these things. all freaked out about that, but what else did you hear from the RIAs there?

What's on their buying? So at the Exchange ETF Conference, which Advisor Circle and ETF Trends and ETF Database co-ran, we were hearing some interest about actively managed ETFs. There was a number of new asset managers that have entered the marketplace in the last couple of years, Capital Group, Federated TROPrice, and this was a chance for advisors to be able to kick the tires, so to speak, with those asset managers, learn about their products, learn how to compare them with traditional index-based products.

And there was interest in the sessions that I was a part of. Those were well-attended. There was a lot of questions from the audience about that, because especially when the market's down, you're looking to see if you can get the benefits of the ETF structure, but with an active manager calling the shot. So we heard about that. And also inflation being top of mind, how high it's been and investors are looking for alternatives. We talked during the main show about alternatives to fixed income, but commodity ETFs in particular have been very popular in 2022.

Gold, but also more broadly diversified products. Those sessions were well attended. We were hearing from advisors that they hadn't really paid attention to commodities. They hadn't had it as part of their traditional portfolio in years, but now they're exploring it or adding it in to get that benefits of diversification and in rising inflationary environment. I have watched the RIA community, the registered independent advisors grow for the last decade. A lot of these are old Morgan Stanley guys who retired and setting up their own shop or Merrill Lynch guys retiring. And I've watched the industry grow. I've watched most of them utilize ETS because it's a lower cost structure so they can charge less.

So they're charging less than the traditional advisors. And yet now they're sort of at a crossroads. Now for the first time in 12 years, bond funds are down and stock funds are down. and they're going to go back and face their clients, and their clients are going to open their quarterly savings and say, my heavens, what happened? And what did I pay you this fee for? What are we doing here at this point?

So they seem to be a little bit worried about that, even though the ETF business is growing, the RIA business is growing, yet I wonder how well they're going to handle a downturn in the market with their clients. Yeah, well, this is an opportunity of them to demonstrate that they're adding value. Obviously, not just in picking individual securities, hopefully they're doing better than the broader marketplace by using some tactical shifts to the portfolio, but adding value as well. Hold hand-holding to make sure that the investors are sticking for the longer term, as who we both admire, Jack Bogle would say, you've got to ride this out, stick with it,

and perhaps shift towards more value-oriented parts of the portfolio, shift towards more defensive parts of the sector to tread water in this down market before having a chance to recover. In a sense, this is the problem all active management faces. And RIAs to extend our active management, essentially. It's the problem the hedge fund people have always said, okay, fine, maybe we're not going to outperform or do amazing in a low volatility environment. But when volatility picks up, oh, we can move really fast and nimbly. And historically, the evidence is hedge funds don't actually outperform. So this is an interesting test to the extent that, RIAs are active managers, how many of them are actually going to be able to outperform

versus me being self-directed and just owning the S&P 500, for example. I think most people who use RIAs are a little smarter than the average person using, say, a wirehouse, because they at least have the sense that these RIAs are lower cost. They're not going to be charging, pick a number, one and a half percent, they're likely charging 1 percent or below. So even that, the investors know that. So, on one sense, they understand the importance of keeping costs low. And yet, at the same time, I wonder how much more outperformance an RIA is going to be able to pull off in this environment. Well, if you're doing it based on, if an advisor is doing it based on the risk profile of that investor base. So if you're less concerned about the risk,

then you might be taking a more aggressive stance with your clients. But there are AAs that I know that have had a more defensive portfolio, not more fixed income than equity, but having more defensive equity, higher dividend-paying stocks that are performing relatively well this year, having exposure to commodities that are performing relatively well.

There's an opportunity to be able to add value knowing your client instead of just putting them into a basic model, but having something more tailored based on risk tolerance, and that's what I think many advisors are looking to do. What do you see for the rest of the, year in terms of flows? Is there anything that's really stuck out to you?

And sometimes flows are useful and understanding things and sometimes not. I usually look for really longer-term trends than a month or so, and it's still a little early in 2022. But is there anything that's really stuck out to you? Well, we're on pace to have what could be either another record year or probably just missed that record in terms of net inflows, perhaps $800 billion of net new money coming in without fix. income having much, carrying much of the water that's there, because of the rising rate environment,

because of the concerns of how aggressive the Fed is going to be, we're seeing fixed income underweight or the exposure to fixed income through ETFs be underweighted. I think that's going to recover. I think investors are going to get a better handle on how aggressive Powell and team are going to be and then looking towards ETFs so that can be able to benefit from it. We've seen strong demand for senior loan ETFs. We've seen strong demand for these less interest rate sensitive products. I think we're going to see fixed income.

If they get closer to their 20% overall share of the marketplace, then we could perhaps see a record year if investors continue to stick with the equities. It seems totally dependent on two things. Number one, the glide path for rate hikes. I mean, a month ago, I had people expecting that the Fed Funds rate would be two by the end of the year. Now we have people at two and a half and there are people at three percent. Right. That suddenly that changes the game a lot, particularly for for high revenue growth stocks, but stocks that may have very low earnings. Right.

The Kathy Wood stuff. So it kind of throws everything up in the air. The other is the whole China story here. You know, this whole thing with this COVID lockdown is really playing havoc. I think this is one of the reasons oil stocks have been down recently. because the growth story for commodities around the world, if you're going to shut China down again, that's going to have a significant impact. So there's an unusually large number of wild cards here, because there's an unusually wide divergence of outcomes that you can get.

It's a big difference between 2% fed funds rate, and 3.5% fed funds rate. And that's going to impact various parts of the EETF ecosystem between emerging markets, fixed income and traditional... All of which says folks that we're just going to going to have to be patient and used to getting the VIX over 20. I think it'll stay a lot between 20 and 30 for a good part of the year until we figure out all of this. And Todd has always appreciate your insights and wisdom on this. Todd Rosenbluth is the director of research

at ETF trends. And everybody, thank you for joining us on the ETF Edge podcast. Invesco QQQQ believes new innovations create new opportunities. Become an agent of innovation. Invesco QQQ, Invesco Distributors, Inc.