ETF Edge - The ETF Flowdown: Mega-Cap Tech in Charge 5/15/25

Episode Date: May 15, 2023

CNBC’s Bob Pisani spoke with Anna Paglia, Head of ETFs and Indexed Strategies at Invesco, and Scott Ladner, CIO of Horizon Investments. They discussed the latest ETF trends and flows experts are seeing this month. Big tech is leading the charge, but is it all just a so-called “mega-cap mirage”? And investors are still putting money to work in fixed income ETFs. They dug why certain pockets of active fixed income, in particular, have garnered so much attention lately – and offered best strategies for ETF investors to play the space. In the “Markets 102” portion, Bob continued the conversation with Scott Ladner from Horizon Investments. Hosted by Simplecast, an AdsWizz company. See pcm.adswizz.com for information about our collection and use of personal data for advertising.

Welcome to ETF Edge, the podcast. If you're looking to learn the latest insights on all things that's changed traded funds, you're in the right place. Every week we're bringing you interviews, market analysis, and breaking down what it means for investors. I'm your host, Bob Tazani. Today on the show, we'll wade through the myriad market variables and give you an update on ETF flows. Big tech is leading the charge. Is it just a mega-cap mirage? A lot of people seem to think so.

Investors are still putting money to work in fixed-income ETFs as well. We'll dig into why certain pockets have. active fixed income have garnered a lot of attention lately. We'll find out the best way for investors to play that particular space. Here's my conversation with Anna Paulia. She's the head of ETFs and indexed strategies at Investco, along with Scott Gladner, CIO of Horizon Investments. Anna, you oversee the triple Qs, which attracts the NASDAQ 100.

This is the big star ETF performer this year. It's up 21%. But I get all sorts of cynical comments when I point this out. They say the tech rally is mostly mega-cap like Apple and Microsoft and Nvidia. 60% of the NASDAQ 100 is down this quarter. So tell me what are people doing here? What kind of flows are you seeing? Are they buying, selling?

Are they shorting the triple cues? What's going on? Bob, you're absolutely right. There is a mix of the story when it comes to the QQQQQ. The fund is up almost 22% and is outperforming the SMP 500 by 14%. And with such strong performance, you would see phenomenal flows into the product. But in reality, year-to-date, the flows in QQQQ have been flattish, but by converse, flows into the Minicube, the QQQM, which is for buy and hold investors, have been positive.

And to us, that indicates that the growth story resonates with clients, but there is a wait-and-see approach because people don't know if this drive, if this performance is only driven by the mega caps or if there is more in there. We are still firm of believers in the QQQ, but it's a win and see for our clients. Yeah, it's a tough play this year with that triple Q's. I want to just move on with to come back to that, but the other big game this year is fixed income. That's dominated. The whole industry flows year to date, essentially, and treasuries, as we all know, they're the big winner. You've had great inflows into your treasury collateral ETF, that's LTLT, that invests in the short-term treasuries. All of those funds have been doing great. But there's

also some interest I see in active fixed income, in more targeted areas, preferred shares are getting some attention. Bank loans. You run that BKLN as well. Tell us about why people are starting to target more specific areas of fixed income other than treasuries. Bob, if you look at the fixed income market, ETFs have crossed $1 trillion. So it took a shorter period of time for the fixed income ETFs to cross $1 trillion than it did for the equity segment of the market.

And we expect this segment to cross $5 trillion in the next five years. However, not all fixed income ETFs are created equal. What we are observing is that our clients want to have more power and more position in the way they allocate to fixed income apps. So you don't see more focus in a bulk better strategies. But rather you see a lot of

flows, a lot of focus, a lot of attention in these more laser focus, the precise strategies. It is a smart better or even an active fixed income media study, but definitely fixed income has been dominating the markets here to date. Yeah. Scott, let me me bring you in here. You oversee $8 billion in assets. More than half of that is exchange traded funds. So you allocate amongst your portfolio using ETFs very liberally. Investors seem interested in treasuries this year, but not that interested in equities. And I'm curious about

that. What are you seeing and what are you advising your clients now about equities? Yeah, Bob, I mean, you're right about that. I mean, we have seen a lot of interest, a lot of renewed interest in the fixing income world in general, and really like the cash world, specifically, let's take kind of the short-term space where you can get paid four and five percent. You know, with that, that's understandable to some degree. I mean, look, we haven't had any, you know, any gains in global equity markets for almost two and a half years. And so people are kind of tired of waiting.

And so, you know, the interest in a kind of short-term, you know, high-yielding sorts of instruments, we think has made some sense over the last, like, six to 12 months. But we think over the next six to 12 months is probably the wrong place to be. because if we are in sort of a disinflationary period and we've seen the peak of inflation and we've seen the peak of rates, we think, you know, the equity allocations, even though they're shunned and they're hated right now, they're probably going to be a better place to be for investors, you know, as we come into the summer and the fall time. You know, it's amazing, Scott, in equities, how negative the sentiment is. And of course, this is bullish because people are on the sideline. But nobody seems to want equities these days. it seems to me that there is an opportunity year. I want you to expand on your point that you just paid negative sentiment, number one, number two, the possibility that inflation is coming down.

The Fed is done cutting rates. And number three, earnings keep holding up pretty well. This earnings, you know, recession that we keep wait, we've been waiting for for six months. So far hasn't happened. Yeah, look, you're right. We've been waiting for this recession, the most forecasted, obvious recession in the history of the world for over a year. for over a year. And it's always six months away. And we think in six months, it's going to be another six months away. You know, this is an economy where we have an under levered U.S. consumer.

We have an under levered U.S. corporate stance. So, you know, people are spending money, companies are making money, and rates have peaked. That's not a bad backdrop overall. And just like you said also, Bob, you know, the fact that sentiment is very poor and very bearish, you know, like it just adds some fuel to the fire. So, you know, it's going to be rocky. I mean, look, we still have debt ceiling ceiling. worries, and we still have things to worry about. But overall, we think that the positive catalysts on positive stories for this market, why this thing can go higher over the next six to 12 months are really underappreciated right now. Yeah, it does seem to me that the risk is to the upside,

particularly if we get some resolution to the debt ceiling. But, Anna, let's get back to equities. I want to get back to this big cap tech divergence because it's got everybody all all up in arms here. The triple Q is the star, but again, 60% of it is, down this quarter of the triple Q of the NASDAQ 100. Traders seem uncertain as to whether the dominance of a small group. And look, this is why we're up so much this year, particularly triple Q's Apple, Microsoft, Alphabet, Amazon. When you get this group moving this much, you're going to be up, even if the rest there's not.

Where do we go from here? I know you're not a tech strategist, but the big question is, does this divergence continue? Well, I don't know if the diversion is going to continue. And I don't know that our investors know that themselves. But this is why I think we continue to see divergence between the flows into the QQQQ and the flows into the Mini QQ, which is the QQQM. So QQQQQ is really used by traders and by big investors really using short-term sentiment to make investments in the Q's. And if you look at that, if you look at the flows that are flage year to date that indicates there is really not a high conviction in the short term.

People are waiting to see how this conversation with the mega caps and tech is going to play out. But if you look at the QQQM, which is the mini QQ for buy and hold investors, that's a different story. We have seen positive growth. We have seen positive into the fund, which indicates there is a longer term conviction on growth. And this is the longer-term conviction that is going to drive closing the fans outside of performance. I mean, performance has been striking, 22% compared to 8% of the SMP 500. So it really depends on whether you have a long-term view or a short-term view. Short-term, a little doubts.

Long-term, there is a positive and high conviction on the strategy. You know, for the last seven or eight months, and Scott, I want to get your thoughts on this, too, but we keep hearing this word quality. You, Anna, oversee the Indexco Quality ETF, which is SPHQ. Why is quality attracting a lot of flows, and how are you defining it? It's the word quality is a little slippery to me, and the way I used to define a years ago, it means rising earnings in a strong balance sheet. But how are you defining it? Here's, by the way, the main holder is Microsoft Apple and Meta in the quality ETF that you oversee there. Tell us a little bit about it.

And what's the criteria? Well, the strong balance sheet is definitely the main driver and the main criteria to describe the quality of a certain stock in a portfolio. We see flows in SPHQ mainly because the equity portion of a client portfolio year-to-date has been driven by uncertainty. So our clients are really worried about what they see in the marketplace, high interest rate, high inflation. They are trying to weather uncertainty by using specific equity ETFs. So it's not a coincidence that you see high quality and low volatility being in the driver's seat. This is not really an investment story for returns.

This is more of a defensive story that plays well under the current. market environment. Scott, this word quality, what does it mean to you and do you have some way of telling your clients about it? And there's over a time when low quality, it's a good thing. What's the opposite of quality? It's not necessarily value. What would be the opposite?

I'm trying to educate traders and investors about this word and what to like about and what to be cautious about. Yeah, look, when you think about quality, Bob, I mean, the way to people generally define quality as, you know, quality balance sheets, good cash flows, low leverage, you know, and generally like somewhat immune from the economic cycle, not completely immune from the economic cycle, but certainly more disconnected than, you know, than some of the junk of your names. And so, you know, to answer your question about the other side of that, the other side is more of a junk portfolio. And but when you think a junk portfolio, it sounds bad,

but it's not necessarily bad at the right time of the cycle. When you want a junk portfolio is when you're kind of coming through the troth and you're starting to rebound out of out of a growth trough. Because then that's the time when you do want high leverage. You do want variability, you know, kind of exposure to the economic cycle. And you want basically a lot of leverage in the system. And so, you know, think small caps. Think small cap growth.

You know, those types of names are more in the more of the junky side when we talk about junk versus quality. But, you know, and is right. You know, quality is probably the safer place to be right now because we do have slowing economic growth. We don't think we're going to get a recession, but we're definitely going to slow growth. And we're certainly going to have some margin impression. And so in an environment like that, you know, it does stand a reason that you should have some exposure to some of these more high-quality names.

Higher quality balance sheets, lower leverage, lower interest expense, these types of things. And at the end of the day, you know, one of the most important aspects to that is it could provide some form of safety and could keep people invested or get them invested in the first place, even if they're a little bit scared. So, you know, that behavioral modification aspect to investing in a quality portfolio at a time of economic uncertainty. certainty could be just as powerful as the sort of the economic implications of doing that. And the other play this year, so we had tech and we had this quality play. We also have a defensive play, low volatility. You run the low volatility ETF as well, oversee it. SPLV. I wonder if we put that up. Sam Paul Larry Vulture is the symbol there, SPLV. It tracks the 100 least volatile stocks in the S&P 500. What's pushing investors into defensive sectors? And I would

notice, these are the classic names you would think. You have Pepsi, Mondalese, McDonald's, Johnson and Johnson, Merck, all of these. Healthcare utilities and consumer staples are in these, essentially. Anna? We see that SPLV really resonates with our clients in a period of times like the current market environment or even last year, 2022. Volatility is something that drives a close in and out of certain asset classes, but in an environment in which, you know, people have to weather uncertainty a little bit. They try to allocate their assets into some stocks or some ETFs that give them access to stocks that have low volatility. This fund, this fund, as you said, selects those companies that have exhibited a lower level of volatility historically. And that gives people some

stability. Stability is important in a time of uncertainty, and it's the same thing that we have talked about quality. Right now, people are using flows, and we are seeing the flows into equity that are really defensive in nature. So whether it is quality, whether it is volatility, people are really trying to make sure that their portfolio is not exposed so much to uncertainty. And this is why this is a story so strong with our clients. Scott, I want to just move on to another asset class, and that's commodities. This has been a tough call this year. The China reopening play is kind of fizzled a little bit.

Oil's been sort of stuck at $70. We had a little run up there in January and February on hopes of a big China reopening, and it's happened, but I don't think it's happened in the big way people were anticipating. So I know Anna runs several big commodity ETFs. is a base metal ETF, DBB, the two runs, and there's the oil fund, DBO. But I'm wondering, Scott, if you can just comment on what role does commodities play in any portfolio at this point? It is an asset class.

Does it have any place in 2023? You know, we think actually that commodity story, it might be a tough one. You know, this going forward might be a little bit of a tough one. You know, Bob, like one of the one of the things that you highlighted in terms of the catalyst, one of the positive catalysts that people were counting on to push commodities. forward this year was the China reopening. And to be clear, we are getting a China reopening, but it's not exactly the China reopening that people have thought about. You know, the China reopening we're getting is a Chinese consumer reopening. It's not really a Chinese state or state-owned

enterprise reopening. And so we're not seeing all this kind of top-down stimulus out of the Chinese government. We are seeing people in China spend money, especially on luxury goods. And so, you know, just to differentiate between, you know, a Chinese consumer reopening, which we are experiencing right now, with things like first or second ending of that, versus a state fiscal stimulus sort of top-down reopening that we're just, frankly, not getting. And it's that top-down kind of state-sponsored reopening that we really thought was going to, people who really thought was going to propel commodities. And that's kind of what you need for that story to really work.

But in the context of a global growth, slowdown, like not disaster slow to it, but a slowdown with a kind of a sluggish Chinese official response to the reopening. We think the commodity story might be a tough play for the rest of this year. Not forever, but for the remainder of this year, we'd just rather be in equities, and we'd rather be in Asian equities if we're going to play that kind of story. And talk about flows, the two big ones, as I mentioned, DBB. This is a base metal ones. We've owned aluminum copper here, three base metals. These are futures. And then we have your oil fund, DBO. What kind of flows are we seeing here? And, you know, one of the tough things to do talking about investing in these is explaining the role here and the fact that when when these are in contango you have to the role gets expensive and it's a problem for investors i constantly get

pointed out about warning investors on the costs of of that particular role and i wonder if you're going to address that as well sure sure thing about so the word that's laggyish in terms of flows is the right word because flows have been flat to negative this year, which is, which if you compare 2022 and 2023, is a little bit the tale of two cities. 2022, incredibly strong market for commodity ATAPs, 2023, it's a little bit of a mixed story. Now, when it comes to the role, we employ a strategy called optimum yield, which is a strategy designed to really select the months in which we believe, the strategy believes, the investment and the rolling of the futures is going to make for the optimum yield.

What it means is that we don't roll from one month to the next necessarily if the next month is not going to be designated as the optimum amount for a role. So if you follow the strategy, it doesn't matter. You don't have to track whether the market is going to be in concert. tango or in backwardation because the strategy is going to look at historical cycles and do that analysis for you. And if you look at these funds, they have outperformed the base commodity markets, especially due to the strategy. So I think that selection matters when it comes to commodity apps, but I agree that the rest of the year is not going to be just like 20-22. So just on the roll,

because I get questions about this all the time. You're saying on DBO, normally you would roll over into the front month contract, but in some circumstances where it might not be advantageous, you might not roll into the front month, you might roll into a contract two months out or three months out, for example. That's correct. All right. And Scott, let me just give you the last word here. The problem we're having is the investors are much more confused than usual.

The commodity play, as you mentioned, is a really tough call. There's got some positives. The dollar's a little weaker, but the China play is fizzling out. Treasuries, everyone is lopsided into fixed income. Everyone is lopsided into treasuries. There seems to be some opportunities elsewhere, but there's not huge flows there. And everyone seems somewhat negative on equity. So this is a really tough call.

The investors seem very confused. Half of them want to believe an imminent recession is here. The other half, as you said, don't see it. and don't believe it. So isn't the best strategy at this point? Stay the course. Know where you are in your life. Know how much risk you want to take. Keep investing the same amount of money and don't worry so much. I'm going back, I'm starting to sound like Jack Bogle here at Vanguard, but isn't that the logical thing to do in something like this? Yeah, you know, it is, Bob. And it's, but that can be hard to do. And because if you're nervous and you're reading headlines all the time and you think

the world's coming to an end one way or the other. Price is growing up. There's a war in your rush to Ukraine, the Chinese consumers not coming back. Like, there's plenty of things to worry about. And we hear about them all the time. And so if you're the end of client, if you're a retail, retail client and you don't live and breathe this stuff every single day, it can be hard to put into practice that which is economically and sort of rationally optimum, which is just what you said. Keep investing, stay on plans, stay on track, don't panic. And so, you know, a middle ground for people like that, or middle ground to take out and dip a totality.

back in and get into a market that we do think is going to end up being pretty good for the next 12 months, even if the next 12 weeks might be a little bit rocky, is to engage in some sort of protection strategies. So, you know, Anna, you and Anna talked a little bit about low volatility strategies, low volatility investing. That's a way to get in. There are other protection strategies out there. You know, at Horizon, we obviously run a few. But there's all sorts of different ways you can skin the kind of hedged equity or protected equity hat. And that's, you know, those strategies in general can get an investor involved and get, get back in the market with some degree of expectation of uncertainty that they're not going to get

killed if things really go off the rails. And so we think that's probably a good way back in for a lot of votes. I want to talk about those protection strategies on the podcast with you, Scott. But I'm going to close by reiterating a comment that Jack Bogle, founder Vanguard, made many, many years ago. It's sometimes doing nothing is the best strategy. He used to say, don't just do something. Stand there. And I know that's contrary to what most people's impulses are, but often trading around market events usually is a mistake. And ultimately, you want to have one strategy and stick with that strategy, which usually does not involve market timing. Now it's time to round out the conversation with some analysis and perspective to help you better understand ETF. This is the Market's 102 portion

of the podcast. We'll be continuing the conversation with Scott Ladner from Horizon Investments. So, Scott, thanks for sticking around and talking with us on the ETF podcast. You know, I recall in the past we had talked about other kinds of strategies that you had out there. And protection strategies are really big and retirement income strategies. I wonder if you could talk about that a little bit, but particularly these protection strategies. Why are they so powerful and why are they catching on so much with investors? Hey, yeah, Bob, thank you for having me on. Yeah, look, protection strategies, they are our best sellers.

That is a thing that folks generally know Horizon investments for quite a lot. And the reason I think is pretty straightforward. It solves a kind of a behavioral or emotional question for a lot of investors. Many investors, you know, they don't necessarily view risk through the same lens that institutional investors do. The institutional investors define risk as volatility. And that's very appropriate if you have like an infinite time horizon through which to invest if you're a pension plan or something like this. But for mom and dad, you know, they don't necessarily have an infinite time horizon. And so generally the way that individual investors define risk is as portfolio losses.

Like did my portfolio go down in value? And so just that simple tweak of kind of redefining very intentionally what the definition of risk is for folks can lead to a, you know, a generation of trading strategies or generation of sort of investment strategies. strategies that are a little bit different than sort of a minimum, minimum variance and minimum volatility strategy. But you have to be directionally correct. So a simple protection strategy would be just owning the S&P 500 and then buying call options at the same time.

So you're now selling call options, excuse me, selling call options. So when you're selling a call option, you're limiting your upside. You're basically betting when you do this kind of protection strategy that the market's going to be sideways or down. it goes up, obviously you're going to lose a good part of that upside. So I understand why, and this is a very simple protection strategy, but I understand why people want it because they think the market is flat to down because last year we were down 20%. But Scott, the market traditionally usually goes up year after year. Seventy-five percent of the time the S&P is up.

I guess my concern is these strategies are popular because last year was a lousy year. We're already up 7 percent this year, right? 100% right, yes. And Bob, you identified maybe the most important characteristic of a protection strategy, and it's kind of like a hypocritic, like a hypocritic oath. At first, do no harm. So if you're going to get, so the key when we're evaluating protection strategy, you're trying to figure out, like, how to design these things, is we need to make them as cost-effective as possible. And so if you can avoid having to hedge, or if you're going to avoid having to take risk off in terms of your protection strategy, like that identification ends up being very important because the gains are a great risk management tool,

like a really underappreciatedly great risk management tool. And so, yes, I mean, if you were just taking kind of a naive approach of, you know, buy stocks and sell calls or buy, you know, or buy puts or something like this, you know, that can be a very expensive strategy, both explicitly and importantly, implicitly. And so, you know, that's not the type of strategies we tend to favor here. We tend to favor a little bit more dynamic ones because we think we can reduce the cost, the kind of a long-term cost of buying this insurance, because really that is kind of what we're thinking about.

People consider this, you know, consider protection strategies, sort of like to consider insurance. You know, you really like to have it if things go really, really badly. But it can be expensive to have it when, you know, if your house doesn't burn down. And so part of the key for these things is designing them, design strategies that don't cost you a lot of money in the good times. I want to move on and ask about retirement income strategies because everyone, including my mother, has been, literally including my mother, has been buying short-term treasuries at 4% pulling money out of their savings accounts. But I wonder about that as a long-term strategy.

I mean, the big worry, of course, is always, you know, am I going to run out of money? And they seem to think that this is some strategy in the long term. Gee, I'm getting 4%. That's a good idea. But I don't quite understand that. It seems like, and I know you and I've talked about this before, the maximum risk portfolio for a retiree would be to invest in a bond-heavy portfolio because it maximizes your capping your returns at 4%. We know stocks get higher returns longer term. So I don't quite understand this flight to treasuries.

The maximum risk, mom's going to run out of money, is to invest all their money in bonds, it seems to me. Or am I crazy? Yeah, no, couldn't agree with you more about it. I mean, it is, again, though, it comes down to how you define the problem. And so, you know, we think that for your mom and my mom and all the moms out there this day after Mother's Day, that it is, you know, the question they're really asking, the risk that they see is just what you stated, that they run out of money. And so, you know, the way you minimize that risk, if that is what the, you know, what the retired person sees is the risk.

The way you minimize that isn't, like you said, isn't with the bond portfolio, which just maximizes that risk, because you know what you're going to get on that bond portfolio. if you spend more than that, you're like, of course you're going to run out of money. And so the right answer is to have some equity allocation in there that's probably a little bit larger than traditional analysis would suggest. I don't know if you get into this area, but I'm going to put you on the spot and ask about annuities because I'm, I get asked this a lot. Now, when I was starting out at CNBC 30 years ago, generally the investment, professional investment community that was being honest shied away from annuities because basically, it was something that you were sold, not that was bought. By that, I mean, most of the money was made by the brokers who got 5% commissions on these things. And the payout wasn't that

great. But with rising bonds, there are people now arguing that there's a more diversified annuity portfolio out there, that it might be worth a second look. Generally, as I said, in my generation, we kind of avoided that as a bit of a sell by the investment community. Do you have any thoughts on that at all? Yeah, look, we think annuities, broadly speaking, can be a useful financial planning tool, used properly, used with some moderation, and with a clear understanding what the tradeoffs are. Because like everything else in life, there's tradeoffs when you decide to use annuities inside of your portfolio. You're gaining some certainty. The things you get are some certainty around your income stream, a big G guarantee from an insurance company for such a thing.

and that can be valuable to some folks. But you do give up a lot. As you stated, these are very expensive products. You give up liquidity to get access to the money. You give up the ability to leave legacy wealth in many cases to your errors. And you give up any sort of inflation protection typically with those products. And so there are goods and they're bad for annuities with respect to managed money portfolios or any other choice than a person might make.

But we do think they can play a role in a portfolio. but it's probably not the only, it should not be the only game in town, it's not be the only part of somebody's investment portfolio. Well, I don't want to beat a dead horse, but it is very interesting to me. It's so predictable, too, that in a year like last year where we had stocks and bonds down, which is a real anomaly and doesn't normally happen, I mean, it's a real anomaly. Suddenly there was a renewed interest in annuities, and it's because exactly what you said, what people will give up an extraordinary amount of upside for,

certainty. They'll give up a half a million dollars, you know, for, you know, a $30,000 a year guaranteed income stream if they can just get that guarantee and that certainty. So my position with most people, when they ask me, is talk to a professional about what the long-term returns are in stocks and bonds. And it's almost the same thing as putting all your money into short-term treasuries at 4%. You're getting certainty, but you're giving up. an awful lot of potential upside and you have to very strongly believe that things aren't going to be much better or that we're going to be in for some period of way way below normal returns in the equity markets to want you to believe that and i still don't see a reason why that necessarily

would be happening even even with the fed withdrawing some uh liquidity uh Scott thank you very much for joining us and really appreciate always a pleasure uh chatting with you Scott ladner's the CIO horizon investments and of course everyone thank you for listening to the et fad podcast