ETF Edge - Wrapping Up a Wild Quarter: Global & Treasury ETFs See Big Inflows 3/27/23

Episode Date: March 27, 2023

CNBC’s Bob Pisani spoke with Nate Geraci, President of The ETF Store, and D.J. Tierney, Director and Senior Investment Portfolio Strategist at Schwab Asset Management. Following a wild first quarter for the markets, they discussed the flowdown – breaking down the biggest winners and losers as ETF investors look ahead to April. Even though stock and bond ETFs have on the whole seen inflows, money poured in at a much slower pace than they did the same time a year ago. What can investors expect in Q2? In the “Markets 102” portion, Bob continued the conversation with Nate Geraci from The ETF Store. Hosted by Simplecast, an AdsWizz company. See pcm.adswizz.com for information about our collection and use of personal data for advertising.

The ETF Edge podcast is sponsored by InvescoQQQQ, supporting the innovators changing the world. Investco Distributors, Inc. Welcome to ETF Edge, the podcast. If you're looking to learn the latest insights on all things, exchange, traded funds, you're 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 Pazani. It has been a wild first quarter for the markets. And even though stock and bond, ETFs have on the whole scene inflows, money poured in and

at a much slower pace than they did the same time a year ago. Today on the show will give you the flowdown. Break down the biggest winners and losers of ETF investors look ahead to April. Here's my conversation with DJ Tierney. He's the director and senior investment portfolio strategist at Schwab Asset Management. Along with Nature AC, he's the president of the ETF store. DJ, you're Schwab's voice for ETS. I know you travel around a lot to Schwab offices around the country.

What are you and Schwab telling investors nervous about the recession? What are you telling them investors are nervous about banks? What are you telling investors to do right now? So keep your eye on the long term, right? Human behavior often leads us all to overreact to short-term market moves or turmoil or things we're reading about. But if you, you know, most investors really have longer time horizons, five years, 10 years, 20 years, if you're working towards your retirement. So find a trusted advisor, get a strategic asset allocation portfolio assembled. and ETFs can do a lot to keep you diversified.

And our first quarter flows are a really reminder of all the different parts of the investment portfolio ETFs can touch. Yeah. You know, I mentioned, DJ, the big flows at the top. They are a little all over the place. We saw outflows from U.S. equity, inflows into equity international,

inflows into treasuries, outflows from corporate and from high yield generally. So investors have been all over the map, this quarter. Can you make sense of this? Sometimes I don't pay attention to inflows because I don't think they say much, but this one is so all over the place. It bears some commentary here, and there's the numbers here we're putting up. Right. And the key is overall flows, you know, we'll might end the first quarter with around 80 billion in ETFs, right? So still, the tool of ETFs are still resonating with investors and advisors and really are still the investment vehicle of choice. And then if you,

if you peel back the onion and you look at some of the subsector moves, you know, like we talked about earlier, U.S. equities, we had a pretty rough 20-22. And so human psychology, human behavior sometimes is to move away from something that hasn't been working well and look for something that has. And fixed income, now you've got yield. International equities outperformed a little bit last year have certainly outperformed in the first quarter. By the way, kind of a welcome move. I think most U.S. investors are under-allocated towards international equities. And so rebalancing there to get some more exposure could make sense for a lot of investors. So, you know, what we're seeing is still reassuring that ETFs are a choice for asset allocation.

Just picking up on the equity flows there, Nate, U.S. equity flows, modest outflows, but even modest is a bit unusual. Pick up on what D.J. was talking about there. Is this a delayed effect from last year's poor performance? Or is it liquidity? Remember, the Federal Reserve has been raising rates and, you know, quantitative tightening's going on. And there's theoretically less money moving into the asset management space. And remember, we talked, you and I about this last week. Some investors are parking huge amounts of cash in money market funds toward the end of March. That's got to be telling us something. It makes sense of this for us. Yeah, so equity ETF flows are particularly interesting to me this

year because you look at the S&P 500, it's up about 4% year to date, but it appears that investors have decided to take a much more cautious approach to the markets right now. I think that's a combination of investor concerns regarding the Fed potentially staying too aggressive for too long and perhaps the economy experiencing a harder landing. Certainly the recent banking crisis is playing a role here. This just isn't an environment. where investors are looking to add risk assets right now, and that's reflected in ETF flows. Now, on the international ETF side,

there's certainly more investor interests there. I think that's really a combination of three things. I think there is a little bit of performance chasing going on here because broad international stocks have fairly significantly outperform U.S. stocks since about the beginning of the fourth quarter of last year. And if you'll recall, it's been tough sledding for international stocks for the better part of a decade plus. And so I think investors are looking at that performance and perhaps reallocating there. I also think there is a subset of investors betting on a Fed pivot at some point, which that could pressure the U.S. dollar.

A weaker dollar does tend to be a tailwind for international stocks. And then some investors view valuations as much more attractive overseas. So I think it's a combination of those three. things. And then I'll just point out one real bright spot for ETFs this past quarter, which you were alluding to, has been on the fixed income side of the equation. About $40 billion has gone into U.S. Treasury ETFs alone this year. And if you look at that, it's really across the curve, but specifically if you look at shorter term U.S. Treasury ETFs, nearly $20 billion has gone into those. And I think the mentality there is very simple, which is given the unsublished

certainty around the Fed and the economy. And then you toss in a regional banking crisis. I think investors are content to hide out in treasuries, scoop up four or five percent yield and wait until things look a little better. But Nate, even with the big inflows into treasury ETFs, overall flows this year are positive, but they're a lot smaller that they've been in recent years. I have 70 billion. This is your number in inflows so far. I mean, this time. This time last year we had $200 billion. We had three times as much in inflows here. So even with these huge inflows into treasuries and international, this is a subpar quarter. I'm just curious about this. We haven't seen this in a while, you know. Yeah. And I think that, again, just speaks to the apprehension

on the part of investors. They're not willing to take risk right now. And I'll give you a good example of this. If you look at an ETF, say, like the technology select. sector spider ETF, XLK, or you look at the ARC innovation ETF, ticker ARKKKK, to me, those offer a real window into investor psyche right now because both of those are up around 20% this year. XLK has $2 billion in outflows. ARKK has slight outflows, about $100 million. That's a clear indication of overall investor sentiment right now. Investors simply aren't buying this up move, particularly when you start,

peeling back the layers and you look at a sector like tech. Yeah. DJ, I want to go back to the bond fund things because this split in flows for bond funds is really quite startling. So you've got a number of these. So your short-term Treasury ETF had inflows, big inflows, I think it was $3 billion. And everybody else's short-term treasury funds had big inflows. But elsewhere, we had outflows from generally outfrofts from corporate bond funds and high-yield funds. So this was sort of one of the more jarring months for bond DTS.

Yeah, I agree. And what Nate was just saying makes perfect sense, and we can apply the same logic to the fixed-income market. So it's overall a little aversion to risk, right? So high-yield bond funds, outflows, even investment-grade corporate bonds, a little bit of outflows, and the corollary inflows into treasuries, right? So it's a seeking safety move, which is not surprising. And And then the yields of front-end treasuries are pretty compelling. There was a point in time in the first quarter where you could get almost 5% yields for front-end treasuries. Now with the rally that's come down, it's closer to four-and-a-quarter, four-and-three-eights.

But that's still pretty, that's a fair amount of income for a front-end treasury ETF. And even in the equity flows, if we look, as Nate was saying, you know, the valuations in international might be a little bit more reassuring. And if you look at where the flows did flow in the first quarter into equity ETFs, If you look at the top 10 U.S. equity ETF inflows, quality, value, and dividend income was the common theme for the top 10 ETFs. Yeah. And DJ, just comment, I think Nate made a very interesting point about tech funds having outflows. After getting it, we had big inflows for two years.

I mean, really big inflows. And now we've had outflows for tech funds in the first quarter, even as Nate mentioned, Kathy Woods' arc fund. So it's curious to me to see outflows when actually tech stocks have been out relative outperformers this year. Usually they go along with the trend, right? But they're not this year. And that's curious to me. I think there's comfort in investing in companies that are making money now.

So there's a term short duration equities, right? Companies that are making money, lower PE, price to earnings ratios. And that's really what we're seeing with the flows. And if you look at the funds, like Nate mentioned, the growth funds, you know, really those are more a bet on the future, on future cash flows years down the road. And by the way, when rates go up, you tend to discount those future cash flows. So there are some fundamental reasons why they might not be seeing the inflows. And then, again, the human emotion of seeking certainty in an uncertain world and an uncertain time right now. Yeah. You know, it's curious to me, Nate, among ETFs, it's not a high yield or quality.

corporate bond fund that seems to have the highest quarter to date outflows. ESG funds are seeing some very noticeable outflows. I-Shares has a ESG fund, ESGU, which has had nearly $6 billion in outflows. Has ESG lost its luster? Is it due to politics or the underlying stocks are poor performers? What's going on here? I think it's a confluence of several factors. And we saw this trend start to develop last year where, first of all, if you look at the performance of ESG funds in general over the past year or two, they've underperformed the broader benchmarks. And investors are saying that underperformance and questioning whether this is something that they want to allocate to in a portfolio.

I think certainly ESG has become much more politicized over the past year. And I'll tell you, just from an advisor's perspective, we don't want politics in our portfolios. We always have to assume that 50% of our clients are on one side of the aisle, 50% on the other. And certainly there's a spectrum there. But ESG has become viewed as much more politicized. And I don't think that's something that advisors want to allocate to. And I think investors are questioning. And then the third point is simply that I think ESG as a whole is under a microscope where in investment,

are wondering, you know, what does this really do? Does, does me investing in an ESG approach have any meaningful difference on society at large? Because that's one of the ways that ESG has been marketed. Now, certainly, we can have a conversation around whether or not screening for certain ESG factors can reduce the risk of a portfolio. I think there's a, certainly a debate to be had there. But I think just stepping back and you look at the way ESG has been marketed as a whole, I think investors aren't buying it, and we're seeing that in the flows. Yeah, I've had some intellectual differences with ESG funds for a long time, but they're intellectual differences.

And remember, ES and G can be very different subjects. So it's a really tough subject to sort of mash these three things together and create performance metrics around it. And then you throw in the fact that some of this has become very politicized. It makes it even more difficult. But, DJ, I want to go back to your point at the top of the hour because, you know, I'm an old Jack Bogle disciple, Charles Schwab disciple, too, stay put, have a plan, know what your risk tolerance is, exactly what you were saying at the top of the hour.

Are Schwab investors, for the most part, fairly sticky with their assets? I sense SWAB investors are really more long-term people, and yet when you get this kind of thing in the last month, it makes a lot of people nervous. And of course, we know people make mistakes when they get nervous and start trying to trade actively. What are you, do you think Schwab investors are well educated about your message, the long-term investing message? Well, the flows, the flows somewhat reassuring, right? Overall, the industry flows into ETFs are still positive. And if you look at Schwab ETFs specifically, and granted, we're a microcosm, we've got 29 ETFs.

But 22 of them did see inflows. And so we still are seeing, by and large, net inflows in investing through our vehicles, which can be a reflection of our investors more specifically. So I'd like to think that the advisors out there that are highly engaged right now in the market time, it's both, by the way, investors calling them and them reaching out to investors, hoping that they're keeping people on an even keel and eyes on the horizon and longer term. because getting caught up in market turmoil and trying to make changes due to near-term events generally doesn't work out that well, right? Nobody can predict the market timing and the market upswings. And so just staying long-term invested with a good asset allocation plan

generally gives the best prospects for long-term outperformance. Yeah. And, you know, people like you and me, Nate, that follow these flows, you know, microscopically sometimes make a big deal out of this. And the quarter flows are a little bit unusual. on a historical basis. But when you look at it, $3 billion in outflows for equities is a drop in the bucket. We're talking about a $6 trillion, $7 trillion business here. So while the numbers are a little unusual in terms of their direction, the actual dollar numbers, even Treasury ETFs,

$39 billion in inflows, is not an enormous number compared to the actual dollar value that's invested in the overall ETF business. I always want to point this out to people who want to sort of make a big deal about these fund flow things. So I think DJ is right. The actual numbers themselves are a little unusual in their direction, but not Titanic in terms of the amount of money that's involved. Do you agree or do you have a different perspective? Yeah, it's a great point. And I would echo what DJ said. Look, we take a longer term approach to investing. And just think back over the past three or four years. We had a once in a generation pandemic. We then had a mean stock and crypto bubble. We had Russia invading Ukraine.

last year. This year we have a banking crisis. There's always going to be something that comes along, and I think you have to stay focused on the longer term. ETF flows in the short term, I think, can be indicative, as we were talking about earlier, of investor sentiment. But longer term, we know in the ETF space the trend is up, and it's up at a fairly significant trajectory. Yeah, and I think that's very significant. The fact that we have in a, in a quarter, with absolutely wild moves, still positive flows into equity ETFs and bond ETFs. And while it's much lower than before, that's quite remarkable still. Gentlemen, thank you very much.

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. We'll be continuing the conversation with Nate Geraci from the ETF store. And Nate, we were talking throughout a good part of the show about flows are still up. for the first quarter, equity and bond ETFs, but they're kind of all over the place. 70 billion in inflows so far. This time last year, there was over 200 billion in inflows. And for 2022, we're only at 600 billion. I know you predict that we might get a trillion

dollars in inflows this year. We're a little shy of the mark. We've got a ways to go. But I'm wondering if it is that important in a year where we had in 2022. stocks down and bonds down, maybe it's kind of understandable if flows are slowing down a little bit. Perhaps a little bit, but I look at the performance of U.S. stocks last year. S&P 500 was down about 18 percent, broad bonds, historically bad year, down 13 percent, and yet we still had 600 billion into ETFs. And if you play that forward, I thought even though there were some risks clearly, you know, on the horizon in the market this year, that it was realistic that we could do a trillion dollars in assets. But as you indicated, we're well short of that pace at this point.

We've had about $70, $71 billion into ETFs in the first quarter. At this time last year, we had about $200 billion into ETFs. And as you drill down further into those flows, on the U.S. equity side of the equation, we've actually had outflows. Yet you look at the performance compared to last year, S&P 500 right now is up 4% year-to-day. Broad bonds are positive. So it's a very interesting situation. Let's put on your thinking cap about what ETF trends we might see.

One of the things that's always amazed me about ETFs is the ability to hop on the popularity bandwagon. We did this six to seven years ago with pot ETFs, and then we did it with thematic tech ETFs. We tried to do it with crypto. Last year, there was an attempt to get single-stock ETFs off the ground. And by and large, I don't know what your thoughts are, but they seem relatively unsuccessful to me, other than perhaps our friend Elon Musk and anything around Tesla. Most of the time, that doesn't seem very popular. There's a couple of single bond ETFs out there.

But, you know, again, that's a very limited area of the market. Is there any ideas in the ETF world that seem to be ripe for development right now for you that might take off in 2023? Yeah, I think one area on my radar right now actually dovetails on the single stock ETFs. And Roundhill recently launched a product that offers highly concentrated exposure to the banking sector. And in this case, it offers exposure to the six largest U.S. banks. so it holds a combination of total return swaps and then the underlying individual stocks to get that exposure. It's technically a non-diversified fund. But what's interesting is I think this is a way for investors to add a little sizzle to a portfolio

because Roundhills planning on launching additional ETFs in this lineup. Again, it's called the big ETF lineup. So they're going to offer exposure to the technology sector, airlines and defense. And if you think about the way investors buying larger constructing portfolios these days, they have their broad core exposure, the vanguard, the I shares, the Schwab ETFs of the world to build out that stock and bond allocation, and then they're supplementing that around the edges and looking for something that can add a little bit more juice, a little bit more potential upside. And so these roundhill ETFs are a way to do that.

And I think they may find an audience because, to your point, the single stock ETFs, they really haven't seen much traction outside of a few names, Tesla, as you noted. But I think that's because you have that idiosyncratic single stock risk, whereas with these roundhill ETFs, still very concentrated, but they offer a little bit more diversified approach. I think that's one area to watch. I think another area to watch is in the crypto space. You look last year, Bitcoin was down 65%. We all know about the endless parade of negative headlines in the crypto space.

It was pretty much a debacle. But things have turned around this year. Bitcoin's up now 70% year to date. If you look at some of the best performing ETFs out there, they cover the blockchain space, the crypto thematic ETFs. Bitwise recently launched a new Bitcoin Futures ETF, BITC, which holds CME traded Bitcoin futures, but we'll look to optimize the role of those futures. So I think that's another area to watch moving forward. But, you know, Bob, I think you know where I it always comes back to those core holdings, I think that's what's going to drive the flows. And, you know, that's really what is front of line for investors. Yeah, the Roundhill was interesting. We had Dave Mata on who launched the big ETFs and talked about concentrated portfolio. There's only six stocks in that. And he did make a big thing about wanting to launch essentially a big tech ETF,

which would consist of those in tech names. It sounds like you're reconstructing the Fang names again, essentially. But this makes a little bit of sense to me to get a concentrated portfolio. This is exactly what Kathy Wood does in her own idiosyncratic way, of course. So, yeah, I think that is a good idea. The bank ETF, the big bank ETF came along just the right moment there when people were concerned about deposit outflows from some of the small and mid-sized banks. So that made some sense to me.

What worries me, frankly, is that these things always pop up at the top of the market. So we've studied this for years, you and I. You know, you buy into pot stocks when they're hot and somebody creates an ETF and you're buying at the top. And the thing underperforms in the next few years is the early investors, you know, are buying right in at the top. I don't know a way to avoid that. I don't fault the ETF industry for chasing what you're. the hot topic is, if people want to buy it, that people will offer it to them. But it is something you have to notice if you're an ETF watcher for more than a few years. There's no question.

And there's been books written about thematic ETFs and how they tend to launch at the top of a cycle. Investors pile in and subsequently underperform. But, you know, specifically with a roundhill ETFs. And even if we want to talk about something like Kathy Woods' lineup of ETFs, What's interesting there is that look last year when an ETAF like A RKK was down 70% plus, yet still saw inflows. And I think the reason for that goes back to what I was alluding to before in that I think investors want to build thoughtful, globally constructed, diversified portfolios, but then they want to play around the edges.

And I'll tell you, just from a behavioral perspective as an advisory, what we have found is that if we allocate, say, 97% of a portfolio to that broad passive exposure, broad U.S. equities, broad international equities, a nice diversified bond portfolio, maybe mix in a little bit of alternative exposure. If we then take that other 3% and allocate to, say, an ARKK or something like these roundhill ETS or pick your thematic segment, that actually behaviorally helps keep investors invested in that other 97%. because most investors have some semblance of a gambler in them. I know I do.

You may have that. And so we find that that small allocation actually helps from a behavioral perspective. Yeah. You know, people like Jack Bogle always used to recognize that, diehard index people like Bogle. And even Bogle said, okay, you think you're a genius, take 10 percent and go ahead and find another fund. I think Bogle would be appalled about people buying individual stocks in a big way. but, and his sort of wink at the investor was, go ahead and try it,

but I think you'll find if you're honest and honestly track your performance, an account for fees, you're not going to outperform the overall market. That was Bogle's bet, and I'm willing to bet for most investors. He's probably absolutely right. Nate, thank you very much for joining us. I really appreciate it. And everybody, that's Nate Jaroski, by the way. He's the president of the ETF Store.

And everybody, thank you for listening to the ETF Edge Podcast. Invesco QQ believes new innovations create new opportunities. Become an agent of innovation. Invesco QQQ, Invesco Distributors, Inc.