ETF Edge - Yearning for Yield – Inside the Hottest Bond ETFs of 2022 10/31/22

Episode Date: October 31, 2022

CNBC’s Bob Pisani spoke with Bryon Lake, Global Head of ETF Solutions at J-P Morgan Asset Management, and Tom Lydon, Vice Chairman at VettaFi. As investors continue clamoring for yield, they discussed more ways to get exposure with higher-yield products, including the largest actively managed ETF in the world – the J-P Morgan Ultra-Short Income ETF (JPST). The fund has been on fire, with more than $22 billion in assets under management – while its sister fund, the J-P Morgan Equity Premium Income ETF, has enjoyed the most inflows of any active fund this year. In the Markets ‘102’ portion of the podcast, Bob continues the conversation with Tom Lydon 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'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. Today on the show, as investors continue yearning for yield, we're delving and do more ways they can get access to higher yield products. We sit down with the man who runs the live.

largest actively managed ETF in the world. That's the JPMorgan ultra short income ETF. Ticker is JPST. This fund has been on a fire recently. 22 billion in assets. While its sister fund, the JPMorgan equity premium income ETF has enjoyed the most

inflows of any active fund this year. Here's my conversation with Brian Lakey's the global head of ETF solutions at JPMorgan Asset Management, along with Tom Lighten, Vice Chairman at Fedify. Brian, ultra-short income, $22 billion in assets, corporate debt duration of one year or less, but the largest actively managed fund in the world, I was really surprised to see that.

What do you own and how did this fund become so popular? Yeah, well, Bob, as we talked about, you know, the rising rate environment has been the story of the year. And so investors are looking for new tools in their playbook. JPST currently yielding 3.2% on the SEC 30-day, 4.4% on its yield to maturity. It's only got a duration of three months. And so investors are using JPST as a place to hide out while they wait for the market to find its footing. So this is invest primarily in a portfolio of short term investment grade, fixed and floating rate. Yeah. Corporate and structured debt. And you're actively managed. Yeah, absolutely. James McNerney is the person running this portfolio. He's the portfolio manager.

He sits within our global liquidity book. And so you think about JPMorgan, you think about our Fortress Balance sheet. And James McNerney sits within that global liquidity book that they all. also do our money market funds. And so he's a very thoughtful investor around this. Thinks about the risk, understands exactly what investors are using with this money. This is their safe money. It's a step out of cash. And he's very thoughtful. And you move in out. You have dollar exposure here. So you move in and out, right? Yeah. Yeah, that's right. Yeah. Some people use it as a long-term strategic. Some people use it as a way to, you know, take some risk out of their portfolio while they're looking for things to redeploy into. Tom, what do you think of all this? It seems like

investors are growing more comfortable with cash-like ETS than they ever had before. I've been talking about these short-term duration products all year. I guess this is what happens when you got stocks and bonds down double digits in a single year. These ultra-short duration bonds look like a lot safer bet to generate yield. Yeah, Bob, you're right. I mean, short-duration money market funds, these were basically dead money up until about a year ago.

But one of the good things about the Fed's hiking rates is short-duration or money-market funds are actually paying something now. So that's a huge benefit. And when you look at that duration being three months and the active management component and specifically what J.P. Morgan is buying, you can actually have a really attractive yield. And when you look at the volatility in the CTF, it's basically flat. They've done a great job of maintaining that net asset value, which is also key and critical. So if you've kept your powder dry and you're looking for areas where you can actually make some money,

these days, it's a great opportunity. You know, this makes a lot of sense, Tom. I mean, historically, bonds compete with stocks. We forgot that, you know. So if I can get a risk-free two-year treasury north of four percent right now, that is actually a pretty serious competition for stocks. Yeah, it is. History shows that yields arise as growth and inflation outlooks increase,

so these short duration are a lot more favorable. And on top of that, Bob, the Fed's been really clear about their path to the future. So when you look at the fact that, hey, rates are going to increase. And as they continue to increase and J.P. Morgan implements the strategy, continues to maintain short duration, but now has higher yielding instruments to work with, we could get this up to 4%. And it's like the good old days, right? Yeah. Well, there is an alternative. We used to say, Tina, there is no alternative to stocks. And now there is an alternative. Yeah. Right. So we have, that's why getting inflows into your funds. Yeah, if you think about historically, the risk premium for equities

is about, you know, 4% plus a little bit of inflation, something like, you know, dividend. You know, when you can get a 3.2 on the SEC or 4.4 like we talked about, that's actually pretty compelling. And if you're an investor looking at the next five years, maybe you want to take a little bit off and protect it in something like this that gives you that return without taking on some of that duration risk. Yeah. You know, I also notice you're mixed managed. actively managed bond funds are really getting strong influence. So you have a a core plus bond fund. JCPB is the symbol there. A lot of firms have these core bond funds that are mixes. Actively managed and you've got a sort of mix of

investment grade, below investment grade, even distressed debt thrown in here. It's all actively managed. Corporates, there's some mortgage securities in there as well. So how do you do this? You're dealing with tens of thousands of potential investment. What's the current mix? How to How does this fund look at this? Yeah, so this is ETF Edge, and so we have to acknowledge that a lot of investors think first about a benchmark or a passive instrument. But when you're looking at a passive kind of fixed income benchmark, that's not exactly how

investors really think about investing in bonds. They want it to be a ballast. They want it to be something that gives them yield. They want it to be something that has a low correlation to equities. And so when you look at JPCB core plus bond, it owns all of those things that can be the ballast in the portfolio. But exactly to your point, Bob, it can go to below credit. It can go to foreign investment-grade bonds as well, which can actually help boost that return

and gives you the opportunity to get additional yield. Tom, how many years have we been saying this? The active guys come on and say, wait till we have a lot of volatility. My heavens, we're finally going to outperform. We know what the long-term record is of active managers. It's generally abysmal. And yet here is a year where we've seen a number of actively managed bond funds actually outperform somewhat compared to their passive investors.

The pendulum is swung, Bob, right? We're now in a situation where with these higher yielding instruments and even some that are deemed somewhat aggressive where you have managers who've been in place for a long period of time, they understand the markets, they can go in, and for these short-term durations, because they hold them to maturity, even though they might be deemed aggressive,

they know exactly what yield they're going to get if they hold that to maturity. And as shareholders from a diversified standpoint, we benefit from that higher yield while they're maintaining a balanced NAV. Yeah. You know, I got, we had the fellow who was doing single bond ETFs on a short while ago. And of course, people are loving this two year because he has the on the run two years. So basically, every month they have a new auction. He sells the old one, buys the new one, and people are getting 4% net. Real 4% yields, unlike other people who own older bonds and their bond funds, and everybody is happy.

Of course, if this changes, if rates come back down again, you know, that's not going to be so appealing. Yeah, I mean, look, the ETFs are tools for portfolios, and there's probably a use case for those. But when we're talking about something like Core Plus bond, we have a portfolio manager that's intentional about what bonds they're owning, evaluating the credit quality, understanding exactly what part of the curve they want to be on. And they're actively managing that portfolio to position it to do what it's intended to do within the portfolio. So that's why we're seeing people use this as a core holding to balance out their portfolio. And over time, I think that's important. Again, compared to passive, where you're just dictated by what the index does, you can float all over the place,

whereas you've got a portfolio manager that's keeping their eye on what they're actually trying to accomplish in the portfolio. Yeah, you know, another big fund with inflows this year that you guys are running, JP Morgan, an equity premium. income ETF. This is another one of those sort of mixed funds here. You want to own stocks in the S&P 500, but it's low volatility and you get an income kicker. And I'm right reading this, 12% dividend? Yeah, that's right. So you get these mixed funds now that try to get an income kicker on it. Explain how this works. First, you're in the lower volatility end, right? So you're looking at consumer staples names. You're looking at Abbie, Hershey, Progressive, Bristol, PEPC is what you own in here.

So there you go, and there's Exxon thrown in. And you also have the dollar thrown in there. But where do you get this 12% dividend? Yeah, so I'd sum up the holdings that you just rattled off is quality balance sheets, right? We want quality balance sheets in this day and age. And so we own those names. A lot of those pay dividends.

And so that starts to contribute to part of the income. And then it's actively managed by a portfolio manager by the name of Hamilton-Riner. He's been doing this for decades. and he's writing one month out of the money calls. And we're collecting premium on that. So that comes into the fund in the way of additional distribution. So you've got the dividend income and then the premium income from those options put together.

Right now it's yielding that 12% that you quoted. Because the names you're talking about here, the consumer staples names, they're usually 2% to 3% typically. That's a long way from 12% dividend yield here. Yeah, well, but remember the premium that comes from those options is dictated by the volatility in the market. And if you look at this year, we've had volatility. And so that's pushed that premium up, and therefore we've been able to harvest that 12%. Historically, we target about a 6 to 8% yield on this portfolio, 6 to 8%. But because of the increased volatility this year, we're pushing.

So, Tom, this sounds like, my God, how do I sign up for this? I got low volatility stocks. I got the S&P. I'm in equities, and I'm getting a 12% dividend yield. What could go wrong here? How could this whole thing change? It sounds kind of magical, doesn't it? It does. It sounds like 6040 is no longer on life support, right, Bob?

I mean, the markets have come back in a decent way where there's good quality stocks with decent dividends. And now that we've taken our medicine on the fixed income side, we're also in a great situation where we can get some decent yields. So, again, things are a little bit rosier today. Just a quick shout out, Bob. I loved your book party last week at the New York Stock Exchange. Again, congratulations. All your friends in the industry turned out. It was a great time.

Well, thank you. Two and a half years in the making, and it was 175 people came, and half the guys on the floor meant a lot to me. I've been 25 years on the floor of the New York Stock Exchange, and after a while you wonder, what exactly have you learned working down here? So that's what the book is about.

Anyone who's interested, shut up and keep talking, Lessons on Life and investing from the floor of the New York Stock Exchange. I wasn't planning on a plug, But Tom's very good at that. He's very good at transitioning into these easy plugs. Thank you, Tom.

Well, you deserve it. Thank you. What's the criteria for inclusion here? So, again, I get back to this miracle, this 12% dividend with all of these nice safe stocks that you own. Where could this kind of go wrong? If all of a sudden the volatility is lower, you're not going to collect as much premium, right? That's exactly right.

And you're asking the perfect question that I encourage all investors to ask is what could go wrong, right? And so exactly that, you know, the volatility could come down and therefore we'd be collecting slightly less premium and that yield would come down along with that. We are, you know, writing covered calls here. So we are giving up some of the upside on this one. If we go into a straight up market from here, we might leave a little bit on the table, right? That's exactly right. We're going to get a call. That's exactly right.

Now, the fact of the matter is that that hasn't happened this year. We know that the primary benchmarks are down 20, 25, 30 percent in some instances. And JetB is down seven. It's an equity portfolio. And so that option premium also plays another role, which is it provides downside protection. And so, you know, investors are saying, okay, I don't want to get completely out of equities. I know that's an important part of my portfolio. Maybe I'll own this portfolio where I can harvest some income.

It provides a little bit of downside protection. And that allows me to navigate these tricky markets as well. So what's the overall, if you had to describe where you're seeing flows, your client flows, You ever J.P. Morgan? They've got a pretty significant business. What are they, am I hitting the theme right here? Short-term duration is sort of the big overall theme for investors? You're hitting it right. So first of all, bull market, bare market investors are always looking for income, right? That's always something that we see. That's perpetual. So number one, if you've got income, that that's something that investors are continually looking for. Number two, when we've got this rising rate environment,

you know that if you've got duration, you've got some duration risk. And so you want to pull that risk in. And now that we've talked about that the Fed has hit these new levels on rates, you're actually able to get something for that as well. And so absolutely, investors are bringing that duration in and doing it in that way. And then thirdly, you know, with JEPI and Jepik, its cousin, which is on a growthier basket of names, they're saying, okay, hey, maybe I can get a little bit of upside here,

and particularly in a range bond market. Tom, VETify is essentially an educational marketplace for investment advisors. What are the RIAs telling you they want to hear? I mean, this must be tough for them. They've got clients. They're using ETFs, stocks down, bonds down double digits. And their clients have got to be asking them what exactly they should be doing. What do they want to hear from you?

So the number one fear that they've had for the last two years is inflation, talking to their clients about inflation as now we're in the fourth quarter. How do you battle that? And as we continue to see rising rates, the good news, Bob, is we've got valuations and stocks that are really at fair levels. And when you look at areas overseas, especially in emerging markets, it may be generational buying opportunities. And on the fixed income side, kind of what we've been tackling here,

yields are back and yields are back to a level that are very attractive, especially for those in retirement or have retirement portfolios. So, hey, we took some medicine for the period of time that we're in. It doesn't mean that inflation's away. The Fed's trying to do its job. But also, there's a lot of tools out there, kind of like we've been talking about today, to fight inflation as well. So things are much better than they've been in the last year and a half.

And with all the ETF tools that are available, advisors are getting creative, but still concerned about inflation number one. Yeah, you know, it's interesting because we're acting like we could perfectly time the markets, in fact, and we all know that it doesn't work that way. Market timing generally doesn't work, and the most important thing is to have a long-term plan, and perhaps we all were a little too much invested in stocks over bonds, and there are now attractive alternatives. So maybe some reallocation is appropriate, but I want to keep pointing out,

most people that my old disciple, I've a disciple of Jack Bogle, he always used to say, don't just do something, stand there. Sometimes it's better to do nothing. So I don't think anybody here is trying to advocate that we start trading around all of this chaos. It's a very difficult situation to manage. It's an important time for investors to go back to what's my North Star? What am I trying to accomplish with my portfolio? And am I aligned to the outcome that I'm looking for? I think one interesting thing with, rates up is that the whole free money thing with rates at zero percent has brought a tremendous amount of discipline into portfolios and companies are having to run in a much more disciplined

way right now. And so, again, we're not market timing here, but, you know, I think a lot of investors are dramatically underweight value. They might have gotten a little overweight growth over the last couple of years. And so thinking about maybe value, and I saw you guys showed the chart on Java a little bit earlier, which is our actively managed value fund, all performing its benchmark, the Russell 1000 value by 6%. Well, you know, the good thing about owning the S&P 500 is right now, of course, growth has become such a bigger part. Look, what happened to energy, which is a value, classic value sector, most for the most part, 3% of the S&P at one point. Now it's 5% of the S&P. But, I mean, if we look at all the tech earnings from last week,

there's a lot of misses, and those had started to become some of the bigger names within the benchmark, and so it's interesting that these other ones are starting to drop it up. The issue is, is a revaluation of growth finally happening. The value guys have been waiting a long time for that to happen. We'll see. But you can definitely see one of the reasons the earnings growth numbers for big cap tech are definitely coming down. And they're holding steady for some other sectors, energy, industrials, holding pretty good. Yeah. And these companies have physical things, right? Like they have oil wells. They have trucks that ship the oil. Like they have actually things on the balance sheet that generate this income. Tech companies have intellectual property. They have

software. That's right. That's important. So we can go on about this all afternoon. I'm going to talk to Tom about this a little bit more in just a couple moments. 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 we'll be continuing the conversation with Tom Leiden from VETify. And Tom, we had a great conversation a few moments ago with Brian Lake from J.P. Morgan about all of the premium income these funds are generating. And it's amazing to me. We have seen these funds that generate income by selling calls do really well.

He was talking about 12% dividend yields on some of his funds, some of his ETFs. We've seen buffer ETFs this year. They cushion losses in return for a cap on gains. They're having a moment. I know we have Bruce Bond from Innovator on ETF Edge in August. So it's amazing, I call this equity plus here has gained. Either you get income or you're protected on the downside by giving up some of the upside. And yet this was never popular until this year.

And obviously the volatility is doing it. Is this stuff going to work in 2023? Well, I think it's going to continue to work. The demand has surely been there, Bob. And we've definitely seen some flows. And part of that came out of the fact that high inflation brought rising interest rates, which is devastating for the fixed income portion of your portfolio. So what we saw with not just financial advisors managing money,

but also self-directed investors who had retirement portfolios, they were shifting away from fixed income while yields were dismally low anyway and looking for alternative yields, right? So if you look for areas like covered call strategies, and there are a ton of them that are out there, many are tied to the energy space where you're not only getting a six or seven percent yield, but you point out some are seven and eight percent, and some also have some tax advantages on top of that. Billions have been flowing into those areas. It's been a way for investors to get the yield that they've been accustomed to in the past without having the exposure to. all the volatility and fixed income. It's been a great period of time.

Yeah, it's been great for active management, actively managed bond funds are finally having a little bit of a moment. I'm not sure about actively managed ETFs necessarily, or stock ETFs. But one of the things I really want to get across, and people ask me this all the time, is whether or not they should suddenly start bailing

on the long-term strategies, they have and throwing a lot of money into bond fund from stock funds. And I want to be very cautious about that or implying somehow that I'm having guests on that are saying that's what you should be doing. What I noticed is, and this is in the book that I talk about a lot, when you have down 20% years and stocks, it's very unusual. There's only 15 times since the 1920s. This has happened peak to trough. That's pretty rare occurrence. And half of the time, you're made whole within a year. So I think my point here, Tom, is I want to be careful about having all these guests on that somehow imply that people should be trying to actively manage their portfolios and market time.

It's a fairly difficult thing to do. And the point is to have a plan here, and maybe some people should be shifting some money into bond funds at this point. But the most important thing is stocks tend to rebound from really bad years like we've had this year, for example. They do. And on top of that, this last year was the first time in almost 40 years where we saw negative bond performance, fixed income performance, and negative equity performance. That doesn't happen that often. If you're retired and you don't have the opportunity to make more income, that's the double whammy. But to your point, don't get emotional. Don't drive your portfolio allocation based on how you feel. your stomach. I mean, you know this more than anybody. You've, you've watched and you've written about all the greats. This is the time when you have to really get that strength and commitment to make sure you keep your long-term allocation. The good thing today is valuations are better, not bad here in the U.S., really good overseas. And then from a fixed income standpoint, yields are

back. Kind of like we were just talking about with J.P. Morgan, boy, if you can get a three and a half for 4% yield and something that's short duration, that's something that we haven't seen in almost risk-free allocations in a long, long time. Yeah. Another thing I've been getting emails about, other than, gee, what should I, should I put more money into bond funds, is crypto ETFs this year.

You know, I've gotten a few emails that say, you know, Bob, you had guests on so enthusiastic about crypto futures ETFs a year ago, and now these exchange traded funds, these crypto funds, they've bought terrible years. I mean, it's the worst performers are essentially some of these crypto funds, these futures ETF funds. This goes to the whole concern about buying into what is the hot story a year ago is not. And I broadly throw these into thematic ETFs. You know, I had this problem talking about pot ETFs five or six years ago.

And then I had this problem talking about thematic tech ETFs with, you know, cybersecurity ETFs five or six years ago. So these things tend to come in and out of fashion, which is, you know, why the Jack Bogle disciple in me, whigs my finger at everyone and says, go ahead, chase whatever you think is popular. But long term, you know, even in crypto, You tend to get reversion to the mean. Well, you do. And I think you have to decide, is it an asset class?

Is it an asset class that's going to stick around for a while? Or is it going to go away? I mean, we've seen in our lifetimes a lot of these different asset classes all of a sudden appear. And everybody chases them at the wrong time and they dump them at the wrong time. If you believe in crypto, if you believe in the future of finance and you have a 2 to 3% allocation, that makes sense. If it went down 50% and it's going to be an allocation, then you level up, just like Kathy would. If you believe in disruptive technology and you feel like this is going to be the future and you had a 5% allocation, now it's worth 2.5% of your portfolio,

and I ask Kathy this specifically, you've talked to her about it. What do you do? Well, she's got more conviction than ever. Why wouldn't you have or level up to a 5% allocation? It's all about the discipline. Right. But see, that's what the one or two percent allocation, why that makes sense to me. Because you asked me about crypto, my gut reaction would be, well, what does it do for your portfolio? Tell me, does it tamp down volatility? Does it add return? It sure doesn't tamp down volatility. It doesn't make the portfolio less volatile. It makes it more volatile. Does it somehow add the returns? I would say, you know, well, all right, if you bought 15 years ago and held on, fine. But other than that, it's a tough argument to make.

So that's why the 1 or 2% makes sense. I mean, it could double in a year, but probably not. But if it doesn't, 1 or 2% is not a serious hit to your overall portfolio. So that's kind of why I don't disagree with people who keep bringing this up to me. Rick Aedlman, my old friend, has been saying this for years. He doesn't disagree when I ask, what does it do for your portfolio? What does it do for your returns? what does it do for your volatility, he just says, Bob, it's a new asset class.

It's a new asset class. And you would have known a little bit of it, but not a lot. That makes a lot of sense to me. Where do you see the ETF business closing out this year? Some success with actively managed ETFs. What about all those people out there that are managing funds that are mutual funds that are down 20% with a lot of potential tax liabilities? In the act of managed mutual fund space, that seems a little worrisome, doesn't it to me?

I'm glad you brought up. What are they going to do? Well, that's it. So what's been going on, first of all, we're looking to maybe have the second biggest year of inflows in ETFs. So, you know, we could be at $600 million, I'm sorry, $600 billion by the end of the year. In a year where both fixed income and equities have been challenged. So that's really good. Even when in the first four months of the year, we saw net redemptions in fixed income ETFs.

So that's bounced back tremendously. To your point, Bob, and I'm glad you brought it up. We continue to see redemptions in mutual funds. And what happens when an active fund manager has to meet redemptions in many cases, they have to go and sell low-cost basis stock. If they then have to take gains from that stock, 95% of those gains have to be passed on to shareholders. And if you're down 20% in that mutual fund, and at the end of the year, you get a holiday gift and a 10% distribution that was unexpected, that's not wanted. So that's one of those things.

I think we're going to be spending some time looking at where more and more folks are saying, look, tax loss harvesting is a real thing. You can do that with mutual funds and then buy like ETFs where you're not going to get that distribution. Well, how do you, I mean, obviously this argues for ETS. because you don't have this problem with the ETS because, you know, any, first off, you have an index fund. You don't have a lot of necessarily a lot of this happening if you're doing active management at all. But I guess the question is what happens here? A lot of people are going to get unwanted tax bills, right? Is this going to accelerate, you seem to be implying, this is going to accelerate active managers going into the ETS?

Is that a correct subtext here? Well, that's naturally happening anyway. I mean, you see all the big name asset managers that made their name in the fund space that are getting into the ETF space for all the right reasons. And now what they're not only doing is creating their own unique, active ETF models, but they're talking about conversions, kind of like what dimensional has done, done to be one of the top 10 ETF issuers out there by converting their mutual funds into ETF wrappers because ultimately it's the right thing to do. It's easier to manage. They're more

liquid and I think we're going to continue to see more of that. We're not going to go the other way and there's some fun companies that are kicking and screaming, but ultimately they're going to have to get into the space even though if they're late to the party and once they get there, Bob, as you know, it's not easy, especially with some of these long and the tooth fund managers to kind of make that move, they're going to be happy they did. Yeah. All right, I'm sure we're going to be talking about this before the end of the year once again. Tom, I'm sure I'll have you back to talk about it, but believe me, it's another reason I see even more money coming into ETS in 2023. I'm going to have to leave it there. Tom Leiden is the vice chairman at VETify. Thank you, Tom,

for joining us and everyone. Thank you for listening to the ETFEd podcast. InvescoQQQ believes new innovations create new opportunities. Become an agent of innovation. Invesco QQQ, Invesco Distributors, Inc.