The bonus this Sunday is an article from this week's Barron's that should be up everyone's alley -- a very good assessment of where ETFs are heading and how to best invest in them. Hope everyone enjoyed the nice cool weekend. Summer comes back with a vengeance in a couple more days.
Succinct Summation of Week’s Events for 5.29.20
Succinct Summations for the week ending May 29th, 2020.
Positives:
1. Markets stabilize on hopes for a vaccine/treatment;
2. Personal income rose 10.5% in April, above expectations.
3. Home mortgage apps rose 9.0% w/o/w;
4. Consumer confidence came in at 86.6 for May;
5. New home sales came in at 623k for April, above the expected 495k.
6. State Street Investor Confidence Index came in at 73.3 for May, above expectations;
7. Wholesale inventories rose 0.4% m/o/m, above expectations.
Negatives:
1. Riots, Protests, Social Unrest lead to sense of country lacking in leadership;
2. Jobless claims fell from 2.446M to 2.123M w/o/w, above expectations.
3. Second estimate for Q1 GDP came in at -5.0%, below expectations.
4. Consumer spending fell 13.6% m/o/m, below expectations.
5. Corporate profits fell 11.1% y/o/y, below prior increase.
6. International trade deficit came in at $-69.7B for April, below the expected $-64.7.
7. Durable goods orders fell 17.2% m/o/m, below expectations.
The
Future of ETFs, and Why Sustainable-Investing Indexes Will Be a Trillion-Dollar
Business
By
Leslie P. Norton --
Barron’s
May 29, 2020 5:30 am ET
Exchange-traded funds, long maligned as the harbinger of the
next crisis, have become the quiet and unlikely champions of the coronavirus
bond market.
During the critical week of March 23, when bond trading dried
up, ETFs played a vital role. The iShares
iBoxx High Yield Corporate Bond (ticker: HYG) traded 168,000
times a day, while its top five underlying holdings traded only 25 times a day.
It was a similar case for iShares iBoxx Investment Grade Corporate Bond (LQD).
This allowed institutional and individual bond investors to manage their
portfolios; that ability to trade actually helped set, or predict, the prices
of the underlying bonds when they did trade.
Then there was the Federal Reserve’s unprecedented decision
(announced on March 23 and implemented May 12) that it would buy
investment-grade and high-yield corporate bonds—and that it would do so via
ETFs. That has driven $55 billion in new money into fixed-income ETFs this
year, according to Todd Rosenbluth of research firm CFRA. That’s 42% of all ETF
net inflows, and more than the $47 billion for stock ETFs.
We checked in with Salim Ramji, global head of iShares and index
investments and a member of parent BlackRock’s (BLK) global executive
committee, about the role of ETFs in this crisis. A former McKinsey partner,
Ramji keeps a close eye on long-term trends. He told us about the outlook for
ETFs, sources of growth, and why the active/passive debate still exists. Read
the following edited excerpts for more.
Barron’s: The Federal Reserve just began its historic
ETF-buying. What does this mean for the industry?
Salim Ramji: Over the past
two or three months, professional investors—including central banks, asset
management firms, and big insurance companies—have been turning to the ETF to
access the bond market. They saw, under some pretty massive amounts of stress
in March and April, that ETFs became the place where price discovery was
happening. As markets got more volatile, the bid-ask spreads in the most liquid
ETFs were much narrower than the spreads in the underlying bond market. It’s
been happening for a number of years. If you look at iShares net inflows in
April, we had $18 billion in fixed-income ETFs. Nearly half came from
first-time buyers of bond ETFs—large, active, fixed-income managers, or
insurance companies, or pension plans—that historically were skeptical of how
bond ETFs would perform under market stress.
Now that the markets have settled down, are there still
discrepancies between pricing of the ETFs and the underlying securities?
It would be about 20 or 30 basis points [0.2%-0.3%], in line
with long-term historical trends. The big thing is that the ETFs themselves
were becoming the place where price discovery was happening. It wasn’t in all
ETFs. But during the week of March 23, our flagship high-yield fund, the
iShares iBoxx High Yield Corporate Bond ETF, became the instrument of
actionable markets. Investors were using it to really understand what was
happening in the high-yield market when the underlying bonds weren’t trading in
a normal way. That’s where you really see price discovery.
Mutual fund firms say, “If there’s no price in the underlying
bonds, how can there be price discovery?” You can’t have it both ways.
Look at the facts. Large parts of the underlying bonds didn’t
have liquidity. It was hard to get prices. Under extreme stress, a number of
our broad-based iShares provided it marvelously in an intense and stressful
week.
How should individual investors navigate the bond market?
I don’t think individuals should own individual bonds. The bond
market has such a lack of transparency, being largely an over-the-counter
market.
A poster child for the problems of ETFs was the U.S.
Oil fund [USO], which invested in futures, and had to change its strategy as
oil prices plunged.
We joined a coalition of ETF providers that represent 90% of
U.S. ETF assets to create a proposal around naming
conventions for all exchange-traded products. Structures that
invest in commodities should be classified as exchange-traded
commodities—ETCs—not ETFs. Levered and inverse [products] should be classified
as exchange-traded instruments. All this would make sure there’s clarity in the
packaging. If our naming convention is followed, a few of our funds will be
classified as ETCs, because they invest in commodities like gold. That’s
appropriate, even if it means foregoing a commercial opportunity.
You mentioned a “coalition of providers that represented 90% of
U.S. ETF assets.” But that’s not a large coalition: BlackRock, Vanguard,
and State Street have more than 80% of U.S.
ETF assets. When does that become a problem?
ETFs are 1% of the $105 trillion fixed-income marketplace. We’re
a minnow. In equities, we’re 5%. We have a very small piece of the very large
ecosystem of professional management. The iShares have grown because we’re
providing transparency, convenience, and often a much, much lower-cost service.
One of the biggest sources of our growth in the past few months,
ironically, has been other active managers. The whole debate around active and
index is more about cost. How much do you want to pay for the return? Investors
are telling us: Less. They’re choosing the option that can get them 98% of the
return for a tenth of a cost.
So, what is the future of the active-versus-passive debate?
In five or 10 years, they will look back and say, “That was a
20th century construct.” Professional investors are really looking at “Where
can I get my sources of return? At the best price? And with the most
transparency?”
People will pay a lot for true alpha generation from securities
selection. But if you can replicate that through asset allocation, factor, or
sustainability exposures, that’s a better way to invest. Our iShares can
provide three of those four [sources of return]. You can get 98% of the returns
of a portfolio just by using iShares, because you can disaggregate sources of
return, get the returns with greater predictability and at lower cost, and then
you can spend your budget on that very scarce resource of true alpha with a
manager who can really outperform from outstanding security selection.
BlackRock announced a big push in January to expand its sustainability offerings.
How’s that going?
A couple of years ago, we managed less than $10 billion globally
in a couple of dozen ESG [environmental, social, and corporate governance]
products. We’ve gained momentum, particularly since January. We’ve raised $17
billion in our ESG lines; we’re now at 105 ESG ETFs and index funds globally.
We expect to be at 120 funds before the end of the year and 150 products over
the next year or so. [Secondly], we want to make available all traditional
market-cap weighted indexes in ESG form. We’ve partnered with S&P for a
sustainable version of the S&P 500, and with MSCI.
The third piece is about integrating ESG into our active
investment process: ESG is integrated into 70% of our active portfolios,
meaning that our portfolio managers have accountability for managing exposure
to ESG risks and documenting how those considerations are used in building
portfolios. By the end of the year, that will be 100%. We manage $1.8 trillion
in active portfolios.
ESG will change investing in a pretty significant way. All the
dynamics that indexation brought are making ESG investing more accessible—more
choice, better cost, and the ability to customize. We think sustainable
indexing will be a trillion-dollar market by
the end of the decade. That’s why we’re behind it so significantly.
Much of the superior performance of ESG has come from the
underperformance of energy.
The performance of ESG indexes, even relative to market-cap weighted
indexes, in the first quarter was very good. It’s broader than just the shifts
happening in energy. Companies that manage sustainable risks better tend to
also manage [other] risks better, and tend to be better-managed. From a factor
lens, they have a greater quality bent; [they] are more profitable and
resilient through periods of turmoil. That comes out in the performance
numbers.
These facts hold, even excluding the shifts in energy.
Sustainability is a long-term risk/reward element through different market
cycles. Sustainable investing takes active risk, relative to a market-cap
weighted index. Our factor lineup also takes active risk. More of our product
development is moving into areas where rules-based, transparent investing can
take active risk. We’re investing in three areas: fixed income, sustainability,
and megatrends, [such as] the climate or the movement toward automation. That’s
going to be a growing part of iShares.
What about active ETFs?
We already offer transparent active bond ETFs like iShares
Short Maturity Bond [NEAR] and iShares
Short Maturity Municipal Bond [MEAR]. We launched BlackRock
U.S. Equity Factor Rotation [DYNF] last year. There are several
active transparent strategies we are excited about. We’re also exploring the
nontransparent space and have a longstanding agreement with Precidian. I’d say
watch this space in the second half of the year.
When does your ESG version of the S&P 500 get as big as the
$174 billion iShares Core S&P 500 ETF?
Oh, gosh. The ESG version hasn’t yet been launched; we expect it
later this year. I think we’re 20 years out. These are long-term investments
we’re going to make. The shift toward fixed-income ETFs didn’t happen
overnight.
Thanks very much, Salim.
Write to Leslie P. Norton at leslie.norton@barrons.com
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