Sunday, May 31, 2020

Succinct Summation of Week’s Events for 5.29.20 (plus The Future of ETFs)

Below is the usual weekly summation, the main positives being the markets stabilizing on hopes of vaccines/treatments and a rise in consumer confidence for May.  The main negatives being jobless claims falling less than expected, GDP falling more than expected, etc. etc.  And, of course, the whopper.  All the rioting and protests that have spread like wildfire this week just highlight the overall problem of the country's lack of leadership. 


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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