Economy
Actively managed exchange-traded funds are seeing an influx of interest as investors are concerned about the escalating market volatility. Active funds are touting their advantages of weathering volatility by making better day-to-day shifts at the portfolio level. One advantage active portfolio managers have is selecting areas where they can have an edge or avoiding places with the most volatility. For instance, tech stocks are down nearly 30% depending on which index you may be looking at. Volatility is expected to continue for the near term as the Fed is projecting another 75 bps hike in the upcoming meeting and a recession is hoving over the economy like a black cloud.
Finsum: Passive ETFs may be contributing to excess volatility according to breaking financial research; it makes sense investors would turn to active funds.
April and May were a tough couple of months for mutual funds and ETFs as they were the first consecutive months of outflows since 2018. According to fund research firm Morningstar, investors pulled $39 billion out of funds and ETFs in May, following $93 billion in withdrawals in April. May was also the first month in three years that ESG-focused mutual funds and ETFs saw any outflows. Investors pulled a net $3.5 billion in ESG strategies during the month, a first since January 2019. The course change comes after ESG funds saw a record $69 billion in new money in 2021. The outflows are mainly attributed to current market conditions. The ESG investing trend is likely still in fashion and flows are expected to turn around once the market reverses course.
Finsum: ESG funds see the first month of outflows in three years as part of a broader trend in fund outflows due to current market conditions.
In anticipation of last week’s interest rate increase, a spike in yields led to a record $58 billion traded in bond ETFs, according to ETF research firm VettaFi. The bulk of this trading was in the secondary market between stock sellers and purchasers. This was especially true in high-yield corporate bond ETFs. This is due to high-yield bonds typically being less sensitive to interest rates compared with Treasuries. While high-yield bonds carry higher credit risk, investors are seeking the greater return potential. The highest traded ETF was the iShares iBoxx High Yield Corporate Bond ETF (HYG), which saw $9 billion in trades. This increase in trading in fixed income ETFs has been at the expense of fixed income mutual funds, which are seeing strong outflows. In the current market environment, where many assets are down, high-fee mutual funds are seen as less attractive than low-cost ETFs.
Finsum: Ahead of last week’s Fed announcement, a spike in yields resulted in a record trade in high yield bond ETFs at the expense of fixed income mutual funds.
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Last week, the Federal Reserve raised interest rates by 75 basis points, the largest increase since 1994. The Fed is taking an aggressive approach to combat rising inflation triggered by pandemic-related supply chain constraints and the war in Ukraine. Consumer prices rose in May at the fastest pace in over 40 years. With more rate increases expected, investors and advisors alike have reason to be concerned about both stock and bond returns in the near term. Bond prices fall as rates go up. In response to that uncertainty, advisors could consider an active bond strategy that adapts to changing interest rates and credit spreads. One way to do that is through a short-term variable income strategy. This can be achieved through the FlexShares Ready Access Variable Income Fund (RAVI), a short-term actively managed ETF. The managers of the fund attempt to identify the highest return potential securities based on macro analysis, credit research, and risk management.
Finsum: In response to persistently high inflation, the Fed is aggressively raising interest rates, which is why advisors should consider a short-term active bond strategy to navigate the current market.
by Kevin T. Cooper, CFA
VICE PRESIDENT | HEAD OF INVESTMENT RESEARCH
It’s common for individual investors to view the S&P 500 Index as the “total U.S. stock market,” but a look under the hood reveals some interesting observations.
Addressing a Popular Misconception
While the Index accounts for about 80% of the value of all publicly traded companies in the U.S., because the stocks that make up the Index are weighted by market capitalization, a small handful of mega-caps drive much of its performance (about 30%).
These companies are the MAAANM1 group of stocks—all of which have grown rapidly as a result of technological innovation and the digital economy. The consequent overrepresentation of these companies in the S&P 500 makes investing in the Index less of a diversification play and more of a bet on technology. As a result, investors in the Index may win when market circumstances favor the technology sector, but they also may lose big when those dynamics change (see chart).
Growth of $1M – MAAANM Stocks (12/31/14 – 5/31/22)
Data as of 5/31/2022. MAAANM refers to six stocks within the S&P 500® Index. Meta, Apple, Alphabet, Amazon, Netflix, and Microsoft. Past performance is no guarantee of future results.
What Clients Need to Know
Clients invested in funds that track the Index should know two things: First, as stated, the Index is not as diversified as they may think and therefore carries more risk than they might imagine. Second, a shift from a decades-long policy of monetary easing to rising interest rates has dramatically changed how the MAAANM stocks are now being valued. This re-valuation of the earning potential of tech-related growth stocks is what drove MAAANM shares down sharply this year (see chart). Until the current macroeconomic environment changes, the challenges facing technology-related growth stocks are likely to continue.
Decline of $1M – MAAANM Stocks – YTD
Data as of 5/31/2022. MAAANM refers to six stocks within the S&P 500® Index. Meta, Apple, Alphabet, Amazon, Netflix, and Microsoft. Past performance is no guarantee of future results.
Action Steps to Consider
In 2023, several stocks in the S&P 500 will be reclassified out of technology into other sectors.2 Though this may appear on the surface to help address the overrepresentation of technology within the Index, the Index’s composition will remain the same, as does the message to investors: Concentration within a portfolio—whether intentional or accidental—carries risk. Clients who have found themselves stung by the decline of the S&P 500 may want to consider a broader investment strategy that includes international stocks; value funds; small- and mid-cap stocks; alternative investments like private placements and real estate; and fixed income assets that are now offering higher yields.
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1MAAANM refers to Meta (formerly Facebook), Apple, Alphabet, Amazon, Netflix and Microsoft.
Diversification does not guarantee a profit or protect against a loss in declining markets. There can be no guarantee of safety of principal or a satisfactory rate of return.
Past performance is not a guarantee of future results. The views expressed are not intended as a forecast or guarantee of future results, and are subject to change without notice. Any sectors, industries, or securities discussed should not be perceived as investment recommendations. There is no guarantee that any investment strategy will work under all market conditions, and each investor should evaluate their ability to invest for a long term, especially during periods of downturns in the market.
The S&P 500® Index is a capitalization-weighted index of 500 stocks. The S&P 500 Index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
The Russell 1000® Growth Index is a market capitalization weighted index that measures the performance of those Russell 1000® companies with higher price-to-book ratios and higher forecasted growth values.
The MSCI ACWI (All Country World Index) ex-USA is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed and emerging markets. The MSCI All Country World ex-USA Index consists of 22 developed and 24 emerging market country indices. Please go to msci.com for most current list of countries represented by the index.
Investments in international securities are subject to certain risks of overseas investing including currency fluctuations and changes in political and economic conditions, which could result in significant market fluctuations. These risks are magnified in emerging markets.
Investments in value stocks may perform differently from the market as a whole and may be undervalued by the market for a long period of time.
Investments in mid-capitalization companies are subject to certain risks such as greater price volatility, lower trading volume, and less liquidity than the stocks of larger, more established companies.
Investments in small-capitalization companies are subject to certain risks such as erratic earnings patterns, competitive conditions, limited earnings history and a reliance on one or a limited number of products.
In general, alternative investments such as private equity or real estate involve a high degree of risk, including potential loss of principal invested. These investments can be highly illiquid, charge higher fees than other investments, and typically do not grow at an even rate of return and may decline in value.
© Copyright 2022 AMG Funds LLC. All rights reserved.
You have probably seen a half dozen headlines in the last six months (at least) that point to a mainstream financial firm buying out a new fintech platform for their custom/direct indexing technology. There has been extreme demand for custom, tax-efficient, solutions for portfolios that give the flexibility, formally reserved for the ultra-wealthy, for much lower initial investments. The biggest advantage is tax alpha which is generated by reducing taxable liabilities through loss harvesting. However, that was really only possible with extremely high net worth as the active management was just too costly. Firms like BlackRock, JPMorgan, and Vanguard have snatched up DI solutions for other reasons as well such as ESG which gives much more flexibility to their clients.
Finsum: The race for low fee/ low initial investment DI is on, but its shape will change as the goldilocks solution has yet to be found.