Economy
Usually, bonds get a bump in bear markets and surging volatility but the largest bond funds have been taking a beating lately. AGG, TIP, HYG, TLT, and LQD are all down over double digits from the beginning of the year. Driving much of that change is a Fed-induced tightening cycle which on top of inflation is sending yields climbing and prices falling. This is all shaping up for the worst H1 in the history of the bond market according to Dow Jones Market Data. In addition to the increasing pressure due to monetary policy, there is real fear the US is already in a recession which could be the bane of the bond market moving forward. One of the growing concerns is that ETFs trade quickly and the less liquid underlying bonds could be left behind causing real market chaos.
Finsum: The liquidity difference in ETFs and bonds is becoming alarming and a full-blown panic with huge amounts of corporate debt could be a liability.
It’s hard to tell if direct indexing is a fad or a true innovation in the financial world but the data is trickling in and it appears to be garnering genuine interest. Custom indexing has long been a tool for institutional and high-net-worth individuals but the new wave of fintech companies who have leveraged innovation to deliver and lower minimums has it gaining traction among a wider audience. Cerulli Associates has direct indexing pegged at growing by 12% annually which will outpace ETFs and mutual fund competitors. Direct indexing differentiates itself from ETFs by giving investors autonomy because they own the underlying assets. This gives the flexibility to add/drop stocks as they can see fit. The most common usage for this type of investment vehicle is for tax-alpha where investors can drop poor performers to tax-loss harvest.
Finsum: Custom indexing is really bringing more options and flexibility to investors which makes investments more democratic than ever.
Many advisors struggle to navigate the large universe of ETFs and mutual funds because the differences can be difficult to fully realize. Sorting through which offering is the best for a given portfolio has long been an arduous process. However, Nasdaq Dorsey Wright has a great solution in their Fund Score, which distills valuable information into a single score. The Fund Score offers advisors an easy way to gauge fund potential and select funds for clients. By weighting a combination of trend analysis, market strength, and peer relative strength they provide the possibility to edge out additional alpha for clients by selecting the ideal fund.
This fund scoring method has a strong historical track record, for example in the latest materials super cycle. For example, funds with the highest scores in the sector such as the First Trust Materials AlphaDEX Fund (FXZ) have had some of the highest gains relative to their counterparts, such as the SPDR sector basic materials fund (XLB). In fact, XLB's lack of success correlated with their lowest fund score for the sector. This isn’t disparaging of XLB’s methodology, because their specific fund weights could prove very successful in the future, and FXZ could suffer as a result of their current weighting. Rather it's a testament to the importance of fund scores as a methodology in selection. Breaking down fund performance attributes and integrating fund scores plays a pivotal role in gaining an edge, and Nasdaq Dorsey Wright can help advisors bring that advantage to their clients.
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To say investors are worried about the volatility in their portfolio in the current environment would be putting it lightly. The stock market gyrations are putting investors and their advisors in a difficult place. One way to manage volatility is to help clients calculate the Value at Risk for stocks or their whole portfolio. While VaR often is thought of as a heavily quantitative endeavor it's simpler in implementation than advisors might imagine, and only a small amount of statistics is necessary to calculate the VaR. It is a handy metric because it's a good gauge of the volatility underlying securities, and can help communicate and find better securities for investors.
Finsum: VaR is pivotal to forming long-short positions for clients and is an excellent addition to an advisor's portfolio of tools.
Oil’s slight dip in the last couple of weeks as compared to the last month has puzzled traders because the war in Ukraine is not stalling and global supply gluts still seem elevated. However, this hasn’t stopped Berkshire Hathaway which has bought up even more of Occidental Petroleum. This week alone they acquired $500 million in shares of OXY, this brings their total stake up to a staggering $8.5 billion. Energy performed amazingly in 2021 and commodities continued to boom into 2022, and oil prices were already moving high well before the war which has only limited supply and boosted demand. OXY has benefited from having an impressive earnings season allowing them to outpace many of their peers.
Finsum: Bidens Oil Tax holiday will be an interesting experiment at the pump, we could see monthly demand over-react to the news.
Fixed-income ETF volume is spiking as investors look to funds rather than individual bonds to fill their portfolio needs. The turnover rate spiked to $58 billion which topped the previous record from the start of the pandemic in March 2020. This is a huge signal that a generation of investors who have become familiar with equity ETFs are turning to the same vehicles for their bond market fix. The most popular funds have been high yield funds such as HYG and JNK which saw $9 billion and $4 billion in trades respectively. Fixed income investors have said that the hyperactive market with daily trading presents an advantage from a price discovery standpoint as compared to individual bonds which might not even see trading on any given day. Undoubtedly, market turmoil is contributing to the high acquisition of bond ETFs.
Finsum: Bond demand is skyrocketing and they are returning to portfolios at a very high rate.