Bond ETFs seeing 'huge flows': Strategist

Investors have been flooding into bond ETFs, says VettaFi Financial Futurist Dave Nadig. When it comes to equities, ETF investors are flocking to U.S. stocks in a bid to chase the performance of the 'Magnificent Seven,' Nadig says. Overall, Nadig tells Yahoo Finance Live that some investors are "trapped in this risk on/risk off model where they're trying to figure out if they want to be aggressive and bet on this economy, staying strong, staying out of a real recession or whether they are trying to be more defensive," describing it as a "barbell approach."

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Video Transcript

AKIKO FUJITA: According to our next guest, the ETF market is still going strong with $135 billion in new assets and about $200 billion in equities, with tech and growth dominating the sector. As part of the ETF Report brought to you by Invesco QQQ, let's bring in financial futurist David Nadig. David, it's good to talk to you today. So money is still flowing into ETFs. People aren't necessarily staying on the sidelines. Where's that going?

DAVE NADIG: Well, it's been an interesting year because we've had $1 trillion in money market mutual funds. That's been sort of this overhang of money on the sidelines, that classic phrase we always use. But inside the ETF market, what we've seen is a really strong bond market. We've seen huge flows into everything, from 30-year treasuries to CLOs and junk bonds. Almost throughout the spectrum, we've seen strong, strong flows. And at the same time, we've had about $200 billion in flows into equities, most of that in the US.

A lot of that is chasing the sort of indefatigable performance of the Magnificent Seven. It's been really hard to beat the S&P 500 again this year, up 15%, 16%. But despite that, we've seen a lot of flows into some more interesting pockets of the market. So it's a strong market. Investors are still participating. It's not going to be a record year in terms of ETF flows, but it's going to be close. And I think given what we've seen over the last two years, that's impressive by itself.

RACHELLE AKUFFO: So then, David, it's Rachelle here. Does it make sense that we're seeing these ETF flows into-- still into tech and growth, when a lot of people are sort of flooding into these safe havens, even if you look at gold's performance today? Help us make sense of why we're seeing this divergence.

DAVE NADIG: Well, some of it is that folks are really trapped in this risk-on, risk-off model, where they're trying to figure out whether they want to be aggressive and bet on this economy, staying strong, staying out of a real recession, or whether they're trying to be more defensive. And honestly, it's a bit of a barbell approach. Obviously, that money market money is very much in the risk-off camp. But meanwhile, when you look at where money is starting to get allocated inside the equity sleeve of ETFs, it's things like defensive income and small cap value.

I'll focus on a couple funds here. Avantis Small Cap Value Fund, AVUV, has pulled in about $2 billion in new money over the last year. It's beating the sort of standard index version of small cap value with some fairly disciplined approaches to trading around the edges. But investors are really leaning into what would normally be considered a bit of a defensive play. At the same time, anything that's throwing off income out of the equity market as a kind of defense play has also been getting huge money.

I'd look at something like JP Morgan's equity premium income product, JEPI, J-E-P-I. That's, again, pulled in billions and billions of dollars this year already. It's just been an enormous asset [INAUDIBLE]. I think we're close to $30 billion in that fund. It had effectively none a few years ago. And the reason is because it's defense throwing off income.

So even while it's underperformed the S&P 500 this year, it's pulling in tons and tons of money because investors like knowing that they have a defensive portfolio that's going to give them that kind of income. It's been so popular, it's actually spawned competitors from BlackRock and Goldman. They're not going to name them all the same way. It won't be BEPI, JEPI, and JEPI, but we'll see basically copycat products trying to chase this kind of money.

AKIKO FUJITA: Speaking of defensive, Dave, where does fixed income ETFs, where do they fall in all of this? It's not something we talk about often in the context of ETF, but when you look at where yields are right now, touching closer to that 5% level, I imagine there's a lot of interest there.

DAVE NADIG: Absolutely. I think the challenge there has been figuring out where to be on the curve. We've seen an incredible amount of money flow into things like TLT, the long bond Treasury ETF. That's actually been a money destroyer. There's now been more money lost trying to bet on the long end of the curve than in all of the leveraged and inverse products for the last couple of years. It's really been something to see. I think smarter fixed income investors are looking for other opportunities.

I think it's worth pointing out that in the US here, we're still in a bit of a rate hike cycle. Maybe it's not going to be a bunch more, but I don't think anybody thinks we're headed for cuts anytime soon. Meanwhile, in other markets, like, say, emerging markets and some developed international markets, they're already going into easing cycles. So there's a real disconnect between what's going on in the US market and elsewhere. I look at funds like XEMD from BondBloxx. That's a US dollar emerging market debt fund. It's yielding about 2%, which doesn't sound great versus the rest of the market.

But if you think that we're going to continue to see things like we've seen in Brazil, which is that easing cycle, there could be real pockets of long-term growth in those non-US bond markets. So I think it's time to think beyond the aggregate and start slicing and dicing a little bit internationally.

RACHELLE AKUFFO: And so, David, digging into that, then, what are some of the international ETFs that you're perhaps steering away from that perhaps look attractive, but you still have some risk issues with?

DAVE NADIG: I think it's-- well, on the equity side, I think it's a little bit tough to get really excited about, say, the UK and the eurozone. Inflation is much more of a problem there than it is in the US. I'm not sure it's completely under control. So I'd be a little bit skeptical of that. I think Asia is probably a little bit better. I'm very skeptical on China at the moment, but I think sort of other broad Asia, India, I think there's reasons to be excited there. I think the bond space is particularly interesting.

I would be looking at international sovereigns, something like Vanguard's BNDX as a currency hedge, sort of global bond portfolio. That's been a very attractive way to get some of that extra diversification into your fixed income. And as I mentioned, from BondBloxx, XEMD, an interesting way of playing perhaps the frothier end of the market, the emerging markets edge. Not something you're going to put in the core of your portfolio, but maybe a really interesting satellite.

RACHELLE AKUFFO: Well, certainly, a lot of options there for people to pick from, if they're looking nationally or internationally. Appreciate you joining us, as always. Certified financial futurist David Nadig, thank you so much.

DAVE NADIG: Thanks for having me.