Interest rate ETF ‘behaves like you’re shorting treasury’ markets: Expert

ETF Think Tank Director of Research Cinthia Murphy joins Yahoo Finance Live to discuss ETF performance in 2022 and why there's strong demand for small-cap ETFs.

Video Transcript

SEANA SMITH: We're closing in on the end of the fourth quarter. And with interest rates on the rise, we're going to take a look at some of the ways that you can hedge that trend. We want to bring in Cinthia Murphy, ETF Think Tank director of research joining us now. And this week's ETF report brought to you by Invesco QQQ.

Cinthia, it's great to see you. So some investors have been able to counter higher rates with a specific hedge. What are you seeing in terms of inflows in some of those popular investment opportunities right now?

CINTHIA MURPHY: Hey, Seana. Yes, it's been really cool to see. There's two ETFs specifically that stand out on that hedging interest rate effort. And they're both relatively new. They're barely a year old. So these are tools that have come up in the market as providers tried to figure out ways that they can help investors mitigate interest rate risk. And we've seen, given they're a year old, they're not really that big, but they've gathered more than $450 million this year.

And so the way they are combating that interest rate risk and hedging that fixed income sleeve of your portfolio is-- one, is the ticker is PFIX. And it does that through a mix of options and treasuries that result in you basically having a portfolio that behaves like you have a put option on a Treasury bill.

So you're kind of shorting treasuries, essentially. There's convexity in there. There's a lot of bells and whistles. But the strategy essentially behaves like you're shorting treasuries. And it's up 85% this year. So it's one of the best performing things out there this year because interest rates have gone up, as you know.

The other one is also really interesting, and the ticker is RISR, riser. And that one achieves the same kind of effect through a negative duration portfolio, which is when you have a negative duration portfolio in fixed income, that's when your prices will go up when rates rise. And so that portfolio is up about 30% this year. It's shelling out 8% yield. So these are new tools to the market that have been really successful in actually delivering what they're designed to do, which is hedging that interest rate risk in your fixed income sleeve.

DAVE BRIGGS: And you're also seeing, Cinthia, strong demand for small cap value ETFs, which points to what?

CINTHIA MURPHY: It's been really interesting because you would think you do not want small caps in the market environment we've had. And we've just started noticing, like, in the last month, a lot of money start to flow into small caps and specifically value. And reading flows, it's trying to assert what investor sentiment is. It's a little bit like reading tea leaves is like what we like to say.

But you could argue that it could suggest that either the concern about recession is already priced in. Either investors are more bullish about what's ahead than bearish. Because in our post recessionary environment, smallcaps tend to outperform large caps. They're also currently at their cheapest valuation relative to large caps in something like 20 years. So in the last month alone, more than 80% of all small cap ETFs picked up assets. In the small cap value, that's even stronger because value's the factor that's working relative to growth.

So it's been kind of interesting to see and in trying to interpret, does that mean that people are a little bit less concerned about recession? Does that mean that they're already positioning for a rebound in which small caps will probably lead? So it makes it feel like an exciting story to follow.

SEANA SMITH: Speaking of an exciting story, I guess, Cinthia, just more broadly speaking, not only US small-cap ETFs, but the ETF industry in general, there is this risk of recession. We know there certainly has been a significant amount of inflows into ETFs. US ETFs seeing more than $60 billion in inflows in the month of November alone. How does this set us up, though, as we look ahead to next year with that risk of recession?

CINTHIA MURPHY: Yeah, so far this year, ETFs have picked up about $560 billion, which is a big number. It doesn't compare to what they picked up last year. But it's a strong number. And it suggests that investors are staying invested. I mean, just yesterday, Dimensional put out a study that shows you miss one week in the market because you're trying to time your stay, and your gains go down 20% if you pick the wrong week.

And there's all sorts of studies out there and statistics that show the moment you try to get out and then get back in, chances are you're going to get it wrong, and you're going to leave a lot of returns on the table. So the ETF flows suggest that people are moving money around. They are trying to find alternatives to that fixed income. They're trying to hedge things like interest rates with new tools.

So it's not that just people are parked in the market. They're trying to be tactical to prepare for a recession or the prolonged bear market. But they're staying invested, and product launches are coming. We have more than 400 new ETFs in the market this year. So innovation is still going. So I think it's a sign of a healthy market. I think it's a sign of investors trying to stay the course and find ways to survive this route. And hopefully some of the studies coming out saying, well, maybe bottoming by mid-next year are right. But I guess we'll see next year.