No time for heroics: ETF investors look for cover

The economy and corporate earnings are humming. Inflation is in check. U.S. stocks are touching records. So why are investors so edgy? ETF flows can help tell the story.

In the early 1920s, football coach Elmer Henderson set the USC Trojans on the path to prominence, ultimately earning the best winning percentage of any coach in Trojan history. Henderson was known as “Gloomy Gus,” a nickname he earned for his tendency to bad-mouth his own team’s chances before a game. It’s unclear whether he was hedging his bets or really worried, but imagining–and preparing for–the worst clearly served him well.

The markets may be going through a Gloomy Gus moment right now. To all appearances, the economy is in great shape. Corporate profits are up, GDP growth is steady, inflation and unemployment are low and banks are lending. The same rising tide that propelled all global financial assets in 2017 are still in place.

Yet, if we track where exchange traded fund (ETF) owners have focused their dollars this year, there’s clearly been a sentiment shift. While investors are staying in the markets, they’re also more reticent and adding ballast to their portfolios.

etp flows line-chart

U.S. ETF investors have added more than $205 billion in net new assets this year (through September 28), most of it in large-cap U.S. stocks and Treasury bonds. (Treasury purchases have largely been “barbelled,” allocated to short- and long-term maturities.) Emerging market stock ETFs, which had gathered $42 billion in 2017, have taken in about $11 billion; the bulk of flows have gone to broad indexes and to China. In fixed income, high yield saw more than $4 billion in outflows, compared with $4 billion added during the previous year.

icon-pointer.svgFollow Martin on Twitter.

In other words, investors are in no mood for heroics. They’re leaving their Superman capes in their briefcases and hunkering down at their desks.

Tail wagging the curve

What’s making investors so nervous? In a word, it’s trade, namely the unknown impact of U.S. tariffs and increased tensions with our longtime partners China, Canada and Europe. In a globalized economy, when one country wobbles everyone feels it. As a result, while growth prospects have been strong, the left tail of the distribution curve has been getting fatter.

So how can ETF investors help hedge their portfolios for uncertainty while still participating in upside potential? Here are four ideas to consider:

1. Take credit for your bonds.

As the Federal Reserve notches up its policy rate, some investors have been turning to short-maturity bonds: 2-year Treasury yields have offered a similar yield to the 10-year, with substantially lower interest rate risk. For incremental yield potential, think about short-term investment grade credit, such as the iShares 0-5 Year Investment Grade Corporate Bond ETF (SLQD).

2. Rethink the role of EM.

Prices for emerging markets stocks, which had a virtually uninterrupted runup in 2017, are off 15% from their highs in January (as measured by MSCI Emerging Markets Index). Yet flows into broad EM indexes, while less robust than last year, have stayed remarkably steady. That’s a mindset shift: ETFs, like the iShares Core MSCI Emerging Markets ETF, (IEMG), are finally being seen by some investors as long-term allocations rather than as risk plays. As I wrote about recently, this latter role is being played by single country ETFs, which make it easier to express market views on a more granular level.

3. Diversify and tilt your factors.

While factors such as quality, value and momentum have historically outperformed the broader markets over long periods, they tend to move cyclically. Investors may want to consider diversifying across factors, via smart beta ETFs, and “tilting” exposures as needed. This year has seen a massive turnaround in flows to iShares Edge MSCI Min Vol USA ETF (USMV) and other minimum volatility products, which aim to help investors stay in the stock market with potentially less risk.


4. Bring sustainability to your core.

Finally, investing through an ESG lens (for environmental, social and governance) can be an innovative way to gain exposure to companies implementing practices that may position them for future growth–from who they hire to planning for climate impacts to securing their data. And for many people, sustainable ETFs align their values with their financial goals.

In his 25-year career coaching college football, Gloomy Gus Henderson ultimately amassed an incredible record of 126 wins versus only 42 losses. If there’s a lesson for investors it’s that even in the winning-est conditions, it’s worth preparing for surprises. Fortunately, there are ETFs that can help for what’s waiting on the field.

Martin Small is the Head of U.S. iShares and a regular contributor to The Blog

The performance quoted represents past performance and does not guarantee future results. Investment return and principal value of an investment will fluctuate so that an investor’s shares, when sold or redeemed, may be worth more or less than the original cost. Current performance may be lower or higher than the performance quoted. For standardized performance and performance data current to the most recent month end, please click on the fund ticker symbols.

Carefully consider the Funds’ investment objectives, risk factors, and charges and expenses before investing. This and other information can be found in the Funds’ prospectuses or, if available, the summary prospectuses which may be obtained by visiting or Read the prospectus carefully before investing.

Investing involves risk, including possible loss of principal.

Index performance is for illustrative purposes only.  Index performance does not reflect any management fees, transaction costs or expenses. Indexes are un-managed and one cannot invest directly in an index. Past performance does not guarantee future results.

Fixed income risks include interest-rate and credit risk. Typically, when interest rates rise, there is a corresponding decline in bond values. Credit risk refers to the possibility that the bond issuer will not be able to make principal and interest payments. Non-investment-grade debt securities (high-yield/junk bonds) may be subject to greater market fluctuations, risk of default or loss of income and principal than higher-rated securities.

An investment in the Fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency and its return and yield will fluctuate with market conditions.

Funds that concentrate investments in specific industries, sectors, markets or asset classes may underperform or be more volatile than other industries, sectors, markets or asset classes and than the general securities market.

International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. These risks often are heightened for investments in emerging/developing markets or in concentrations of single countries.

There can be no assurance that performance will be enhanced or risk will be reduced for funds that seek to provide exposure to certain quantitative investment characteristics (“factors”). Exposure to such investment factors may detract from performance in some market environments, perhaps for extended periods. In such circumstances, a fund may seek to maintain exposure to the targeted investment factors and not adjust to target different factors, which could result in losses.

The iShares Minimum Volatility Funds may experience more than minimum volatility as there is no guarantee that the underlying index’s strategy of seeking to lower volatility will be successful. Diversification and asset allocation may not protect against market risk or loss of principal.

A fund’s environmental, social and governance (“ESG”) investment strategy limits the types and number of investment opportunities available to the fund and, as a result, the fund may underperform other funds that do not have an ESG focus. A fund’s ESG investment strategy may result in the fund investing in securities or industry sectors that underperform the market as a whole or underperform other funds screened for ESG standards.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date indicated and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any of these views will come to pass. Reliance upon information in this post is at the sole discretion of the reader.

The strategies discussed are strictly for illustrative and educational purposes and are not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. There is no guarantee that any strategies discussed will be effective. The information presented does not take into consideration commissions, tax implications, or other transactions costs, which may significantly affect the economic consequences of a given strategy or investment decision.

This post contains general information only and does not take into account an individual’s financial circumstances. This information should not be relied upon as a primary basis for an investment decision. Rather, an assessment should be made as to whether the information is appropriate in individual circumstances and consideration should be given to talking to a financial advisor before making an investment decision.

The iShares Funds are distributed by BlackRock Investments, LLC (together with its affiliates, “BlackRock”).

The iShares Funds are not sponsored, endorsed, issued, sold or promoted by MSCI Inc., nor does this company make any representation regarding the advisability of investing in the Funds. BlackRock is not affiliated with MSCI Inc.

©2018 BlackRock, Inc. All rights reserved. iSHARES and BLACKROCK are registered trademarks of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. All other marks are the property of their respective owners.