THE WALL STREET JOURNAL. Monday, March 9, 2020 |R7
JOURNAL REPORT |INVESTING IN FUNDS & ETFS
ALY SONG/REUTERS
W
hen an asset class
underperforms over
a long period, indi-
vidual investors
tend to flee.
So why hasn’t that happened with
emerging-market-equities funds?
Money has flowed into these invest-
ments, despite poor recent returns,
and some experts expect the trend to
continue this year even as China con-
tinues to battle a coronavirus out-according to Morningstar. Emerging-
markets funds, as tracked by Lipper,
were down 4.9% compared with a 8.4%
average decline for U.S.-stock funds.
So what is behind the recent in-
flows, 87% of which went into ETFs?
Part of the allure of emerging-mar-
kets stocks is diversification. That is,
the stocks generally zig when the U.S.
market zags, which is why investors
seeking to reduce risk will devote a
portion of their portfolios to them.
But when one asset class signifi-
cantly trails another, as is the case to-
day, investors might find themselves
overexposed to the stronger per-
former and underexposed to the
weaker one. To get back to the bal-
ance they desire, they will reallocate
their holdings.
“They are coming in and seeing
they are more exposed to U.S. equities
than they’d like to have, and they are
using ETFs as a way to reallocate,”
says Mr. Rosenbluth. In this case,
some of these investors were likely al-
locating more money to emerging-
markets funds.
“Emerging markets have been too
low for too long,” says Art Hogan,
chief market strategist at National Se-
curities Corp. in New York.Time to catch up?
Many investors believe in something
called mean reversion. That is the
idea that underperforming assets tend
to catch up to their long-term average
performance given a long enough pe-
riod. That means years of high re-
turns in some markets are often fol-
lowed by years of lower returns.
“Logic dictates that emerging mar-
kets should catch up, and that has
been driving a lot of the cash flows
into the space,” Mr. Hogan says.
That’s especially so because emerging
markets have lagged behind so much
over the past two years, he says.
Mr. Hogan says the current corona-
virus crisis, which hit China first, is
likely to make the emerging-markets
sector even more attractive to inves-
tors this year, in part because China is
further along in dealing with the cri-
sis than many developed countries.
“We saw that the growth of infec-
tions was rising exponentially, and
now it’s rising incrementally,” he says.
“That’s why one could say that we’ve
already seen a good chunk of the bad
news in China.”Mr. Constableis a writer in
Edinburgh, Scotland. He can be
reached [email protected].-4.9%
Emerging-markets
funds’ two-month
decline, not as bad
as U.S.-stock funds’
average 8.4% drop.ties, according to Investment Com-
pany Institute data. (Emerging mar-
kets include less developed but
generally fast-growing economies
such as China, India, Russia and Bra-
zil, as well as many others.)Past underperformance
The inflow coincided with a period
of significant underperformance in
the sector. In the two years through
December, the MSCI Emerging Mar-
ket Index, which tracks a broad bas-
ket of emerging-markets stocks,
gained 1.3%, lagging behind the S&P
500’s 25.7% gain, according to Morn-
ingstar Direct—a difference of 24.4
percentage points.
Before that, the latest period of
underperformance for the sector
was in 2014 and 2015, when the
MSCI lost almost 17% versus a 15.3%
gain for the S&P. In that period, a
much smaller $4 billion flowed into
emerging-markets stock funds.
During the coronavirus epidemic,
emerging markets have held their
own. In February, total returns for
the MSCI EM index were minus 5.3%
versus minus 8.2% for the S&P 500,ETF Closures Continue at Brisk Pace
BYTANZEELAKHTARThe first two months of
2020 saw a record number
of exchange-traded funds
close—a reflection of the
flurry of new ETFs that
have tried to attract inves-
tors in recent years, many
of them unsuccessfully.
Data from CFRA First
Bridge ETF shows 51 clo-
sures in the U.S. in January
and February. Invesco alone
closed 42. For all of last
year, 152 U.S. ETFs closed,
and 153 the year before that.
“The number of ETFs
listed globally closing annu-
ally has increased steadily,
doubling between 2015 to2019,” says Kenneth La-
mont, a senior analyst at
fund-trackers Morningstar
Inc. The increase in failures
has come as providers have
expanded into more-com-
plex and niche products to
differentiate their ETF line-
ups, and have competed by
lowering fees, says Mr. La-
mont.
Even with closures on the
rise, Morningstar data
shows 840 new launches for
both U.S. and European
funds in 2019, compared
with 410 closures.
But many products ulti-
mately find themselves on
the chopping block when
they fail to reach profitabil-ity, Mr. Lamont adds.Trimming an
‘obesity’ fund
Niche ETF products that
have struggled to gain in-
vestor interest include sev-
eral offerings from Janus
Henderson Group , which
recently announced it will
close and liquidate Organics
ETF (ORG) and Obesity ETF
(SLIM).
These types of ETFs are
“eye-catching but gim-
micky,” says Mr. Lamont,
who adds that neither cate-
gory has come close to at-
tracting enough assets un-
der management to be
profitable, including atlarger houses such as In-
vesco, which has recently
said it is trimming 42 less-
successful funds from its ex-
tensive product range.
Despite their increasing
rate of failure, niche and
thematic ETFs are increas-
ingly popular to launch.
Todd Rosenbluth, director of
ETF and mutual-fund re-
search at CFRA, says barri-
ers to entry in the ETF mar-
ket are low compared with
launching other types of in-
vestment products.
Still, it’s difficult to suc-
ceed in a crowded market
dominated by a few deep-
pocketed asset managers,
he says.Trend spotting
“Annually, ETF providers try
to spot the next trend that
investors will gravitate to-
ward, and inevitably when
the assets do not flock in to
some, the firms decide to cut
bait and shift their focus,”
says Mr. Rosenbluth. “Funds
that have less than $50 mil-
lion after three years are
more likely to close,” he says.
Morningstar’s Mr. La-
mont says that if more ac-
tively managed funds take
the form of an ETF rather
than a conventional mutual
fund, it is likely to increase
the total number of ETFs
even further.
“The whole structure of
the ETF market is likely to
shift dramatically, should
ETFs become the chosen
wrapper for active funds in
the future,” adds Mr. La-
mont.Ms. Akhtaris a writer in
London. She can be reached
[email protected].Tracking Exchange-Traded Portfolios
PerformancefiguresaretotalreturnsforperiodsendedFeb.28;for largestexchange-tradedfundsand
otherportfolios,rankedby asset size.
Assets Volume Expense Launch Performance (%)
Fund Symbol ($ billions) (000s) ratio date February YTD 1-year
SPDR S&P 500 ETF SPY 262.09 37,848,159.1 0.09 01/22/93 –8.2 –8.3 8.1
iShares Core S&P 500 ETF IVV 192.67 1,936,628.5 0.04 05/15/00 –8.2 –8.3 8.2
Vanguard Tot Stk Mkt Idx ETF VTI 131.57 2,226,893.2 0.03 05/24/01 –8.2 –8.2 6.8
Vanguard 500 Index ETF VOO 129.19 2,315,100.8 0.03 09/07/10 –8.2 –8.3 8.2
Invesco QQQ QQQ 84.63 14,658,317.4 0.20 03/10/99 –5.8 –3.0 20.2
iShares Core US Aggregate Bond ETF AGG 76.31 1,678,377.0 0.04 09/22/03 1.8 3.7 11.6
Vanguard Developed Markets Idx ETF VEA 73.85 5,088,691.8 0.05 07/20/07 –7.6 –10.1 0.02
iShares Core MSCI EAFE IEFA 68.80 3,869,647.2 0.08 10/18/12 –9.1 –11.2 –0.4
Vanguard Emg Mkts Stk Idx ETF VWO 61.36 5,484,492.4 0.10 03/04/05 –3.7 –8.5 0.5
iShares MSCI EAFE ETF EFA 57.46 11,898,915.8 0.32 08/14/01 –9.1 –11.0 –0.6
iShares Core MSCI Emerging Markets IEMG 55.32 6,776,742.9 0.14 10/18/12 –5.4 –9.8 –2.4
Vanguard Total Bond Market ETF BND 54.28 1,637,591.8 0.04 04/03/07 1.7 3.9 11.9
Vanguard Value ETF VTV 49.68 504,901.2 0.04 01/26/04 –9.8 –12.1 0.4
SPDR Gold Shares GLD 48.34 4,145,245.1 0.40 11/18/04 1.6 5.6 21.6
iShares Core S&P Mid Cap ETF IJH 46.75 690,686.2 0.07 05/22/00 –9.5 –11.9 –3.4
iShares Russell 1000 Growth ETF IWF 46.66 597,538.7 0.19 05/22/00 –6.8 –4.8 14.9
Vanguard Growth ETF VUG 45.94 325,945.5 0.04 01/26/04 –6.5 –3.6 16.8
iShares Core S&P Small Cap ETF IJR 41.95 1,415,408.1 0.07 05/22/00 –9.6 –13.2 –7.7
iShares Russell 2000 ETF IWM 39.91 7,125,255.2 0.19 05/22/00 –8.4 –11.4 –5.0
Vanguard Div Appreciation ETF VIG 39.30 513,027.1 0.06 04/21/06 –8.4 –7.9 7.4
iShares Russell 1000 Value ETF IWD 36.61 721,746.5 0.19 05/22/00 –9.7 –11.6 0.4
iShares Edge MSCI Min Vol USA ETF USMV 35.98 1,668,573.2 0.15 10/18/11 –8.1 –6.0 9.4
Vanguard Real Estate ETF VNQ 35.70 2,247,139.4 0.12 09/23/04 –7.1 –6.0 7.7
iShares iBoxx $ Inv Grade Cor B ETF LQD 34.24 2,473,654.6 0.15 07/22/02 1.3 4.0 18.0
Vanguard Intm Term Corp Bd Idx ETF VCIT 29.78 940,059.0 0.05 11/19/09 1.1 3.5 14.6
*Expense charge is a maximum of 8 cents a share †Assets are estimated N.A.= Not applicable, fund is too new.
Note: Total returns are based on the change in the net asset values, not changes in market prices. Net asset values can vary from market prices, which
therefore can reflect a premium or discount to the net asset values. Source: Thomson ReutersBYSIMONCONSTABLEbreak. In fact, many emerging mar-
kets have been holding up better
than the U.S. stock market, as China
deals with its problem and the de-
veloped world is hit with cases.
“Much of investing can be tied to
emotion, so it is a challenge to see
an investment perform badly and
then decide to add more to it,” says
Todd Rosenbluth, head of ETF and
mutual-fund research at analytics
company CFRA. “Many investors are
inclined to cut their losses.”
That’s what makes some recent
fund-flow data surprising.
In the two years through Decem-
ber, investors funneled a net $41 bil-
lion of new money into exchange-
traded funds and mutual funds
focused on emerging-markets equi-INTERNATIONAL INVESTING
Emerging Markets
Lose Money, Get More
Have the stocks been too
low for too long? That
could be driving investors
into the asset class.Chinese e-commerce
giant Alibaba is a
major holding of
emerging-markets
funds.IN TRANSLATION
Quad 4
There is a term flying around Wall Street that should
scare anyone with money in the market.
“Quad 4.” While it is used to describe the state of the
economy, it also has implications for investing.
The term—originated by Darius Dale, co-head of
macro strategy at Hedgeye Risk Management in
Stamford, Conn.—comes from an investing framework
that looks at the trend of two vital economic metrics:
GDP growth and inflation. The former measures how
fast the overall economy is growing. The latter tells us
the rate at which the prices of goods and services are
moving.
Keith McCullough, Hedgeye’s founder, says he and his
team aren’t focused on whether GDP growth and infla-
tion are good or bad, per se. Rather, they look at
whether those metrics are heating up or cooling down.
At any point, inflation can be rising or falling. Thesame is true of economic growth. When the two are
combined, you get a four-quadrant matrix that can be
used to analyze where the economy is in the business
cycle. That, in turn, can offer insights into how assets
may perform.
When falling inflation coincides with slowing eco-
nomic growth, the U.S. economy is in Quad 4. Hedgeye
sees that commencing in the second quarter of the
year. “Quad 4 is the lowest point of the economic cycle,”
says Mr. McCullough.
When the economy is in Quad 4, stocks of tech com-
panies and other growth-oriented businesses tend to
perform poorly, he says. U.S. Treasury bonds, gold bul-
lion and utility stocks tend to be better bets.
“Our entire macro research business is based around
the idea that you don’t get run over by Quad 4,” says
Mr. McCullough.
—Simon ConstableAvoidthe4
This chart grades
thestateofthe
economy through
two metrics: GDP
growth and inflation.
Quad 4 is when both
growth and inflation
are slowing.GDPgrowthInflationAccelerating DeceleratingAcceleratingDecelerating1
2 3
4
Source: Hedgeye Risk Management