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ETF INSIDER

January 13, 2022

Welcome to this week’s ETF Insider. Some high-flying ETFs of 2021 are giving
investors a New Year’s hangover a week into 2022. Cathie Wood’s Ark family of
funds and the Bitcoin futures products may have clients wondering why they ever
bought into such hot products in the first place.

But one trendy category is proving to be winning when it comes to performance:
environmental, social and governance strategies. We dig into last year’s returns
for the biggest ESG ETFs. The results could prompt more advisors to look again
at such strategies. And another direct index shop gets financial backing from an
established manager.

Tell us what you’d like to see more of in this newsletter:
editorial@financialadvisoriq.com

Jackie Noblett, producer of ETF Insider at Financial Advisor IQ

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BIG ESG FUNDS OUTPERFORM (YES, EVEN AFTER FEES)

By Jackie NoblettJanuary 13, 2022

Environmental, social and governance-oriented ETFs get a lot of flak for being
more virtue signaling – and fees – than substance.

But data from last year shows that, for the most part, ETFs based on indexes
weighted toward ESG metrics can go toe-to-toe with cheap “conventional”
competition and win.

Seven of the ten largest U.S. equity index-based ESG ETFs outperformed the $300
billion, broad-benchmark-based iShares Core S&P 500 ETF, known by its ticker
IVV. And that was after accounting for fees, according to a Monday research note
by CFRA director of ETF research Todd Rosenbluth.







Among the benchmark-beaters were two strategies that re-weight the S&P 500 by
sustainable metrics: the $452 million State Street SPDR S&P 500 ESG ETF (EFIV);
and the $865 million DWS Xtrackers S&P 500 ESG ETF (SNPE).

The iShares Core ETF—which charges a 3 basis-point fee— returned 28.8% for the
year. Meanwhile the State Street product rose by 31.3% and the DWS-run strategy
rose by 31.4%. Both charge 10 basis points.

How did they do it? Rosenbluth does not dive into the differences, but a review
of the ETFs’ disclosures reveals some details.

State Street and DWS use the same underlying index. S&P greens up its flagship
benchmark for them by excluding companies in objectional industries like tobacco
and weapons. The ETF then takes that list and tilts toward companies that score
the best, relative to peers, on a corporate sustainability assessment conducted
SAM, the company’s ESG ratings affiliate.

The result is an index that, compared to the traditional S&P 500, has about two
percentage points higher exposure to Apple and one percentage point more of the
portfolio in Microsoft. But it’s devoid of Facebook parent Meta Holdings – which
made up just under 2% of the iShares S&P 500 ETF as of Jan. 10.

CFRA does shed some light on what makes some of the other ESG products tracked
shine. The $4.1 billion iShares MSCI KLD 400 Social ETF (DSI), $4 billion
iShares ESG MSCI USA Leaders ETF (SUSL) and $575 million iShares ESG Advanced
MSCI USA ETF (USXF), for example, were between four and six percentage points
underweight Microsoft and they do not own Apple, Amazon or Meta.

The outperformance that ESG tweaks to a widely used benchmark delivers appears
to back the claim that investing in greener stocks is investing in strong
performing stocks.

But not all ESG index funds fared well.

In fact, two of the largest U.S. stock ESG ETFs – the $25.6 billion iShares ESG
Aware MSCI USA ETF (ESGU) and the $6.4 billion Vanguard ESG U.S. Equity ETF
(ESGV) – trailed the benchmark by more than two percentage points in 2021,
CFRA’s analysis found. It should be noted that Vanguard’s fund is an all-cap
strategy, and therefore is more concentrated in mid- and small-cap names than
the S&P 500.

Meanwhile, the iShares ESG Aware strategy is the most similar to the S&P 500 ETF
from a top-10 holdings perspective, according to CFRA.

Strong returns help bolster the financial argument for sustainable investing,
but for some clients ESG is about creating impacts beyond their portfolio. Some
argue that the two have little to do with one another, but Morningstar’s Jon
Hale disagrees.

“[I]f you are an investor who wants your investments to have some broader
positive impact on the world, the way to do it is by helping convince companies
to address the material ESG issues they face,” Hale said in an article on
Morningstar’s website last week.

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BITCOIN, ARK ETFS TAKE IT ON THE CHIN

By Jackie NoblettJanuary 13, 2022

Many clients were asking their advisors last year about disruptive tech
companies and cryptocurrencies, and how to get in on these red-hot trends. But
some of the biggest ETF beneficiaries of these high-flying investments are
finding it tough sledding of late. And that may have clients asking what their
advisors have gotten them into, anyhow.

The $1.1 billion ProShares Bitcoin Strategy ETF burst onto the scene in October
and became the second-fastest fund ever to climb to $1 billion in assets. Now,
it’s vying for a less enviable record: worst performance start for an ETF,
according to a Bloomberg report.

The fund’s 30.2% drop in the first two months of trading places it among the 10
most dismal debuts, Bloomberg data shows. Meanwhile, sales of the product have
come to a standstill. The fund drew just $91 million in net new money during the
six-week period ending Jan. 7, according to FactSet.

Another 2021 advisor favorite, Cathie Wood’s flagship Ark Innovation ETF, has
sunk to the bottom of its peers in performance. The $14.4 billion fund’s value
fell 38.7% last year after being sitting atop of 2020 heap, according to
Morningstar data cited by Financial Advisor IQ sister publication, Ignites. The
median holding in the growth tech strategy is down 55% since hitting a 52-week
high, Ignites reports.

The returns of both funds can be stomach-churning, but the reality is very
little has changed in either, except for investor sentiment over their
respective asset classes

In fact, the futures-based ProShares Bitcoin Strategy ETF has done a little
better than Bitcoin itself. Value for the cryptocurrency sank more than 34% in
the same period, Bloomberg reports. And the fund has shown similar levels of
volatility to the underlying asset, essentially demonstrating that the ETF is
working as designed, as reported.

Not surprisingly, investors have soured on the strategy, pulling in just $91
million in the last six weeks ending on Monday, according to FactSet.

Ark Innovation may be an active strategy, but Wood and her team appear to be
staying the course, despite tech stocks of all stripes taking a beating from
investors, as investors sell risk assets in expectations of a rate increase. The
fund has bled about $340 million in the past six weeks, FactSet data shows.

The tech-heavy Nasdaq Index is already down 10% in the first seven trading days
of 2022.

Ultimately, the products represent the kind of high reward, but high risk,
strategies that ETFs have effectively brought to the masses. Advisors would be
wise to remind investors – and maybe themselves – why they bought the product in
the first place, and whether that reasoning still makes sense today.

And when the next skyrocketing ETF comes past your desk, remember to remind
clients to buckle up for a potentially bumpy ride.

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UPSTART DIRECT INDEXER GETS BIG-FIRM BACKING

January 11, 2022

A version of this story previously ran in Financial Advisor IQ's sister
publication, FundFire.

Baird and investment affiliate RiverFront Investment Group have jumped on the
direct indexing bandwagon by acquiring a minority stake in direct indexing shop
Gamma Investing.

Gamma Investing has amassed $20 million in assets under management since
Lorraine Wang launched the direct indexing separately managed account specialist
in January 2021, following a career of more than 14 years at Invesco. Gamma
retains its operational independence after the transaction’s close on Jan. 3,
according to the firms’ executives.

“[Wang] was looking for strategic partners and we were really interested in the
direct indexing space,” said Karrie Southall, chief operating officer at
RiverFront. “[Custom indexing] is just such a hot topic and there's so much
opportunity… that this was just a great investment for us.”

RiverFront expects custom indexing strategies to grow faster than mutual funds
and exchange-traded funds.

Wang, who led Invesco’s global head of ETF products and research at Invesco
PowerShares before striking out on her own, also has ambitious plans in the
direct indexing space.

“I believe that direct indexing is the next game changer in asset management
since ETFs,” she said. “The primary reason direct indexing would be a game
changer is because of the benefits that they could provide to advisors and
clients that funds are not able to offer… The space is in the very early
innings.”

Direct indexing SMAs allow investors to customize strategies according to their
goals, social values and tax situations. Technology has allowed managers to
expand their target markets by requiring lower account minimums.

Assets in direct indexing strategies tripled between 2018 and 2020 to reach $215
billion, and account for 17% of the retail separately managed account market,
according to an October study by McKinsey & Co. .

The outlook for growth in the direct indexing space remains “very positive,”
said Ju-Hon Kwek, senior partner at McKinsey’s New York office. The first few
weeks of the year suggested that volatility will be stronger this year,
increasing the appeal of tax-aware strategies, he added.

“On the supply side, a number of the large players have built or acquired direct
indexing capabilities and invested to educate financial advisors,” Kwek said.
“You are going to start getting greater awareness and penetration in the
market.”

Managers have flocked to the direct indexing space over the past year, mainly
through acquisitions. The list of managers that took steps to play in the space
include PGIM, Franklin Templeton, BlackRock, Vanguard and Morgan Stanley, which
scooped up the largest player in the direct indexing space – Parametric
Portfolio Associates – through its $7 billion acquisition of Eaton Vance.
Managers aiming to differentiate themselves in the custom indexing space need to
strive for higher levels of customization, Wang said. She also highlighted
investing and operational independence as competitive advantages.

“Independence is very important to us because it allows us to be nimble and
flexible in bringing innovation in this space and not to have baggage in terms
of existing processes and technologies,” she said.

Gamma will use its in-house sales team and third-party distributor Valor
Consulting and Distribution to market its products.

“With this transaction, what we need the most is distribution, expertise,
guidance and resources,” Wang said.

Terms of the acquisition, including the size of the stake, were not disclosed.

Mariana Lemann





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ESG INDEX SWITCHES IRK DISTRIBUTORS

January 10, 2022

A version of this story previously ran in Financial Advisor IQ's sister
publication, Ignites Europe.

Fund selectors have expressed disapproval with passive funds changing indexes to
incorporate environmental, social and governance factors.

Experts warn that not all selectors are at the same point in their “ESG journey”
and changing underlying indices could lead to a loss of trust.

This comes as some of Europe’s largest exchange traded fund providers, including
iShares, DWS and BNP Paribas, have changed indexes on some of their products.

Funds are being encouraged to include ESG considerations in their objectives as
an ever-larger proportion of flows is moving into sustainable products.

Passive products classified as sustainable under European Union finance rules
had net inflows of €8.4 billion ($9.6 billion) in November alone, according to
Morningstar data.

But not all professional fund buyers are happy with passive funds being
repurposed as sustainable.

Jose Garcia Zarate, associate director, passive strategies at Morningstar, says
one fund selector he spoke to was “upset” that an ETF they held had switched to
an ESG index, which excluded energy company Shell.

The selector wanted to maintain exposure to the Anglo-Dutch oil and gas giant,
Garcia Zarate said.

Some selectors think investing in stocks excluded from many ESG indexes could be
advantageous at a time when other investors are divesting from these companies,
he adds.

Chris Chancellor, senior director of global insights at Broadridge, said views
of this kind among European fund selectors are “not common but not unknown.”

“Whilst it is easy to think the whole industry and all participants have shifted
to ESG, it’s clearly not the case,” he said.

“[Asset] managers would do well to remember everyone is on an ESG journey and
that some fund buyers may not have even started that.”

Detlef Glow, head of Europe, the Middle East and Africa research at Refinitiv
Lipper, said, “I can understand that some investors are concerned when ETF
promoters change the underlying indices of their ETFs since they may have a
different investment objective than that of the new index.”

Glow said ETF providers “need to be careful when making the decision to
repurpose an ETF” as this can have “massive impacts on the relationship between
the ETF promoters and their investors.”

The issue for fund selectors goes beyond ESG considerations, according to
Chancellor.

He said, “fund selectors hate funds being changed without prior warning.

“For [a fund] to change without prior warnings and conversation means
[selectors] may have a fund that doesn’t fit with the reasons they added it to
the portfolio.”

He added, “Change with little warning creates a trust issue.

“If a change is forced on [a client] at short notice, that doesn’t feel like a
partnership and you lose trust that is hard to build in the first place.”

A report from Broadridge quotes one anonymous Swiss discretionary manager as
saying that they “particularly dislike it” when asset managers “convert their
products into ESG and [socially responsible investment] products without our
consent or notifying us beforehand”.

Nicolo Bragazza, senior investment analyst at Morningstar Investment Management,
agreed, saying: “Clients need to be put in the best position to make investment
decisions, and therefore clarity and transparency are key.”

To keep clients on board, asset managers may need to go above and beyond
regulatory standards, which give investors time to redeem before a fund changes
its investment objectives or benchmark index.

However, direct communications with ETF clients are not always straightforward,
according to Peter Sleep, a senior portfolio manager at multi-manager Seven
Investment Management.

“There are no conventional shareholder registers with ETFs, and issuers often do
not know who their shareholders are,” Sleep said.

This means that some investors “may miss the change” in their ETF’s index, he
said. Sleep added that ETF providers will get in touch with large investors, if
they know who they are, to “make sure they are comfortable with the change”.

Some firms aim to avoid client withdrawals by launching new passive ESG funds
alongside similar existing non-ESG products, with the potential to merge the two
products later on.

“The downside is that [firms] have to find investors to seed the new fund, but
there are usually investors that are happy to switch,” said Sleep.

Deborah Fuhr, founder of consultancy ETFGI, agreed that more ETFs will be
launched, saying there is “likely to be a lot of product proliferation globally”
as a result of differing client views on ESG, as well as differing regulatory
pressures.

It is harder for firms to take a “homogeneous approach” as they are obliged to
follow standards set in each market where ETFs are sold, Fuhr said.

Ed Moisson

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BLACKROCK CUTS FEES ON $35B IN BOND ETFS

By Jackie NoblettJanuary 7, 2022

A version of this story previously ran in Financial Advisor IQ's sister
publication, Ignites.

BlackRock has shaved fees on two bond ETFs amid strong flows and price
competition.

Fees on the $25.5 billion iShares MBS ETF dropped by 2 basis points to 4 bps,
and expenses on the $9.1 billion iShares 0-5 Year TIPS Bond ETF fell 1 bp to 3
bps, the firm disclosed Wednesday.

The fee cuts "will further empower investors to manage risk and their
portfolios" in an economic environment of continued inflation and rising
interest rates, said Steve Laipply, head of bond ETFs at BlackRock, in an email
response to questions.

The cuts place the MBS ETF’s price on par with its biggest competitors. Last
month, Vanguard announced that the fee of its $15.3 billion Mortgage-Backed
Securities ETF slipped 1 bp, to 4 bps, as part of a slew of expense reductions.
State Street’s $4.2 billion SPDR Portfolio Mortgage-Backed Bond ETF also charges
4 bps, or 2 bps less than it did before last March.

The iShares MBS ETF collected $913 million in net flows last year, according to
Morningstar Direct. The Vanguard Mortgage-Backed Securities ETF, meanwhile,
added $2.6 billion, and the SPDR Portfolio Mortgage-Backed Bond ETF garnered
$1.5 billion.

iShares’ short-term TIPS strategy, meanwhile, has long been the cheapest ETF to
invest in inflation-protected securities. It focuses on the shorter end of the
duration spectrum compared with its bigger brother, the $38.6 billion iShares
TIPS ETF, which charges 19 bps.

TIPS funds have been broadly popular with investors amid rising inflation.
Inflation-protected bond ETFs took in $40.2 billion last year, according to
Morningstar Direct, making it the fifth-best-selling category in the
Chicago-based researcher’s database, and the top-selling segment within fixed
income.

The 0-5 Year TIPS Bond ETF took in just under $6 billion last year, while the
TIPS Bond ETF amassed $12 billion, according to Morningstar Direct.

BlackRock has suggested that investors place more money into inflation-protected
strategies in 2022. Prices for such strategies will continue to rise faster than
pre-pandemic levels, according to the New York-based firm’s investment outlook,
which suggests that investors should be “positioning portfolios to live with
inflation” in their fixed-income holdings by piling money into
inflation-protected and floating-rate bonds.

Overall, BlackRock’s U.S. ETFs collected $209 billion in inflows last year,
according to Morningstar’s database, second only to Vanguard’s $327 billion
haul.

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DIM OUTLOOK FOR GOLD ETFS AFTER A DREARY YEAR

January 10, 2022

A version of this story previously ran in Financial Advisor IQ's sister
publication, Ignites.

Gold ETFs are coming off their worst sales year in eight years and are facing
severe market headwinds going into 2022, the Financial Times reports.

Investors pulled a net $9 billion from the funds last year, marking the steepest
annual outflow since 2013, according to data from the World Gold Council cited
by the FT.

Gold prices rose to a record high of $2,067 per ounce in August 2020, steadily
falling since then to close out 2021 down 12.6%. Though demand was higher last
year for physical gold in jewelry, bars and coins, as well as in industrial uses
and from central bank purchases, investors kept their distance. Overall, they
redeemed a net 173 tons from physically backed ETFs, World Gold Council data
shows.

The selling pressure was most severe in the United States, where gold ETFs
registered net withdrawals of 201.3 tons, or $10.8 billion.

This year, increasing interest rates and a stronger dollar can be expected to
hold down gold prices, industry analysts say.

“Many of the drivers that tend to be positive for the U.S. dollar — tighter
central bank policy, less U.S. fiscal stimulus, and rising real interest rates —
also tend to be negative for gold,” Mark Haefele, chief investment officer at
UBS Global Wealth Management, told the FT.

Central banks’ unwinding of “ultra-accommodative” monetary policies this year
could be “outright bearish” for gold, JPMorgan analysts said.

There may be “more selling pressure” on gold, prompting continued ETF outflows,
said Ed Morse, global head of commodity research at Citigroup. Morse projects
there will be outflows of 300 tons this year, and 100 tons in 2023.

Strategists from State Street Global Advisors, which manages the bellwether
$56.3 billion SPDR Gold Trust, are taking a rosier view. They predict gold will
resume a long-term structural bull market trend, lifted by strong demand in the
jewelry, industry and technology sectors in China and India.

 * To read the Financial Times article cited in this story click here if you
   have a paid subscription

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