ETFs have ‘become the choice of a new generation’ as inflows top $1 trillion: Strategist

Morningstar Director of Global ETF Research Ben Johnson joins Yahoo Finance to discuss ETF inflows topping $1 trillion, plus the best and worst ETFs of 2021.

Video Transcript

ALEXIS CHRISTOFOROUS: Time now for our ETF Report brought to you by Invesco QQQ. Investors continue to pour a record amount of money into exchange-traded funds. In fact, inflows into ETFs crossed the $1 trillion mark last month for the first time. And to meet that growing demand there were also a record number of ETFs launched in 2021.

Here with his picks of the year's best and worst is Ben Johnson, CFA and Morningstar director of global ETF research. Ben, glad you're here because it can be a confusing world out there with all those ETFs. Before we get to your picks, just talk to us a little bit about these record inflows, and where most of that money has been flowing? What are the trends that you're seeing?

BEN JOHNSON: Well, really what we're seeing is a continuation and in many respects an acceleration of trends that have been in place for years now. And we've seen a lot of big round numbers pop up onto the headlines this year $1 trillion globally flowing into ETFs for the first time, $800 billion of that flowing into US ETFs. US ETFs today collectively hold more than $7 trillion worth of investors' hard-earned savings.

We've seen a record number of new launches in 2021, more than 400 new ETFs brought to market. It's the second year in a row where ETF launches have actually outpaced new mutual fund launches. It's the first time ever, we actually see mutual funds converting to ETFs.

So what we see here is a continuation of a trend that shows that the ETF as a wrapper, as a way of packaging, and distributing, consuming investment strategies has become the choice of a new generation. More and more investors are opting for this better technology which is more cost-efficient, more tax-efficient, easier to invest in than traditional mutual funds. And it's officially snowballed, ETFs have arrived. They've arrived and carved out a home in more and more investors' portfolios all around the world.

KARINA MITCHELL: I wonder, Ben, it sounds like even the economic conditions also favor this growth into the ETF space but those conditions do change next year as we see more volatility, we'll see rate hikes, there's a little bit more cautionary of approach to where people invest. So does that momentum continue and what are the factors that people will be looking at? For example, are they looking at shorter duration, investing for a shorter period?

BEN JOHNSON: I think it's an important consideration. And certainly over the course of 2021 markets have been supportive, which is I would argue for many reasons why we've seen these new records. That said, what we've seen historically is that in periods of stress ETFs have continued to chug along, continued to get net new money from investors because they've proven themselves in these times of stress, they've proven an avenue of liquidity for people who are looking to reallocate their assets away from riskier ones to less risky ones, from stocks to short-term bonds for example.

So whatever the market environment might be, there is an ETF that offers an underlying exposure that an investor might want to seek out. Be the tide high, be the tide low, be it somewhere in between, be worried about inflation, for example, this year where we've seen a record amount of money allocated to TIPS ETFs, or be it allocating towards future growth and the next hot trend. And we've seen certainly billions of dollars pour into thematic ETFs that capture themes ranging from artificial intelligence to autonomous vehicles.

ALEXIS CHRISTOFOROUS: Ben, I want to get to a couple of your best-ofs for the year, let's start on a positive note. You like Schwab International Dividend Equity ETF, there's a lot going on there. You've got international, you've got dividend-paying. And then also Dimensional Core Fixed-Income ETF, a little less sexy but there nonetheless, tell us about these.

BEN JOHNSON: Well, boring is beautiful and I think it's important that investors understand that. That owning a broadly diversified basket of firms that have a long history of paying and growing dividends and charging a very low fee or paying a very low fee in the case of SCHY, the Schwab ETF is a great bet. Especially over the long term if you're worried about something like inflation, right?

Over a very long period of time, there have been few better hedges against inflation than equities, which over the long-term have grown at a rate that's exceeded inflation. A lot of the companies included in that portfolio have grown their dividends at a rate that's exceeded inflation. This is the international cousin of the Schwab US Dividend Equity ETF, a long-time favorite of ours, a fund that carries a Morningstar analyst rating of Silver. It has all of the same DNA, all of the same features that we think have appeal for investors in its US sibling in SCHD.

KARINA MITCHELL: And that leaves me to ask you about some of the worst performers out there, and you say thematic funds tended to feature very prominently on that list, particularly, work-from-home theme funds. Can you name some of those?

BEN JOHNSON: Yeah, so it featured prominently on our list of 2020's worst ETFs were ETFs that tried to capitalize on the moment that we were living through, when we were working, living, shopping, doing everything from home. So there were three work-from-home ETFs that were launched in 2020. Fast forward to 2021 and in the land of thematic ETFs what we've seen is a bevy of different, let's get back out in the world and enjoy ourselves, themed ETFs launched. Perhaps the most prominent of which is a two-times levered travel and vacation-themed ETF with the clever ticker OOTO for out-of-the-office from Direxion.

Now, what we see with these thematic ETFs, while certainly the narratives are compelling and they're often timely, is that investors are really placing a bet, it's a trifecta bet, to borrow an analogy from the horse track. They're betting that they're getting the theme right, that it's durable, work-from-home didn't pan out as being all that durable, that they're getting the stocks right, that the fund actually owns the stocks that are going to capture an economic benefit from the theme and that they're getting valuations right, that all of the market's enthusiasm about these stocks isn't already priced in. And what we see more often than not is that these bets fail to payout. When they do, they payout big, which is why I think investors tend to be attracted to them but they should know that most of the time that these funds fail, that they were designed more so for saleability than they were necessarily on the basis of any sort of long-term investment merit.

ALEXIS CHRISTOFOROUS: All right, Ben Johnson, Morningstar director of global ETF research. Thanks for joining us today.