MW Small-cap stocks unloved in ETF flows - but Rob Arnott likes these 'underdogs'
By Christine Idzelis
U.S. ETFs are on pace for record inflows in 2024 after a strong August
Hello! This week's ETF Wrap looks under the hood of unusually strong flows in August. I also caught up with Rob Arnott, founder of Research Affiliates, about his firm's new ETF.
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Investors are pouring capital into exchange-traded funds at a pace that puts the U.S. industry on the path for an annual record in 2024, but small-cap stocks remained largely unloved in August.
Small-cap equity ETFs saw more than $1 billion in outflows in August, increasing their bleeding this year to more than $20 billion, according to a State Street Global Advisors report on U.S.-listed exchange-traded-fund flows. By contrast, large-cap equity ETFs have attracted around $223 billion in 2024 through August, including $23 billion of inflows last month.
Small-cap stocks, particularly in the category of "value," have been "lagging very badly" in performance, said Rob Arnott, founder of Research Affiliates, in an interview. But he has an eye for "the underdog," saying some stocks that land in the small-cap value category as a result of being "kicked out" of market-capitalization-weighted indexes may be bound for outperformance.
With that concept in mind, his firm has created its first exchange-traded fund, the Research Affiliates Deletions ETF, which will begin trading Sept. 10 under the ticker symbol NIXT. The ETF applies a "quality" screen to avoid investing in "value traps," filtering out companies with "anemic" profit margins or weak cash flows relative to the cost of servicing its debt, said Arnott.
When "deeply out of favor" stocks are removed from market-capitalization indexes focused on the top 500 or 1,000 U.S. companies, the price of their shares tends to fall in the deletion process, according to Arnott. But the same stocks may wind back up in the indexes that booted them, he said, adding that companies being added to indexes tend to see their stock prices rise.
"Underdogs often come back and surprise to the upside," said Arnott, speaking to the long-term mean reversion that the firm's new ETF aims to capture.
The Research Affiliates Deletions ETF was designed to buy low and sell high, with the Russell 2000 Value index XX:RUJ serving as its benchmark, according to Arnott.
Shares of the iShares Russell 2000 Value ETF IWN have risen 4.2% this year through Thursday, lagging the U.S. small-cap equities-focused Russell 2000 index RUT as well as the S&P 500 SPX and Russell 1000 RUI indexes, according to FactSet data.
The iShares Russell 2000 ETF IWM has seen its shares gain 5.6% so far in 2024, but the fund is trounced by large-cap stocks in the U.S. For example, the SPDR S&P 500 ETF Trust SPY has climbed 15.6% this year through Thursday, while the iShares Russell 1000 ETF IWB is up 14.7% over the same stretch, according to FactSet data.
While ETFs focused on "value" stocks attracted more inflows than those targeting "growth" in August, the U.S. equity style has been unpopular over the past three months while lagging flows into growth ETFs year to date, according to a chart in the State Street note.
ETF investors have favored large-cap and growth stocks in particular in 2024, the chart above shows. Megacap growth stocks have captured investors' attention amid enthusiasm for artificial intelligence, with Nvidia Corp. $(NVDA)$ and Meta Platforms Inc. (META) seeing outsized gains this year, although some Big Tech stocks are struggling so far this quarter.
Read: Apple and Nvidia in talks to invest in OpenAI: report
Meanwhile, shares of the Invesco QQQ Trust Series I QQQ, which tracks the growth-oriented Nasdaq-100 index, are up 12.6% so far this year through Thursday. The iShares Russell 1000 Growth ETF IWF has jumped 16.8% over the same period, while the iShares Russell 1000 Value ETF IWD has trailed with a year-to-date gain of 11.6%.
Hot August flows
U.S.-listed ETF flows were strong in August despite equity funds broadly taking in a lackluster $36 billion, according to the State Street note.
"Investors stayed local in August," said Matthew Bartolini, head of SPDR Americas research at State Street Global Advisors, in the note. "U.S. equity ETFs' $38 billion of inflows represents 103% of all equity flows, as the combined outflows of $5 billion from emerging market, regional and single-country ETFs offset the $4 billion into broad developed ex-U.S.," Bartolini wrote.
Trailing three-month flows for China-focused ETFs are "the worst they have been," he said.
Still, emerging markets excluding China is an ETF category that's "actually been growing a lot" in terms of assets under management, according to Aniket Ullal, head of ETF data and analytics at CFRA Research. For example, the iShares MSCI Emerging Markets ex China ETF EMXC had around $795 million of inflows in August, he said by phone.
Overall flows last month into ETFs were much stronger than usual at $73 billion across asset classes, partly because investors broadly piled into bonds, according to State Street.
During the first eight months of 2024, U.S.-listed ETFs garnered $610 billion overall, a record for such a stretch that put the industry on track to potentially attract unprecedented annual inflows of $950 billion, the report shows.
"August has historically been the worst month for ETF inflows, averaging just $32 billion over the past five years," said Bartolini. "ETFs gathered more than double the historical August average."
As usual, here's your look at the top- and bottom-performing ETFs over the past week through Wednesday, according to FactSet data.
The good...
Top performers %Performance AdvisorShares Pure US Cannabis ETF 7.1 YieldMax TSLA Option Income Strategy ETF 5.0 Invesco China Technology ETF 3.1 KraneShares CSI China Internet ETF 3.1 iShares U.S. Consumer Staples ETF 2.6 Source: FactSet data through Wednesday, Sept. 4. Start date Aug. 28. Excludes ETNs and leveraged products. Includes NYSE-, Nasdaq- and Cboe-traded ETFs of $500 million or greater.
...and the bad
Bottom performers %Performance YieldMax COIN Option Income Strategy ETF -12.4 YieldMax NVDA Option Income Strategy ETF -9.8 United States Oil Fund LP -7.8 ProShares Bitcoin Strategy ETF -7.7 Amplify Junior Silver Miners ETF -7.1 Source: FactSet data
New ETFs
State Street Global Advisors on Thursday announced three new ETFs: the SPDR SSGA US Equity Premium Income ETF SPIN, the SPDR S&P Emerging Markets ex-China ETF XCNY and SPDR Bloomberg Enhanced Roll Yield Commodity Strategy No K-1 ETF $(CERY)$.ProShares said Thursday that it launched the ProShares Russell 2000 High Income ETF ITWO, which uses a covered call strategy benchmarked to the small cap-focused Russell 2000 index.Roundhill Investments said Sept. 4 that it launched the Roundhill Ether Covered Call Strategy ETF YETH, designed to give investors exposure to ether without directly investing in the cryptocurrency. The ETF uses "a covered call strategy on ether-tracking ETFs," the firm said. GraniteShares announced on Sept. 4 a trio of new single-stock ETFs with short and leveraged strategies tied to underlying stocks Palantir Technologies, Uber Technologies and Coinbase. The investment program of the three funds - the GraniteShares 2x Long PLTR Daily ETF PTIR, GraniteShares 2x Long UBER Daily ETFUBRL and GraniteShares 1X Short COIN Daily ETFCONI - is "speculative" and "entails substantial risks," according to the statement. Tradr ETFs announced Sept. 3 it launched eight leveraged ETFs under a new series of products that "reset their performance target on a calendar week or calendar month" as an alternative to "daily resets." Six of the ETFs seek 200% exposure to the weekly or monthly performance of the SPDR S&P 500 ETF Trust, the Invesco QQQ Trust Series I and iShares Semiconductor ETF SOXX, while the other two new ETFs have "magnified long weekly exposures" to Nvidia and Tesla, according to the announcement.Calamos Investments said Sept. 3 that it plans to launch on Sept. 9 the Calamos Laddered S&P 500 Structured Alt Protection ETF (CPSL), which bundles ETFs that "offer 100% downside protection over their one-year outcome periods."
Weekly ETF reads
One-Day-Only ETFs Are Jack Bogle's Nightmare Brought to Life (Bloomberg)Leveraged Nvidia ETF issuers saw trading surge in bearish products ahead of earnings (Reuters)Active ETFs set to hit $1tn in assets (Financial Times)Merrill Lynch to triple number of active ETFs on its platforms (Financial Times)Bitcoin ETFs Bleed $287M, Largest Daily Outflow in Four Months (CoinDesk)
-Christine Idzelis
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September 05, 2024 18:20 ET (22:20 GMT)
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