ETF flows are at all-time highs, driven by 'inflation-fighters'

Morningstar Director of Global ETF Research Ben Johnson joins Yahoo Finance Live to discuss Fidelity offering direct-indexed accounts, indexing for ETFs, and the outlook for the booming ETF market.

Video transcript

KARINA MITCHELL: We are going to pivot now-- want to bring your attention now to our ETF report brought to you by Invesco QQQ. Let's bring in our next guest to discuss what's on the horizon for the ETF space. Ben Johnson, Morningstar Director of Global ETF Research. Ben, thank you so much for joining us.

I want to start off by asking you-- Fidelity is apparently making a foray into direct indexing, into that space, which some have said that could be pegged to a potential ETF category. What's your opinion on that?

BEN JOHNSON: Yeah. So while I think many have worried that direct indexing could be a category killer for low cost, diversified ETFs, what I would say is that, ultimately, long-term, it's probably going to sit side by side with ETFs in relative peace and harmony. It's an interesting angle, it's an interesting tool in investors' toolkit to get diversification tax efficiency, and I think most importantly, most notably, customization.

And now at an entry point as low as a $5,000 investment minimum with Fidelity's new offering, that brings direct indexing as close to retail investors mom and pop as it's ever been before. So it's an interesting development, but it's got a high hurdle to beat. A low cost portfolio, diversified mutual funds, or index ETFs can cost investors less than 10 basis points a year.

Fidelity is going to be charging 40 basis points for this service. So at a minimum, it's going to have to add about 30 basis points worth of value. Even more if you line it up next to one of Fidelity's own existing offerings, which is its zero fee index mutual funds, which, you know, investors might prefer overpaying 40 basis points for something that's a bit more customized. And certainly Fidelity, on the contrary, would rather charge 40 basis points than nothing to more of its customers. So it's going to be interesting to see this ongoing tension and this ongoing tug of war between the incumbent ETFs and index mutual funds and this new form of indexing-- direct indexing.

ALEXIS CHRISTOFOROUS: Ben, paint the picture for us-- the year has been a rocky one for the stock market, and there has been a lot of volatility. How is that translating into interest in the ETF market? Are you seeing a lot of money flowing into ETFs? And if so, where in particular?

BEN JOHNSON: Well, we're seeing continued momentum at large into the ETF category. Last year, we saw record flows-- and record flows by a massive margin. We'd actually surpassed the prior annual record in terms of ETF flows in July of 2021-- that prior record having been set just the year prior in 2020. So what tends to shift is the contours of flows.

What are the areas of the market that investors are most interested in? And what we saw in 2021 was a noticeable uptick in anything that might be an inflation fighter-- be it TIPS. TIPS ETFs saw record inflows. We saw renewed interest in gold-backed ETFs. Fast forward to today and what we're seeing is a pivot away from inflation fighters and towards value strategies of all types, as we've seen value stocks make a bit of a comeback.

Now, whether or not this is truly the long-awaited comeback for value stocks or another false spring like we saw in 2021 is yet to be seen. But what is certain is that investors have been allocating money at the margin to value ETFs.

KARINA MITCHELL: And, Ben, I'm wondering, it's a time of such volatility, what are you advising clients on duration of ETFs?

BEN JOHNSON: Well, what you see is that ETFs offer you the full spectrum. You can cut up the interest rate curve, you can cut up credit markets-- slice, dice, even julienne them now with the launch of bond blocks ETFs imminent that offer the finest slices yet of sections of corporate credit markets. So investors have, I would say, more tools at their disposal than they ever have before.

So if they want to manage interest rate risk in a very fine fashion, if they're worried about rates rising, they can do that by coming in closer to shorter maturity bonds. They can do that through bank loan ETFs that adjust their interest rates as interest rates change. They have a multitude of tools at their disposal today that they didn't even just 10 or 15 years ago.

So ultimately, the right decision depends on the investor in question, depends on their preferences, their tolerance for risk. But the good news is they've got as many low cost choices, as many low cost implements as they ever have at their disposal.

KARINA MITCHELL: And need to remain vigilant this year, for sure. All right, we will leave it there. Ben Johnson, Morningstar Director of Global ETF Research, thanks for stopping by today.