The up-and-down, back-and-forth nature of the capital markets as of late must have investors thinking they’re a passenger on The Mayflower. Though the latest volatility has affected all corners of the market, it’s made mutual funds seasick while exchange-traded funds (ETFs) remain steadfast.
Through Dec. 27, ETFs have received over $310 billion in flows year-to-date, while mutual funds spewed outflows to the tune of $122 billion in December alone. Conversely, ETFs have received a capital influx of $51 billion.
“We’ve seen this divergence between mutual fund investors and ETF investors–ETF investors have actually added $50 billion so far in December where mutual fund investors have taken out over $120 billion,” said ETF Trends Publisher Tom Lydon on Fox Business’ “Countdown to the Closing Bell” on Friday. “So is there a behavioral change in the works? Possibly, but there’s a lot of volatility. Santa surely put a lot of Dramamine in investors’ stockings, and they needed it on days like today.”
A Wall Street Journal article reported that 517 mutual funds will pay out at least 10% of net assets as taxable gains. In fact, looking at the largest active funds, they collectively yielded an average of eight percent year-end capital gains distributions–in the end, it’s mutual fund shareholders holding the tax bill despite looking to these funds for their intrinsic benefits, but in the end, they are less diversified and pay higher costs compared to ETFs.
Even amid the constant oscillations of volatility in the capital markets, ETFs are seeing positive flows while investors flee mutual funds. As of the week ending Dec. 19, ETFs saw over $25 billion in inflows while mutual funds lost $56 billion–the biggest outflow of capital from mutual funds since mid-October in 2008. According to data from the Investment Company Institute, outflows have increased on a weekly basis since Nov. 20.
In the mutual fund space, total equity, world equity and taxable bonds are seeing the most outflows. From the period between Nov. 28 to Dec. 19, mutual funds saw outflows of $117 billion, while ETFs gained close to $50 billion.
Volatility Continues to Reign
For the past three days, gains have played a game of “now you see it, now you don’t” with investors, particularly on Wednesday as the Dow Jones Industrial Average began with a loss and then surged to 1,086 points–its largest single-day gain ever. Investors witnessed the same whipsaw of volatility on Thursday as the Dow lost 600 points before rallying just before the close to end with a 260-point gain.
Friday saw a return to the red with a 76.42-point loss–a trend that has been persistent in December–the Dow is down 9.40 percent as it closes out another volatile month. The capital markets got a reprieve early in the month from the ongoing trade wars between the United States and China as U.S. President Donald Trump and Chinese president Xi Jinping agreed to cease fire on their tariff-for-tariff battle last week.
As part of the agreement, both nations agreed to withhold imposing further tariffs on each other for 90 days while they work out a firm, ironclad deal to start 2019. However, volatility continues to rack U.S. equities as the reality of a permanent trade agreement is still open for discussion with contentious topics like forced technology transfer and intellectual property possibly derailing negotiations.
Quality Options
As 2018 becomes 2019, investors can wash their hands of the last few months of volatility and look to ETFs that take advantage of the shift from the growth-fueled investments during the extended bull run to a focus on the quality of investments–being selective and using due diligence as screeners to find the best-performing stocks.
As such, Lydon mentioned investors flocking to funds like the iShares Edge MSCI USA Quality Factor ETF (BATS: QUAL). QUAL seeks to track the investment results of the MSCI USA Sector Neutral Quality Index composed of U.S. large- and mid-capitalization stocks with quality characteristics as identified through certain fundamental metrics.
“We’re seeing big shifts into quality stocks and quality ETFs,” said Lydon.
“It’s a great opportunity to get some bread and butter stocks in your portfolio if you’re worried about volatility and you’re worried about big margins, these are the quality stocks that a lot of people are shifting to,” said Lydon.
Getting Disruptive in 2019
Whether we like it or not and whether we want it or not, disruptive technology in the form of robotics, artificial intelligence (AI), machine learning, or any other type of disruptive technology is the next wave of innovation that will permeate all sectors in some form or fashion. To take advantage of this transformative movement, Lydon suggests looking at the ARK Innovation ETF (NYSEArca: ARKK).
ARKK’s focus is primarily on domestic and foreign equity securities of companies that coincide with the ETF’s investment theme of disruptive innovation–a technology or strategy that disrupts the status quo and develops its own niche market. ARKK invests in both developed and emerging markets with the intent to use American Depositary Receipts (ADRs)–securities offered in the U.S., but are offered as a specified number of shares in a foreign corporation.
For investors who missed out on the serendipitous run of FAANG (Facebook, Amazon, Apple, Netflix, Google) stocks, disruptive options like ARKK could be the next tech wave.
“If you wish you took advantage of FAANG stocks 10 years ago, you might have the opportunity for the newest FAANG stocks, which might be in areas like robotics, automation and genome sequencing,” said Lydon.
For more market news, visit ETFTrends.com.