Halfway Through 2022, ETF Investors Have Stood Their Ground
U.S. ETFs hauled in $297.3 billion in a turbulent first half of the year.
Halfway Through 2022, ETF Investors Have Stood Their Ground
The first six months of the year were painful for investors. The Morningstar Global Markets Index punctuated a turbulent start with an 8.63% decline in June. The broad gauge of global equities tumbled 20.4% for the year to date through June, its worst start to the year in its 20-plus years of performance history. Bonds offered little relief. The Morningstar US Core Bond Index, a portfolio of U.S. government bonds and investment-grade corporate debt, declined 10.23% in the first half. The Bloomberg U.S. Aggregate Bond Index suffered its worst six-month stretch since 1980.
Dreadful results did not deter investors from piling into exchange-traded funds. U.S. ETFs hauled in $297.3 billion in the first half, including $36.9 billion of inflows in June. Stock ETFs collected $32.7 billion, while their fixed-income counterparts tacked on $2 billion of new money last month. That raised their flow totals to $189.5 billion and $66.9 billion for the year to date, respectively.
Here, we’ll take a closer look at how the major asset classes performed last month, where investors put their money, and which corners of the market look rich and undervalued at month’s end–all through the lens of ETFs.
Exhibit 1 shows June returns for a sample of Morningstar Analyst-rated ETFs that serve as proxies for major asset classes. A blended global portfolio retreated 5.56% in June. Its bond sleeve couldn’t offset its losses in stocks. Vanguard Total Bond Market ETF BND slid 1.66% after it notched a modest climb in May, and Vanguard Total International Bond BNDX extended its streak to seven consecutive months in the red with a 1.72% decline. Bonds have not been the stabilizing force that blended portfolio investors hoped for this year: BND and BNDX sunk 10.43% and 9.9% in the first half, respectively.
The stock sleeve weighed on the blended portfolio’s performance even more heavily. Vanguard Total World Stock ETF VT fell 8.35% in June, its worst month since the onset of the coronavirus pandemic fueled a 14.76% decline in March 2020. U.S. and international stocks shared the blame last month, as they posted near-identical drops.
Vanguard Total International Stock ETF VXUS concluded the first half with an 18.15% decline. Its developed-market holdings–especially those that hail from mainland European countries like Germany, France, and Switzerland–fared among the worst. The Morningstar indexes that track those stock markets all retreated between 20% and 29% in the first half. Their woes underpinned the iShares MSCI EAFE ETF’s EFA 19.05% pullback over the first six months. IShares Core MSCI Emerging Markets ETF IEMG rode a solid second quarter to a milder 17.34% first-half decline. Chinese stocks–which shape nearly a third of the portfolio–came to life after pandemic-induced lockdowns halted their economy earlier in the year. The Morningstar China Index followed a 12.99% first-quarter drawdown with a 2.77% gain from April through June.
U.S. stocks haven’t shown such signs of resilience. Vanguard Total Stock Market ETF VTI cascaded 21.38% in the first half of the year, its worst six-month return since the October 2008-March 2009 stretch that closed the global financial crisis. Historic inflation and the consequent interest-rate hikes have formed a powerful headwind that stopped U.S. stocks in their tracks. As the Federal Reserve tries to rein in inflation without tipping the economy into recession, it remains to be seen when stocks will find their nadir.
Stocks of all sizes have wobbled as they tried to navigate the new economic environment. IShares Core S&P 500 ETF IVV, iShares Core S&P Mid-Cap ETF IJH, and iShares Core S&P Small-Cap ETF IJR posted comparable drawdowns between 18.9% and 20% in the first half. Small-cap firms tend to respond more acutely to economic factors, but IJR narrowly led its more-established brethren over that span. Meanwhile, the tech mammoths that powered the market for years have come back to Earth. Poor June returns crystallized brutal first halves for 2021 standouts Amazon.com AMZN and Nvidia NVDA. But few have fallen as swiftly as Meta Platforms META; its 52.06% year-to-date loss pushed it out of the S&P 500's top 10 and qualified it as a value stock in several widely followed indexes.
Meta was hardly the only once-high-flier to fall in the first half. Pain was widespread for growth stocks; Vanguard Growth ETF’s VUG first-half drawdown (30.4% loss) more than tripled that of its value counterpart, Vanguard Value ETF VTV (9.39% loss). VTV benefited from its cupboard of mature, well-established stalwarts, as familiar franchises like Coca-Cola KO held up well. Favorable exposure to drug manufacturers helped steer it ahead, too. Eli Lilly LLY, AbbVie ABBV, and Merck MRK each climbed between 15% and 21% in the first half.
VTV’s key ingredient was tremendous contribution from energy stocks. Even after a rocky June, Energy Select Sector SPDR ETF XLE closed the first half with a 31.6% gain, while no other SPDR sector ETF finished in the black. Companies like ExxonMobil XOM and Occidental Petroleum have thrived as a supply/demand imbalance drove up oil prices. Energy stocks constituted 6.5% of VTV to start the year, compared with 0.3% of VUG. VTV has also benefited from comparatively meaty allocations to the more-defensive utilities, healthcare, and consumer staples stocks.
IShares MSCI USA Value ETF VLUE has not kept up with fellow value fund VTV. It tethers its sector allocation to the broad market, leaving it saddled with heavy tech exposure, few energy holdings, and a 16.2% first-half decline. That still beat fellow single-factor ETFs iShares MSCI USA Quality Factor ETF QUAL and iShares MSCI USA Momentum Factor ETF MTUM, which booked losses of 22.72% and 24.7%, respectively. Meanwhile, iShares MSCI USA Minimum Volatility Factor ETF USMV has delivered on its defensive mandate: It outperformed 93% of its large-blend Morningstar Category peers in the first half.
If the tumultuous start to the year has a silver lining for investors, it’s that stock portfolios look undervalued after the blows they have absorbed. The Morningstar price/fair value ratio grades VT as 12% undervalued at the halfway mark. IShares Core S&P Total U.S. Stock Market ETF ITOT looked cheaper still, as it traded 19% below its fair value. Even wider discounts can be found in U.S. small-cap stocks with IJR (25% discount) or in emerging-markets stocks with IEMG (26%). More uncertainty lies on the horizon–and investors would be wise to proceed with caution–but the woeful first half of 2022 could present an opportunity for investors to buy at a discount.
Diving Into Dividends
This year’s market whirlwind has not blown ETF investors off course. They piled nearly $300 billion in U.S. ETFs over the first six months. ETFs had tallied about $172 billion more of inflows at the halfway point in 2021, which is likely a function of the market’s hotter start last year.
Stock ETFs, which constitute about three fourths of the total universe, have led the way with $189.5 billion of inflows so far this year. Investors have taken note of value funds’ relatively stable performance. The large-value category’s $57.4 billion first-half haul led all categories. VTV has spearheaded the category; its $1.3 billion June inflow pushed its year-to-date collection to $12.9 billion. Growth funds have not been nearly as popular. Even after raking in $4 billion in June, the large-growth category tallied only $7.6 billion of inflows for the year to date.
Much of value funds’ lucrative start to the year can be traced to the success of dividend funds. Portfolios that base their construction on stocks’ yield, dividend sustainability, and/or dividend growth have thrived so far this year. Since these funds favor stable firms with the financial health to consistently distribute dividends, they tend to hold up well in market downturns. Yield-oriented funds have made out especially well because they piled into beaten-down energy stocks prior to this year. Many have converted their stellar performance into healthy inflows. IShares Core High Dividend ETF HDV and SPDR Portfolio S&P 500 High Dividend ETF SPYD, both of which beat more than 90% of their peers for the year to date, have collected $5.5 billion and $3 billion in 2022. Schwab U.S. Dividend Equity SCHD, a more-conservative option, led all dividend ETFs with $7.3 billion of first-half inflows.
Defensive sector ETFs attracted healthy investment amid the market volatility. Healthcare, consumer staples, and utilities funds collected between $4 billion and $7.5 billion apiece in the first half. Meanwhile, more-cyclical tech, consumer discretionary, and financials ETFs all saw money rushing out. Financials funds surrendered $13 billion over the first six months of the year–second most of all categories.
Fixed-income funds notched solid inflows of their own in the year’s opening half. After enduring outflows in January, they rattled off five consecutive months of inflows and collected $66.9 billion in total. Investors craved safety within the fixed-income world, too. Short-, intermediate-, and long-term government bond funds collectively hauled in $29.8 billion in the first half, while their diversified peers of the same time horizons welcomed a paltry $5.9 billion. IShares 1-3 Year Treasury Bond ETF SHY reeled in $5.9 billion, which led all Treasury bond funds over that span.
Investors have aimed to dial back credit risk, but their attitudes toward interest-rate risk are more nebulous. Long-term government bond funds’ $14.8 billion first-half haul nearly exceeded the combination of intermediate ($9.1 billion) and short-term government bond funds’ take ($5.9 billion). However, the ultrashort bond category pulled in $32.9 billion in the first half–the most of all fixed-income categories and enough for a 32.2% year-to-date organic growth rate.
Flows into commodities ETFs also swelled in the first half, as investors fled to areas of the market that stood to protect them from inflation. While their momentum has cooled off recently (they shed $2.5 billion in June), commodities funds welcomed $15.3 billion of new money over the first six months. ETFs that concentrate on precious metals have made out well; SPDR Gold Shares GLD paced all commodities ETFs with $4.8 billion of inflows from January through June. Broader commodities ETFs have absorbed $6.2 billion of their own, led by Invesco Optimal Yield Diversified Commodity Strategy No K1 ETF PDBC ($3 billion).
Active ETFs continued to punch above their weight in flows over the first half of the year. ETFs that do not track an index hauled in $43.6 billion, or 14.7% of all ETF flows over that span. That seems a modest clip but represents about 3 times the 4.9% market share of active ETFs. So, while these options are not the main event in the ETF universe, they continued to expand their footprint.
The cream rose to the top of the ETF universe in June, when Vanguard and iShares were the sole ETF providers to pull in more than $3 billion. These behemoths pulled in $103.8 billion and $72 billion, respectively, in the first half, well ahead of their next-closest competitor, Charles Schwab ($15.7 billion).
The usual suspects led the way for Vanguard,; its $16.8 billion collection ranked first in June. Vanguard S&P 500 ETF VOO reeled in $7.1 billion, while the even-broader VTI absorbed $2.1 billion. The more unique standout this year is Vanguard High Dividend Yield VYM, which booked a $5.8 billion first-half inflow after pulling in $1.9 billion in June. This Silver-rated fund has captured the stellar payoffs to dividend stocks this year; it held up better than 79% of its peers over the past six months.
IShares’ $13.8 billion of inflows landed it in second place for June, which is also where it ranked over the first half. June flows into its fixed-income lineup were quiet, but its bond ETFs’ popularity has kept it in the 2022 flows race. Bond ETFs constitute less than a fourth of iShares’ total assets but accounted for more than 44% of its net flows so far this year. A trio of Treasury funds–iShares Short Treasury Bond ETF SHV, SHY, and iShares 20+ Year Treasury Bond ETF TLT–spearheaded the success, pulling in between $5 billion and $9 billion apiece in the first half.
Cannabis Fund Have Gone Up in Smoke
The fair value estimate for ETFs rolls up our equity analysts' fair value estimates for individual stocks and our quantitative fair value estimates for stocks not covered by Morningstar analysts into an aggregate fair value estimate for stock ETF portfolios. Dividing an ETF's market price by this value yields its price/fair value ratio. This ratio can point to potential bargains and areas of the market where valuations are stretched.
Few genres of thematic funds have faced more tumult than those that aim to leverage the legalization of cannabis or other drugs. These funds claimed nine of the 10 spots on Exhibit 8, which features ETFs that traded at the lowest prices relative to their fair value at June’s end. Each fund on the list with at least a one-year track record has tumbled at least 74% over the past 12 months. It has seemed there was no place to go but up for these funds for quite some time, but their slide has continued even further.
A pair of sector ETFs find themselves on the more-expensive half of Exhibit 8: Vanguard Energy ETF VDE and Vanguard Utilities ETF VPU. Ironically, these tend to be value sectors, known for their attractive price valuation multiples. But as these portfolios have stayed afloat, their price/fair value has inflated. VDE traded at a 15% premium at the end of June, while Vanguard Information Technology ETF VGT traded at a 12% discount. At the end of June 2020, it was VDE that traded at a 33% discount, while VGT was 17% overvalued. The sector shift between the haves and the have-nots over the past 12 months has been swift and profound.
Dividend stocks’ resilient performance in the first half helped push a pair of active dividend ETFs to the pricier side of Exhibit 8. T. Rowe Price Dividend Growth ETF TDVG warrants a look despite its lofty multiples. Sturdy veteran leadership and a time-tested approach earned this fund a Morningstar Analyst Rating of Silver. Indeed, the fund has stacked up nicely over the past six months, ranking well within the large-value category’s top quintile over the first half.