Yes, I’ll Take “Vanilla” Please

A lot of people are talking about ‘Sharon‘ this month.

For those new to Heisenberg, ‘Sharon’ is my 70-something neighbor. She’s (probably) rich. She’s got a spaniel. She likes Merlot. And she also likes her Bluetooth earpiece.

I caught Sharon talking about record high stocks a few Saturdays ago while I was relaxing on the porch enjoying a pre-dawn cigar and the first of what would be many espressos (I was forced to begin substituting copious amounts of caffeine for alcohol after my pancreas went on strike last November). I’ve suggested that ‘Sharon’s’ newfound interest in stocks is emblematic of retail money’s mad dash off the sidelines this year.

As you’re probably aware, the largest broad market stock ETF witnessed a massive $8.2 billion daily inflow (the largest in over two years) the Wednesday following Donald Trump’s surprisingly conciliatory speech to Congress…

retail

(Bloomberg)

…and as it turns out, investors have dumped some $125 billion into ETFs YTD. That’s the best start (inflows wise) since the industry’s inception nearly a quarter century ago. According to BlackRock, about 85% of that money is from individual investors.

In yet another testimony to just how retail-ish these flows have been, FactSet is out with a breakdown of February’s figures and it certainly looks as though mom and pop are following granddaddy Buffett’s advice: go passive. Consider the following:

In February, among segments that have solid passive options, only 36 actively managed funds increased their market share, 51 had no flows, and another 22 had outflows. More strikingly, active management in equity ETFs took a $168 million dollar hit, as the AlphaArchitect suite shed its active status, switching to index-based exemptive relief. All told, active management in segments where investors can choose passive lost market share, pulling in only half the assets that their starting market share would imply.

As we just saw, February’s ETF investors piled on passives over actives (given the choice), and into vanilla funds over strategic and idiosyncratic strategies. Digging deeper, we find that only rarely did investors deliberately choose a non-vanilla strategy. Parsing the ETF landscape into segments where passive vanilla exposure is a choice and those where no vanilla choice exists reveals that wherever a choice existed, ETF investors’ decisions went overwhelmingly to vanilla.

Vanilla

Notably, only one out of every nine investor dollars pouring into ETFs in February represented a deliberate decision against vanilla exposure. The 11% that chose some non-vanilla strategy in segments have both vanilla and alternatively constructed ETFs. In segments where vanilla funds compete with other strategies, vanilla outpaced the others almost 6:1, while redemptions ran a far more moderate 2:1. In total, in these mixed segments, vanilla dominated the other strategies by more than 5:1.

This doesn’t bode well for active management. Here’s why. Have a look at stock correlation:

Correlation

(Goldman)

This should be a stockpicker’s market. That is, Trump’s policies should create clear winners and losers and collapsing correlation supports that notion. Dispersion hasn’t risen materially yet, but it should if we get even a peep out of realized vol. I don’t know if it’s simply a communication problem or what, but if active management can’t attract investors in a market that by all accounts is finally offering them a chance to outperform their benchmarks, well then they might as well just throw in the towel.

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