The stock markets saw increased volatility in May, caught in a tug of war between strong corporate earnings releases and a higher-than-expected inflation reading. Meanwhile, bond market yields remained remarkably resilient. Despite the lackluster performance of the broad market, some of the best ETFs and mutual funds brought in stellar returns.
"The month of May experienced one of the strongest quarterly earnings reporting periods that I've seen in my 40+ years of experience in the money management industry," said Leo Grohowski, chief investment officer at BNY Mellon Wealth Management. "Obviously, we were coming off a very weak first-quarter period in 2020. But to have 87% of the companies in the S&P 500 beating earnings expectations was truly an outstanding quarterly reporting period."
He said this helped offset "the highest inflation reading that we've had since 2009. We had the CPI report (Consumer Price Index, which came out mid-May) that was much hotter than investors expected."
Best ETFs And Mutual Funds Stood Up To Inflation
All in all, U.S. diversified equity mutual funds gained on average 0.5%, according to Lipper Inc. data. The 10-year U.S. Treasury yield hovered around 1.6%. The Dow jumped 1.93%, while Nasdaq was the only major index to post a negative return of 1.44% for the month, trimming its YTD performance to 7%. Year to date, U.S. diversified equity funds are up a solid 13.43%. Value and equity income funds were clearly among the best mutual funds in May. Growth equity funds underperformed.
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Within sectors, those that can withstand inflation showed the strongest results. Precious metals equity, natural resources, basic materials and financial services were among the best ETFs and mutual funds. Technology, health/biotech, utilities and consumer services funds lagged.
World equity funds jumped on average 2.34% in May, topping off their YTD advance at 9.63%. India region, European region, Latin American and international value funds surged between 4% and 7% in May. India, European region and international value funds scored YTD returns between 12% and 18%.
A similar picture emerged among some of the best U.S. diversified stock ETFs. Invesco S&P SmallCap Value with Momentum holds the top spot with a YTD return of 50.1%. The $332 million fund jumped 6.45% in May. Top holdings include Gamestop, Veritiv, United Natural Foods and Green Plains – up between 33% and 1,078% YTD.
Energy And Travel ETFs Gain
Energy ETFs have displaced cannabis ETFs, with Invesco Dynamic Energy Exploration and Production up 12.24% in May and 67.7% YTD.
"In May (we saw) a reemergence of stronger gains in the travel sector," said Greg Bassuk, chief executive at AXS Investments. "By contrast, we saw some large caps and small caps struggle to the extent they're in sectors that are going to be more challenged as we see inflation rise."
For this year, Bassuk believes a few areas are poised for strong growth. One is Infrastructure.
"We believe that is one area that Congress and the Biden administration are going to reach a deal on," he explained. "Companies in the infrastructure space, we think, are very well positioned. Both in the near term, June, because of the news of those developments, but then importantly throughout 2021 as the programs get put into place."
Also, sustainable investments such as clean energy, wind and solar are here to stay, he said. Another bullish area for best ETFs and mutual funds is venture capital (VC).
Venture Capital Shows Promise
"During the pandemic, all these VC funds took a wait-and-see approach," he explained. "And now that the economy is reopening, there's a lot of money being put to work in venture capital early-stage companies."
AXS Thomson Reuters Venture Capital Return Tracker (LDVIX) is the only fund available to retail investors that replicates the performance of the venture capital industry. The $279 million fund is up 11.1% YTD and charges an annual fee of 1.51% to own it.
Within fixed income, general domestic taxable funds rose an average of 0.4%. Inflation-protected bond funds were among the best mutual funds, up 1% in May for a YTD return of 1.61%. Emerging markets local and hard-currency debt funds rose as the dollar weakened. World income funds also did well. All, however, are still in the red for the year.
Michael Fredericks, managing director and head of income investing at BlackRock, expects more volatility in the coming three to four months as economic growth and inflation will show another strong reading. However, he believes some of the growth will fade in the second half of 2021 as the stimulus money gets spent.
Inflation Could Impact Best ETFs And Mutual Funds
"The big question I think is: Where do you think inflation and growth will be two years from now?" he said. He points to two options: going back to the benign inflation and growth we saw in the post-global financial crisis years, or a world where inflation is running hotter in a more persistent way.
"Whether we're running a 2% or a 3% inflation rate makes a big difference," he noted. "At a 2% inflation for 20 years, the price levels rise by 50%. But at 3.5% inflation, price levels double in 20 years."
As a result, he added, this can make a big difference for folks approaching retirement: "The compounded effect is pretty brutal, especially when the yields available in core fixed income are so low."
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For the remainder of this year, though, "a key thing to watch is the playbook of the Federal Reserve," he said. While the Fed may be a long ways away regarding raising interest rates, they may be getting closer in terms of adjusting the pace of asset purchases.
Where Can Best ETFs And Mutual Funds Find Higher Yields?
Fredericks is also lead manager of $18 billion BlackRock Multi-Asset Income (BCICX), $1.4 billion BlackRock Dynamic High Income (BDHAX) and $821 BlackRock Managed Income (BLADX) funds. They're up 4.51%, 6.43% and 2.74%, respectively, this year.
To offset low yields, he focuses on two areas in the market: equities and low-duration fixed income. He also points out that there is a lot of built-up cash in the system that will be looking for additional yield. Because of the positive economic outlook, he's less worried about defaults in lower-grade high yield bonds.
Fredericks currently favors floating-rate notes, bank loans, non-Agency mortgages and some commercial mortgages. On the equity side, he likes dividend-growth companies due to their strong business models and increasing dividends over time, which should offset inflation.
With an expense ratio of just 0.15%, iShares International Dividend Growth invests in global companies with a history of growing their dividends. The $224 million ETF yields 2.3% and counts Nestle, Royal Bank of Canada, Sanofi and Unilever among its top holdings.
