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How to use ETFs to invest in companies with good cash flow

Many strategists have been calling for a pullback in stocks, but so far, the market has been resilient. So what should an investor do? VettaFi Financial Futurist Dave Nadig tells Yahoo Finance Live that many financial advisors are "looking at companies with an excess of free cash flow whether or not that's turning into dividends". Nadig shares his top way to play a free cash flow strategy.

Video transcript

- Though the market seems to be resilient, some aren't quite as convinced about the economy. So where should you be positioning your money? Our next guest has a few suggestions. Dave Nadig, VettaFI Financial Futurist joins us now for the ETF report brought to you by Invesco QQQ. Dave, always great to see you here. Just off the top, so what do you suggest given the current market environment that tends to be vexing a lot of investors right now?

DAVE NADIG: Well, we've had a lot of folks talk about barbell, and you had a guest on just recently talking about trying to stay safe with the risk-free rate with treasuries, but then sort of look out into those corners of the market where you might be able to get some outsized returns, find real value that's not overvalued. For that latter thing, what we're hearing a lot from advisors about is cash flow investing.

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That is looking at the cash flows of companies and looking at those companies that have an excess of free cash flow, whether or not that's turning into dividends or not. This is a metric that's been used as a proxy for value, if you will, for quite some time, and frankly, it's really worked for investors over the last 2, 3, 5 years. The big player in the space is COWZ from Pacer, that's the ticker C-O-W-Z for Cash Cow if you like that.

It's about a $12 billion fund. It owns 100 securities out of the Russell 1000 top 1,000 securities in the US focused on those with the highest free cash flow. Over the last 3 years, it's up 90% versus the S&P being up about 50% and over the last 2, 3, 5 years, it's beaten both the S&P and traditional value plays. So it's been a really interesting way to be in the market, but not be in there with 23 PE and no dividends coming out the other side.

- Yeah. One of the-- one of the themes I've heard over the last two years, which seems to have worked in a lot of different markets is quality of the balance sheet. And I think that kind speaks to it. OK, we were talking about stocks there, what about bonds? Anything interesting happening in bonds that you like, any opportunities?

- Yeah. So the flip side of that barbell, if you will, of trying to be a little bit safe with your equity is trying to manage your duration correctly. Particularly on a day like today where, you know, most of us think we're heading into another rate hike, you don't want to be long, in the 20 on a day that the rate hikes' coming in. Everybody understands that about duration.

When we pull advisors, we find that 50% of them are holding a duration shorter than the average benchmark, the Bloomberg aggregate, and about only 17% are holding longer than that duration. So how do you tweak that if you've got an active bond manager that you really like and you're just trying to get shorter on duration? One thing that we've seen is a rise of these very targeted Treasury products, I'll highlight the ones from BondBloxx, where you can get individual tickers that get you duration of 6 months, 1 year, all the way out to the 20-year.

And so if you're looking to bring yourself in a little bit there, you can just go ahead and grab a little bit of extra exposure in something like XHLF, which is their six month duration Treasury fund and just adding a little bit of that can help you bring that duration down, lower your exposure to a day like today when we're going to get a rate hike.

- All right. You're an investor, you're watching Yahoo Finance at 2:00 PM. You get the big decision. Then you sit through all of Powell's testimony later today. Is it going to mean anything in terms of the overall strategies we're talking about right now, or is this just kind of a perfunctory check mark box to get on to the next meeting perhaps?

- I think it's mostly a perfunctory check mark. I suppose there could be something in the speech in the commentary that really is a surprise, but frankly, I mean, nobody ever really expects surprises. But I think this is pretty well understood. We are rolling off the top of the hike cycle whether it's now, whether it's the next one. I don't think anybody thinks we're headed towards 8%, right? I mean, we are definitely towards the end of the cycle. It's just a balancing act between the economy, inflation, and rates. And whether or not we can just get that Goldilocks soft landing, I'm a little bit skeptical, but I think there's probably a higher likelihood than not.

- Let me ask you, we're talking about in broad strokes here the equity and bond markets. Anything else catching your eye recently? I just noted WTI crude, for instance, jumped above its 200-day moving average, commodities have been perking up. Anything in that arena?

- Well, interestingly, you're right. The performance of some commodities and real assets have perked up, but there have been no flows whatsoever. Advisors and investors have really just been eschewing the entire space after really running into commodities last year when nothing else was working for folks. So it hasn't been a big push back. However, I would point out a lot of folks are looking at energy as a potential winner here over the next year or two, whether that's raw energy in the form of something like WTI, or looking at things like midstream, looking at Pipeline companies, looking at those places where a strong economy is going to keep that oil moving.

- And then we got time for one more here. On the international front, while China slowed down, much talked about this year, really not rebounding as quickly. Anything in that arena, or with any respect to anything you see around the world that's interesting?

- Well, we've seen a lot of interest in Japan. And now interestingly, this time around, while there has been money flowing into Japan and that money's been well rewarded, folks haven't been hedging out the currency risk there, which is probably a mistake. The big fund there is DXG from WisdomTree, which is a hedged-- a currency hedged version of getting Japan exposure. I think that's a really interesting play. The other thing I hear from a lot of strategists is to keep your eye on Europe. So I think that looking at those hedged Europe exposures, again, another really interesting way to play it.

- Yeah, really interesting to track these fund flows across the world. Thank you, Dave Nadig, VettaFi Financial Futurist.