Eric Balchunas – The Past, Present & Future of ETFs - [Invest Like the Best, EP.93]

My guest this week is Eric Balchunas, the senior ETF analyst for Bloomberg and the author of the Institutional ETF toolbox. This episode is intended for those in the asset or wealth management industry who have considered using ETFs in their portfolios, or for the individual investor who likes to stay up to date on trends in the market for asset management products. We cover all aspects of ETFs in some detail, and luckily in ways that have little overlap with a few other recent ETF-centric episodes on two of my favorite podcasts: the Meb Faber Show and Capital Allocators with Ted Seides with Matt Hougan and Tom Lydon respectively. We open with Eric’s favorite ETF tickers, discuss the pros and cons of ETFs versus other investment vehicles, and explore the largest areas of opportunities for new ETFs coming to market in the years to come. ETFs have become the vehicle of choice for many investors, so it was about time we covered them in depth in this forum. As you’ll hear, Eric is the right person to teach the world about ETFs, thanks to deep domain knowledge and unflagging enthusiasm. Please enjoy my conversation with Eric Balchunas on the past, present, and future of ETFs. For more episodes go to InvestorFieldGuide.com/podcast. Sign up for the book club, where you’ll get a full investor curriculum and then 3-4 suggestions every month at InvestorFieldGuide.com/bookclub. Follow Patrick on Twitter at @patrick_oshag Books Referenced Quantitative Momentum: A Practitioner's Guide to Building a Momentum-Based Stock Selection System Links Referenced Chart – There Are Now More Indexes Than Stocks Show Notes 2:32 - (First Question) – Eric’s favorite ETF tickers 4:07 – How Eric got started into his career and how it led him into the ETF world 8:04 – An overview of the ETF landscape 10:10 – Active managed ETFs 12:17 – Chart – There Are Now More Indexes Than Stocks 13:32 – Key variables he thinks about when assessing a new ETF 15:18 – Evaluating shiny object ETFs 17:30 – The appeal of ETFs 20:18 – Future regulatory concern of the tax treatments of ETFs 22:10 – The liquidity advantage of ETFs and why that can actually be bad for investors 24:19 – What would Eric do to build the perfect ETF 26:03 – What are the future trends for new ETF’s launched 29:40 – Categories that work well in the ALT world of ETFs 31:32 – Most effective marketing strategy for ETFs 35:50 – Quantitative Momentum: A Practitioner's Guide to Building a Momentum-Based Stock Selection System 36:28 – How will the winning asset managers have done differently in this space 41:56 – How the next downturn could impact ETFs 46:17 – Do ETF’s create pricing distortions 50:33 – What trend is Eric most interested in right now 53:21 – Alpha through Beta 55:51 – Kindest thing anyone has done for Eric Learn More For more episodes go to InvestorFieldGuide.com/podcast. Sign up for the book club, where you’ll get a full investor curriculum and then 3-4 suggestions every month at InvestorFieldGuide.com/bookclub Follow Patrick on twitter at @patrick_oshag

Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.

• 0:00Patrick O'Shaughnessy?

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• 0:32Patrick O'Shaughnessy?

  This podcast is sponsored by CFA Institute, the global association of investment professionals whose mission is to lead the investment profession by promoting the highest standards of ethics, education and professional excellence for the ultimate benefit of society. CFA Institute serves a global community of investment professionals, working to build an investment industry where investors' interests come first, financial markets function at their best and economies grow. The Chartered Financial Analyst credential is the most respected and recognized investment management designation in the world. The views expressed in this podcast do not necessarily represent the views of CFA Institute. Hello and welcome everyone. I'm Patrick O'Neal and this is Invest Like the Best.

• 1:15Patrick O'Shaughnessy?

  This show is an open-ended exploration of markets, ideas, methods, stories and of strategies that will help you better invest both your time and your money. You can learn more and stay up to date at investorfieldguide.com.

• 1:31Speaker 02

  Patrick O'Neal is the CEO of O'Neal Asset Management. All opinions expressed by Patrick and podcast guests are solely their own opinions and do not reflect the opinion of O'Neal Asset Management. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of O'Neal Asset Management may maintain positions in the securities discussed in this podcast.

• 1:56Patrick O'Shaughnessy?

  My guest this week is Eric Balchunas, the Senior ETF Analyst for Bloomberg Intelligence and the author of the book, The Institutional ETF Toolbox. This episode is intended for those in the asset management or wealth management industries who have considered using ETFs in their portfolios, or for the individual investor who likes to stay up to date on trends in the markets for asset management products. We cover all aspects of ETFs in some detail, and luckily, in ways that have little overlap with a few other recent ETF-centric episodes on two of my favorite podcasts, The Meb Faber Show and Capital Allocators with Ted Seides. Those conversations were with Matt Haugen and Tom Lydon, respectively. We open with Eric's favorite ETF tickers, discuss the pros and cons of ETFs versus

• 2:38Patrick O'Shaughnessy?

  other investment vehicles, and explore the largest areas of opportunities for new ETFs coming to market in the years to come. ETFs have become the vehicle of choice for many investors, so it's about time we covered them in depth in this forum. As you'll hear, Eric is the right person to teach the world about ETFs, thanks to deep domain knowledge and unflagging enthusiasm. Please enjoy my conversation with Eric Balchunas on the past, present, and future of ETFs. Fun question, which is for your favorite couple of ETF tickers, which I think is back to single ticker marketing. This is an important thing to pick.

• 3:14Speaker 03

  Yeah, absolutely. Tickers matter. I mean, Tan and KWT were launched the same week, same midsize issuers. Tan got all the assets. Block and BLCN were launched the same week. Block has the majority of that. People call it a ticker premium. So, to me, the greatest, the Mona Lisa of ETF tickers, I know, I'm deep in this stuff, is Moo. Moo, to me, is the standard. Every analyst would agree. It's just a little above everything else. It's got it all. It's agribusiness. You know, who doesn't love cows? And the key is it's a verb. And then that's also a cynic dope, which I hope I pronounce that word right, which is a word that represents a bigger issue, like the badge, meaning the police force.

• 3:55Patrick O'Shaughnessy?

  Interesting.

• 3:56Speaker 03

  Right? Like, some small thing about this represents the whole entity. And Moo is that. And so, it works on so many levels. It's friendly, it's inviting, and you kind of know what it is. Now, Tan is also arguably a verb. That one's up there. And there's a couple that, you know, Hack is also a verb. That one was a killer one. And then Meb Faber, who I know you know.

• 4:17Patrick O'Shaughnessy?

  He's the king of this idea.

• 4:18Speaker 03

  If anything's going to unseat MJ, which is the Marijuana ETF, which has a huge head start on the rest, it's Tok. Toke rules. It is a verb and it's a good verb.

• 4:28Speaker 04

  Meb's the Leonardo of ETF tickers.

• 4:31Speaker 03

  That's right. That's right. Yeah. A little Picasso action there. Yeah, no, I think that will be really helpful in that space in particular, but those are two that are a couple that come to mind.

• 4:39Speaker 04

  Fantastic. So Eric, maybe you could begin just by giving a brief bit of background of how you got started in your career and how that led into ETFs because you're sort of the most, one of the most prolific writers on all things ETFs, something we've never explored on the podcast before. So I'm excited to do it with you. A bit of framing and background would be great.

• 4:55Speaker 03

  Sure. So I didn't seek them out. Obviously I was in college in the 90s at Rutgers and I was a journalism major, but I was on Cook College and you couldn't, you know, just graduate with that because it was a science school. So I minored in environmental economics and economics really caught my attention in college. So Bloomberg was a kind of a natural place to want to go, but I didn't get accepted when I first applied to Bloomberg. So I worked at Institutional Investor Newsletter Division. And what I got assigned to was covering funds. This is a newsletter called Fund Action. That's how I got my first introduction into the mutual fund. Back then we were covering a lot of fidelity, T-Roe Price. That's who ruled the landscape then. Vanguard was real small, ETFs just starting. But I was a little annoyed at PR people who seemed to be behind the keyhole. I was getting fed press releases and I was like, I gotta go on the other side.

• 5:41Speaker 03

  So I went to the dark side, as they say in journalism, and became a crisis communication and PR person for a firm called Abernathy McGregor and learned a lot about, I worked with different managers like Bank of New York and one of our clients, I listened to one of your podcasts recently where they mentioned long-term capital management. That was one of our clients. And lucky for me, I could work the video camera. So I actually got to be in the room when they media trained John Meriwether and it was, it was fascinating. These guys were different. They rolled in with sweater vests. That was unusual at the time. And yeah, it was a very intense thing. I always tell new people or younger people that if you can just learn the technology, you'll probably get into bigger and better meetings because the old guys can't use it as well. And that got me into a lot of cool meetings back then. But anyway, I digress.

• 6:27Speaker 04

  Any favorite lessons from being inside of crisis management? That seems like a really interesting world.

• 6:33Speaker 03

  Yeah, I think the big one, if you're really in trouble, or if you have a job interview, we'll call those two high-pressure communication situations. One thing I saw them do, which I thought was great, was this triangle method where you draw a triangle and in the middle you put your main message, like, I'm good for this job. And then on each side of the triangle, you put. One of the attributes that would lead to that, and then each attribute has a couple sub-points. That way, in your mind, you have a visual, and you don't end up far away from that. And everything you say on the outside, you end with the, "And that's why I'm good for this position," or "That's why we didn't do anything wrong." Right. So, that is high, top-shelf PR secret dispelled right here. Right. So, I gave it to friends in the late 90s on interviews, and they said it worked really well. So, and I've used it myself.

• 7:17Speaker 03

  Anyway, ultimately, I got a job at Bloomberg in PR in 2000, and that was an amazing job. It was just before Mike went to become mayor, and I was on the PR team, and I got to work with all the different parts of the company. But after 9/11, I had a near miss, and I moved back home in South Jersey. And during that time, I transferred from the New York office to the Princeton office. And all they do in Princeton is data. So, for the next 16 years, I spent working with fund data, reading prospectuses, putting in data, you know, answering A-desks from clients. Like, I'll tell you, there was no more humbling move from going from PR in New York to data and data entry. It was rough for a couple of years, but I hung in there, and in 2006, I got handed ETFs as a data assignment.

• 8:01Speaker 03

  And having learned mutual funds and that structure, and I knew hedge funds, I knew closed-end funds, the structure, to me, seemed like many evolutionary steps forward. I met a few of these sort of evangelists at the time, and kicked the tires on them. And I found myself thinking, you know what? This is a major opportunity. And so, I spent the next 10 years not just doing data, but reading every book possible on all the underlying asset classes, and catching up for some lost academic time, and just becoming the ETF guy within Bloomberg. And then, 2013, 2014 is when the rest of the world kind of like got interested, and I was ready and waiting.

• 8:35Speaker 04

  Maybe you could build a map for us of the ETF landscape itself. So, everyone's familiar with the broad trend, which is an insane amount of money coming into ETFs from actively managed mutual funds, although those have continued to do very well from an economic standpoint for their managers. But a huge, huge wave of money that doesn't seem to be slowing anytime soon is coming into ETFs. So, maybe describe what that landscape looks like. Like, what kinds of buckets? How would you build? Like a taxonomy system around what currently exists and then we'll obviously talk about what might be happening in the future.

• 9:05Speaker 03

  Sure. So obviously the standard way I should say to look at it is by asset classes. And US equities rule. I mean, that's the big one. International's next and then fixed incomes growing about 20%. Smart beta is about 18%. Alts are like less than 1%. So it kind of makes sense, but I don't bucket it that way a lot. I bucket it into dirt cheap and shiny objects. To me, those are the two. 99% of flows go to one of those two things. Cause if you look, I mean, literally, we always track expense ratio buckets and flows. And if you look, whether it's volatile or the market's up or the market's down, it seems to be about 90% of flows go to products that charge 20 basis points or less. And almost all that is Vanguard and BlackRock. So there's this sort of duopoly forming within the ETF space.

• 9:48Speaker 03

  The rest of the money goes to like highly exotic stuff like leveraged ETFs. Or someone who just hit a home run, like a theme, like the robotics ETF went from oblivion to the upper class in like six months because it returned 60%. Kathy Wood of ARC did the near impossible by, again, she's just crushing the market. If you can just sort of look like this incredible shiny object, you just will get some assets. What happens with that money, by the way, the good news for the issuers is that when it inevitably crashes down, only half the money leaves. I'm convinced people forget they bought it because it was done on performance chasing. Or they really just bought into the story. Either way, as long as you get one of those moments where you're just going through the sky like a shooting star.

• 10:31Speaker 03

  You can attract assets, it seems, no matter what your fee is. Most everything else seems to be just drifting south. I call it the great cost migration. And so to me, that's generally the landscape that we're living in.

• 10:43Speaker 04

  Obviously that's driven by, we'll call it pure passive, meaning cap weighted indexes of some type. And that would even count something like an XLE that's just buying energy stocks, but it's not doing anything special with those names. I don't want to spend a ton of time talking about cap weighted indexes just because frankly, they're boring. So I'm curious to hear your take on the non-cap weighted, which I acknowledge is probably most of the flows and most of the assets. To talk about that part of the universe a little bit. From my seat, what I've seen is very. Very few actually active strategies try to use the ETF wrapper. So maybe you could begin by talking about why you think that's the case. Why haven't there been more successful, you know, higher cost, higher active share, higher tracking error type strategies in this format?

• 11:26Speaker 04

  And maybe talk about some of the benefits of why active managers might want to start to consider it, things like taxes, for example.

• 11:31Speaker 03

  So when you think about smart beta, which is that general term for anything non-market cap weighted, it's a broad area. Half of the launches are smart beta. So even though a lot of the assets are going to this sort of low market cap, a lot of the new launches are smart beta because what you're seeing is this repackaging of your active secret sauce into an index. So a lot of smart beta, leaving aside discretionary active for a second, smart beta is active. So a lot of, you see Goldman has done it, Fidelity, JP Morgan, all of these big heavy hitters, the insurance companies.

• 12:04Speaker 04

  Everybody.

• 12:05Speaker 03

  Everybody. They're just taking their secret sauce, most of them are self-indexing, and designing an index is the new active in a way. And ultimately, they're able to lower the fee, tax efficiency is a little better. And that's why my friend Michael Venuto will say, and I agree with him, the active-passive debate is, it's way more nuanced than that. And I think that's a sledgehammer way to put the trend. I think it's more really about fees and structure, which is what you see. Because what is really passive, anyway? Anything outside of market cap weighting the whole entire market to academics would be active. And there's a lot of things that take little active bets that are even market cap weighted. So all you really are seeing is this sort of conversion of these active strategies into indexes. And there's a chart that got a lot of play that I put out once, and I don't know, everybody

• 12:50Speaker 03

  flipped out, which shows the number of indexes has now eclipsed the number of stocks. And it's just shooting up, it looks like a hockey stick. Now, nobody will point out that there's actually more mutual funds than the number of indexes on that chart. Nobody really cares about that, there's 7,000 mutual funds. But, long story short, I think that scared people. It was like, whoa, how can you make more indexes than stocks? A, that speaks to the fact that the number of stocks have been flat for a while. B, a lot of those indexes are smart beta. A lot of them are going to just live in oblivion. Most of the big indexes that you see all the money going to have been around for a long time. But over the course of the next 20 years, this is what is going to happen. The other option is to go pure active. Now, there is about 125 actively managed ETFs. They make up about 1% of the total assets.

• 13:35Speaker 03

  Because I think smart beta sucked up a lot of oxygen that discretionary active was hoping to get. So if you consider smart beta active, then you're looking at 20% of all ETF assets are active. So to me, that's a good thing for active thinking about getting in is that I think you could be deterred by thinking, well, man, only 1% is in active ETFs. But honestly, most of smart beta is active just repackaged into an index. So 20% is pretty good. That's a lot of assets. That's about 700 billion in assets.

• 14:03Speaker 04

  It's a big market.

• 14:04Speaker 03

  Yeah.

• 14:04Speaker 04

  Since you've looked at so many of these and spent so much time in the data and have educated yourself on all aspects of ETFs, when you're approaching a new one for the first time, just with a blank slate, what are the key variables that you're ticking through to sort of start to build, let's say, a quality assessment or your assessment of that strategy in that ETF?

• 14:24Speaker 03

  If it's smart beta, first thing I look at is what's the original exposure, how much active shares we say we get. That's where the blockchain ETFs got dinged a little bit rightly because there are a lot of, just basically like XLK, at least half of it is built just like XLK. So how much is that really worth paying the 70 basis points when you're getting a lot of the same return stream as XLK? I look at correlations, I also look at standard deviation, how jumpy is this thing going to be? What's the index weighting methodology? I have this thing called legal performance enhancing drug, which is equal weighting. A lot of theme ETFs will come out in equal weight, and that to me is a legal version of a PED because it just jacks up your volatility and ultimately, at some point, you're going to outperform when the size factor is in play. But the media and everybody else is just going to go, wow, that theme's working. And so you see a lot of that. And

• 15:07Speaker 03

  I try to point that out. I'm not saying, they'll argue that, well, we have to be equal because this theme isn't big enough to just track these large caps. But still, there's little things like that that you've got to watch out for because as an investor looking for exposure, it's fine if the active share is low or you own a lot of the same stocks. But you should know that. Maybe that's a better way to... Take out your core exposure and replace it with that. But on the flip side, if you're looking for something that maybe will have a bigger alpha generation possibility, then you're probably going to have to look for something that's a little jumpier. And that, to me, is really a classic way to evaluate smart beta. On the beta side, I think a lot of it just comes down to fee because all the new beta products coming out, the only thing they're really doing is just trying to undercut or vanguard the next person.

• 15:50Speaker 04

  So what about the shiny object category? So a great term for what is a colorful collection of ideas?

• 15:56Speaker 03

  It's my new term for performance chasing. It's alive and well, but it's not, it used to be you could performance chase with like 3% or 4% outperformance, but now it's got to be 30% or 40% outperformance. It's got to really like, it's just got to be like something you cannot possibly ignore.

• 16:10Speaker 04

  So when you're looking at one of these new things, I don't want to presume that you hate every one of them. Is there ever a scenario where a shiny object or something that's doing something? Because typically to get 30% outperformance, you need to be doing something very unique. You mentioned ARK, I'm going to have Kathy Wood on the podcast in probably a couple of weeks or maybe a month. And I think that's a fascinating story, right? Super focused on a very specific theme and trend and a deep dedication to it. So do you ever come across one of these that you think is high quality and interesting for investors?

• 16:37Speaker 03

  Well, let's go with ARK. And ARK gets a lot of pushback because people just assume it's going to crash and burn someday because it's really heavy FAANG. At one point she had GBTC, which is the Bitcoin ETN in there. That really juiced up the performance. But at the end of the day, if you're using this on the outskirts of a portfolio, well, great, that's what you want. You want someone swinging for the fences. What Kathy recognized, and I think was something you saw I share, she just recently copied, was she recognized that companies like Amazon and Tesla and Google, it's really difficult to peg which sector they're actually in. And so FAANG stocks aren't in one sector. And she just said, you know, let's just bust through and just pick out innovation. Doesn't matter what sector it's in. That was a really good idea. Ultimately, though, it got her heavy into FAANG and obviously some of these other stocks

• 17:22Speaker 03

  that are high flyers. Biotech is big weighting in her portfolio. And that really worked out for her. So it's some, her active share, if you want to talk about that, I believe last time I checked was about 95%. Even though you recognize a lot of the names, she's just beefing up on them. And taking some other bets. So to me, that's a legitimate act of fun. It charges, I think, 75 basis points. No one cares. Like I said, she did the impossible, which is to grow organic assets by about 100% last year. But when you go up 70%, like I said, you're hard to ignore. Now, people will say, well, she's going to come back down. But again, you can't have everything. If you take on a lot of risk, that works both ways, but it also works going up.

• 18:02Speaker 04

  Sure. Can you talk a little bit about the features, again, thinking about it from the lens of an active manager, of why ETFs are interesting, and maybe specifically taxes? So this is something that you see a lot about. I think it's fairly complicated. It would be great with you to kind of deconstruct why taxes are something that's relevant when thinking about ETFs from an investor's perspective.

• 18:22Speaker 03

  Yeah, and not to get boring, but the reason ETFs are taxed.

• 18:26Speaker 04

  We get boring.

• 18:27Speaker 03

  Well, when you talk about, when I say the words creation redemption, I'm telling you, people fall asleep. That phrase, there's something about it.

• 18:32Speaker 04

  How about we start with like, how about we start with like, the after-tax savings that people can generate over 10 years or something? That's not less boring.

• 18:40Speaker 03

  Sure. Well, I mean, ultimately, if you look at ETFs and their capital gains distributions, it's almost nothing. All ETFs over the entire time. If Morningstar did a great study of this, I mean, it's almost 0%. It rounds down. But I mean, occasionally that happens. If an ETF has a lot going for it, like currency hedged ETFs did back in the day, or frontier markets, where they just, they're going up, up, up, up, and there's no redemptions to sort of wash out some of those gains, you will have a distribution. Those are some of the rare cases. But normally, they're able to wash out the gains using the creation redemption process. Don't fall asleep. Because this is interesting. Because back in the day when they made the ETF, and they set up this creation redemption process, which is really just based on commodity warehouse receipts, applied to stocks and bonds.

• 19:23Speaker 04

  Can you explain what that is?

• 19:24Speaker 03

  Yeah, so Nate Most, and a lot of people, this crystallizes what the creation redemption process, to me, is the flux capacitor of ETFs. It's how ETFs work. Just like, that's how time travel. That's a metaphor I use in my book. I'm big into pop culture metaphors. They help get a point across, especially if the material's boring. But in this case, creation redemption was Nate Most saying, how can we protect the investors in the Fund from all the trading. That's the reason Bogle said no to the first ETF when he was approached. He didn't want any part of it. So what Nate most worked at the Pacific Commodities Exchange. And he thought, well, look, you can, you can store your soybean oil up there in the warehouse. And I can get a receipt for it and I can trade the receipts. And if I get a bunch of receipts, I can go take them to the warehouse and get the equivalent soybean.

• 20:08Speaker 03

  I can know they're there. All he did was apply that warehouse receipt concept to stocks and bonds.

• 20:14Speaker 04

  Where the trading is not taxable.

• 20:15Speaker 03

  Exactly. So you're basically what you're doing is you're

• 20:18Speaker 04

  Genius.

• 20:18Speaker 03

  You're exchanging shares of SPY, which is like a receipt for the 500 stocks that is in the basket. There is no taxable event there. That was a happy accident. They didn't mean for that to be a big deal. And that's probably one of the five biggest attributes to ETFs. For some people, that's major. That's how powerful the ETF is. That one feature alone is almost enough to move someone out of the other structure. Then you throw in the cost, the tradability, the transparency, and that's why the, like I said, that's why I found them to be like a five evolutionary steps at once.

• 20:51Speaker 04

  What do you think, if any, is the risk that this tax deferral, we'll call it, within the ETF structure, which allows, to be clear, right now, if it's a passively filed ETF, this is my understanding, so correct me if I'm wrong, allows you to effectively have turnover, like an active strategy would, without commensurate cap gains or gains of any kind, taxable gains of any kind, sort of in perpetuity. And when you do the math on that, Munger was always famous for this. If you can get your after-tax return up by a percent or two, and then you're a real investor for the long run, like you're talking enormous amounts of money that are effectively saved. The way I sometimes worry, I try to be skeptical and worried about that because tax revenue is being collected on gains in the multi-trillion dollar mutual fund industry.

• 21:35Speaker 04

  And usually if there's a pot of potentially taxable money, the government's pretty good at finding that pot. And this seems like such a pot. So what do you think are the regulatory concerns, if any, about the future tax treatment of ETFs?

• 21:46Speaker 03

  It's always possible. Occasionally on Twitter, someone fights back and says, this shouldn't be. Mutual funds shouldn't, should be tagged, they should be on level playing fields. It's very difficult to understand. What I just described, if you put it in like more academic terms, again, you'd fall asleep reading it. And I think for legislators, I'm not sure how they would even understand it and who would lobby them to do it. The ICI. Has ETFs too. So that's where it gets complicated. All these companies also have ETFs. So who would lobby at this point? One other point on this I would like to make is that you could also argue it the other way, that what you should lobby for is for mutual funds to have that taken away. Because you're already getting taxed when you sell the ETF. So I think that's fair. Should you also get capital gains because somebody else in the fund left?

• 22:29Speaker 03

  I think that's what really annoys people about mutual funds. And rightly so. That's not fair. Selling when you get out, I think, is more fair. And that's what you get on ETFs. It's not like ETFs are devoid of tax. They just want that extra fund level taxation where they just get taxed for doing nothing.

• 22:43Speaker 04

  So you mentioned, just let's just tick them off again, that there are five big evolutions. So it's transparency, price, I think I missed one. Transparency, fees, taxes, and where are the last two?

• 22:53Speaker 03

  Well, liquidity.

• 22:53Speaker 04

  Liquidity, sure. Tradeability.

• 22:55Speaker 03

  Liquidity is a double edged sword, though. The idea that you can get in and out whenever you want. I think this brings up one of my, I find a lot of attacks on ETFs to be like sour grapes. But the one that has resonance is John Bogle's attack, which is they tempt you to trade. And if you can avoid that temptation, because if you trade, all the cost savings are just going to go away, right? Behavior will crush everything. And that's what a lot of people are wondering about, what will happen in the next crisis? Will people behave better in mutual funds because maybe you can't get out till the end of the day? Or there's backend loads, whatever. I've heard that case, that behavior is better in mutual funds. In Germany, they did a study and they found that the ETF portion of the portfolio did worse than the mutual fund portion because people traded it more.

• 23:38Speaker 03

  So I think this is probably the most valid concern. But at the same time, this is what people like about ETFs, especially on the institutional side. And that's what makes that low beta, those flows, interesting. Some of those flows going to cheap beta are people, institutions using them like futures contracts. They're in a whole different dimension than the retail investor or the advisor. So you have all these different people playing in the same sandbox. We just looked at Bridgewater is a huge owner of IMG. And so are a ton of advisors. So, you know, and you could argue like-

• 24:08Speaker 04

  What's IMG?

• 24:09Speaker 03

  IMG is the iShares Emerging Markets ETFs. They also own VWO and EEM. But the fact that the world's largest hedge fund is in a product like this, and if you look at the holders of SPY- That's a who's who of institutions. Everyone uses it endowment. So that is also, I think, an interesting attribute to the liquidity. The intraday liquidity is major for the institutional side, and that's really why the ETF was launched back in 93. They just wanted to get more trading on the exchange. This was Amex in third place behind Nasdaq and NYSE, and they just wanted volume, and they got it. But then Barclays, and ultimately what became iShare, saw it as a retail investor's product, and that's what sort of now you have asset gathering in addition to volume generating.

• 24:52Speaker 04

  So if you had to design the perfect ETF, kind of thinking about these dimensions that we've talked about, and given the however many thousands of these things that you've looked at, how would you start to build that? If it was your job tomorrow to go build the ETF that you wanted to put your own money in, and let's just say, let's say it was equities to keep it simple, how would you go about thinking about that process?

• 25:09Speaker 03

  I don't want to bore you. I know, and I heard one of your podcasts, you were like, "How can we defeat Vanguard?" And I think that's the right strategy.

• 25:15Speaker 04

  I love Vanguard.

• 25:16Speaker 03

  Active managers should get fired up and take some fight. But I will say, there is a perfect ETF. There's a couple of them. The broad market ETFs on the equity side, to me, are pretty perfect. And I don't mean to highlight Vanguard. Some people will accuse me of being like a Vanguard cheerleader. I'm only calling it like I see it. But VTI, to me, is a perfect ETF, and I'll explain why. It tracks the entire stock market, so you get 99% of the market cap. It's highly liquid now, so there's no bid/ask spread is a penny wide, but it's really 0.01%. It couldn't be any cheaper to trade. And then in addition, the four basis points that it charges are cheap enough, but, and we just looked at this this week, the passive management, because there's some small caps in there, Vanguard's able to lend those out to hedge funds.

• 26:00Speaker 04

  Get a couple of basis points.

• 26:01Speaker 03

  Yeah, they get two basis points from that, and they get another two just from their massive trading desk, able to pick up a few bips. So the tracking difference on that, over time, has been zero. So in a way, that, to me, is the perfect ETF. You literally are getting exposure to the entire enchilada for nothing. I'm not sure, you know, and you said, you asked me about my own money, I'd probably leave it in that for long term. But, you know, my wife and I, especially my wife, she likes to take some chances, so we'll go into some more, you know, I don't know.

• 26:27Speaker 04

  Shoddy objects.

• 26:28Speaker 03

  Yeah, we shoddy object. Our other account, but if you're asking for like a buy and hold type ETF, I think you can't probably do better than VTI.

• 26:35Speaker 04

  What do you think is missing in the lineup today? So obviously, we're not done launching ETFs. You mentioned a huge number of these are what we call smart beta ETFs, which is just another way of saying, you know, rules-based indexes that don't cap weight. So what do you think is missing in the lineup? Or said differently, what do you expect that the big emerging trends are going to be in terms of new launches in the coming couple of years?

• 26:57Speaker 03

  One area I think has massive potential is alts. This is hedge fund strategies made into ETFs. It hasn't taken off lately, probably two reasons. It hasn't really had a good environment for it. But every time the market goes down, you see that ETFs that have a little short position tend to go to the top of the list. They start to become the shiny object, even though they're only up 2%, it's better than down 10. So I think alts, when they have their day, it's going to be interesting. And Goldman and JP Morgan are building little mini armies of hedge fund type ETFs. Goldman's going to do it through replicating using other ETFs like synthetically. And JP Morgan literally is a hedge fund in an ETF wrapper. AQR to me is fascinating, and I wrote a blog on this.

• 27:39Speaker 03

  If AQR converts like their market neutral mutual fund, which is amazing, and gives that star power, that could really, that could really make that category pop. Vanguard also has a market neutral fund. Vanguard, I think that's going to be their next filing, is that market neutral. And if Vanguard vanguards the alt space, or if Goldman vanguards it because they've been known to come in cheap. If you have cheap hedge fund type alts in a good environment, that could blow up. That's one just sitting and waiting for a couple of catalysts. Now, we talk about Bitcoin. I know you love Bitcoin.

• 28:12Speaker 04

  Yeah, let's talk about crypto.

• 28:13Speaker 03

  I'm very bullish on a Bitcoin ETF. I wish there was one today. I just think the ETF structure gives investors the best possible chance. Now, would it trade at a premium because arbitrage would be a little messy? Probably, but I can tell you'd be way better than GBTC, which trades at 50 to 100%. I've talked to market makers who think it would maybe be 1 or 2%. That's not bad. I mean, that's the cost of access. And if you want to go get Bitcoin your own, great. But I think for some people, that's actually worth it. And I think when you bring in market makers that are in the US and have deep liquidity and just, they're used to making markets in like China, A-share ETFs and gold, they just know what they're doing. That will just sort of help take care of itself in terms of which exchanges to use,

• 28:55Speaker 03

  how to store it. I just think it's almost a launch and learn type situation. If you wait until Bitcoin's perfect before approving one, it might just be sort of pointless at that point because you can just get Bitcoin, or maybe nobody will care at that point, I don't know. But the way they're looking to wait on this, I'm okay with it sort of being launched. It's worked in Sweden to a degree. GBTC shows there's interest in it. If you can get a billion dollars and be like kind of broken and trading OTC, you imagine a Bitcoin ETF would be pretty big. And I also think if someone sees it's called a Bitcoin ETF, I worry a lot about small investors buying an ETF they don't understand because now ETF democratize everything and you could buy something like XIV and go, whoa, I had no idea. Bitcoin to me, even though it would be sort of rated R in my

• 29:39Speaker 03

  traffic light system, which would be a red light, I think it's called Bitcoin. People understand it's Bitcoin. There's other products to me that are more like a wolf in sheep's clothing, like the United States Oil Fund. That sounds really innocent, but you're going to get hit with about 30% roll costs a year. Jesus. Oh, it's brutal. But it sounds so innocent. When oil was down a couple of years ago, I had friends from college texting me saying, I just bought USO. I'm like, they don't know what roll cost is. They don't know what, they've never heard of the word contango. At least Bitcoin sort of comes across as like, hey, it's Bitcoin. I mean, most people know that it's this sort of different environment and they shouldn't expect the S and P 500 in terms of the degree of risk.

• 30:13Speaker 04

  Let's go back to alts. I'm curious if you could parse that category a little bit more. So you mentioned equity market neutral. That's a fairly straightforward one. Are there other big categories that you think lend themselves well in the alts world to an ETF structure?

• 30:25Speaker 03

  Well, the one that sells the best now is a multi-strategy ETF from QAI, Index IQ. That one probably works pretty well because the prob, this is where we come back to how much beta to put in your sort of smart beta ETF.

• 30:37Speaker 04

  Sure.

• 30:38Speaker 03

  Because that one has this correlation of 75% to the S and P. To me, that's not really an alt, but a lot of advisors like it because it has, it tracks better. It's not going to raise questions and it does have a low volatility. If you look at more true alts, I think they're going to really shine if the market sells off. So they're already there. There's long, short, there's event-driven, there's a couple market-neutral. I think it's not the products aren't there, it's having either the low fee or the big name-brand to come in and deliver that strategy and show, hey, look, you can actually get a hedge fund now in a better, tax-efficient structure that is lower fee than a hedge fund. I think the idea of a hedge fund, though, part of the selling point is it's exclusive.

• 31:22Speaker 03

  And you would definitely lose that. That's why I always say there's always going to be room for asset managers and hedge funds to make a living because a lot of institutions may want the fact that it's exclusive. It's like the private pool. An ETF is like the public pool down the street, and there's just always going to be big investors who just do not want that. But I think for advisors in retail, especially, I think, liquid alternative mutual funds, last time I checked, don't quote me on this, have about 200 billion. Alt ETFs, which are cheaper and more tax-efficient, have 2 billion? So just digging into the mutual fund assets alone, let alone trying to pull some of these actual hedge fund clients down, is big. And JP Morgan is now, you know, they're out, they literally said, "We want to democratize hedge funds." And if it's JP Morgan saying it, over time, I think that's going to matter.

• 32:05Speaker 04

  What's the most effective marketing strategy that you've ever seen for an ETF?

• 32:08Speaker 03

  Oh, easy, DXJ. DXJ, okay, this is the Japan currency hedge ETF from Wisdom Tree. This wrote the book. They should teach this in MBA courses on marketing. So this is the first time I've seen what's called single ticker marketing. As soon as Abe got elected, and DXJ, which is currency hedge, it basically neutralizes the yen, goes long Japan stocks, that thing just starts taking off, because Abe is like killing the yen. And it's just starting to crush EWJ. Now, a lot of flows went into EWJ. But Wisdom Tree came out, and they just put it in this nice, easy-to-explain thing. Take the yen out of Japan. DXJ. It was the first time I'd seen someone effectively do single ticker marketing. When the stars aligned for that strategy, they went all out. It was on TV.

• 32:52Speaker 03

  Jeremy Schwartz was on panels. They were writing white papers. Everyone involved got on. It was like, because they're like a speedboat and not an aircraft carrier, they didn't have to go through, they just got out quickly and they got out everywhere and they went on one ticker and they owned that space. And what's funny is Deutsche Bank had a product that did the same thing. They got no assets. Cause once you get, let's say $50 million a day in volume, it's very difficult for anyone to stop that snowball rolling downhill. So they knew early on, as long as we get the volume and we got the shiny object moment, now let's just go all in, get the volume and become the one people use. And then, then there's no looking back. Then, then the fish jump in the boat and they got a home run. And that was the last time I can remember when a non-black rock Vanguard ETF led flows for a year. And it was unbelievable.

• 33:35Speaker 04

  So one of my big concerns with ETFs is the one you already mentioned, which is they're just, they're too easy to trade. They're too accessible. And part of the reason that, that a lot of people have done so well in private vehicles is because they can't rip it up and screw it up. And so I'd love to ask the same question a second time, but for marketing around what is not meant to be a trade, but, but an investment, let's say, something to be held for the very long term. And maybe it's VTI, maybe it's Vanguard. So what, what would be an investor-led marketing story that you think has been well done? Or a firm that's supported their product in a high integrity way?

• 34:09Speaker 03

  I hate to go back to Vanguard, but every time there's a sell-off, I'm telling you, man, these flows do not budge. They have their investors trained like Navy SEALs in terms of discipline. In 2008, Vanguard took in money every month. Think about that.

• 34:24Speaker 04

  Yeah.

• 34:25Speaker 03

  Even in October, the market was down 17%. So whatever they're doing is working and whatever they're doing is almost impossible because the whole media apparatus is designed to keep the ball in the air and chase the shiny object around the soccer. It feels like kids playing soccer. And so it really inspires people to do this. So I have this sort of premise I'm working on, and it's actually a future book idea that I'm thinking about, which is The Art of Doing Nothing. And that, to me, is the next, I guess, phase in the investor enlightenment period we're in. Okay, fine, you get low costs, you know, structure matters. Okay, we all figure that out now. What's the next thing? Because if you can't control yourself behavior-wise, all of that is sort of meaningless.

• 35:09Speaker 03

  You might as well be stuck in your mutual fund then. So I think the next phase is to explain to investors how not to ruin it for themselves. And that's hard. And what's interesting to me, and I wrote a column on this, it's not ETFs that need testing. A lot of people think, oh, ETFs need to be... They haven't been tested. That's horse crap. They lived through a lot, believe me. It's investors, and ETF investors, that need the testing. And they did okay in this first quarter. It was volatile. A lot of the hot-money ETFs that are used as futures definitely saw flows. If anything, institutions really behaved badly. But the allocators were pretty good. The ones who use like the iShares Core products and the Vanguard Core, which are used by allocators and advisors, they held up pretty well. Now, can they take a 2008 and hang in there? It's yet to be seen.

• 35:52Speaker 03

  If, you know, you're on Twitter a lot, you can see it on Twitter, which is the thought leadership area of the financial world, I think, that people are talking about this. Behavior is becoming more and more of a discussion point. The problem is, talking about doing nothing, the idea that to do nothing and to hang in there, especially for factor investing, kind of goes against the whole entire media apparatus. So I'm not sure how this is going to play out, because the whole system is set up to keep people moving money around. And what you really should do is do nothing. And reading Wes Gray's book, who I know you know, and he calls it intestinal fortitude. That, to me, is a... or he calls it sustainable investing. You gotta get a term around this thing. Like, smart beta was a term from hell. The new one is machine learning. Dear lord, that is...

• 36:37Speaker 03

  Behavior needs a term like that, like sustainable investing is a pretty good one from Wes, or intestinal fortitude, or he has no pain, no gain. Something needs to catch on that gets people starting to think about behavior, in my opinion, from me watching these trends. And that's probably a bigger challenge for all asset managers, not just ones in ETFs, is to teach investors how to do nothing.

• 37:00Speaker 04

  Can we dive in on that idea a little bit more? We were talking before we hit record about your opinion on just how asset managers sort of communicate with their investors, with the broad audience, and how kind of stale it is. Maybe you could riff on what you think good asset managers are going to do in terms of their communication and their interaction with their audience that's different from the past, that the winners, like when we look back 10 years from now and we look at the winners that did something differently, what do you think that will be?

• 37:25Speaker 03

  Right, so I think fees and structure will matter, but so will relationships, engagement. I think you guys are good at this, the Ritholtz guys as advisors are good at this. No matter what you're into, I just think it's a different culture, and I think getting out there and showing your personality, being a human being, and that's what I think gives the small guys an advantage now. Because if you look at the big asset managers, and I always say this, sometimes I'll give a little kick to active, maybe more than sometimes, but I never hear any pushback, besides people who are anonymous, from an actual active mutual fund manager. And if I was an active mutual fund shop that was sort of seeing outflows, I would start to unleash my managers or best people to combat this narrative. The narratives get stuck and they're hard to break, and the assets can follow the narratives.

• 38:10Speaker 03

  It's real. So by being out there and engaging, I think you can sort of help shape the narrative, because you influence thought leaders in a Gladwellian sense, those connectors are like, oh, let me actually not just follow the narrative I read in five other articles, but I heard this guy talking about this, or this asset manager saying this. And I think it can actually move the needle. And I also think that letting people in the process is really interesting, so to keep them engaged in the process. That ultimately probably will help in the behavioral aspect, and it might give them a little more pause if they're thinking of pulling money out of this factor strategy or smart beta fund, because, oh, this one's cheaper. I think it's because, oh, I know them, I trust them, and that matters to me. And I think that is probably an advantage of the smaller investors out there.

• 38:53Speaker 03

  Whereas the big guys have distribution, which is really huge right now, but who knows where this will all end up, but I think engaging with your investors is huge and advisors are starting to do that really well, but asset managers, I think, have done it less well.

• 39:05Speaker 04

  So it's narrative building as a form of marketing over boots-on-the-ground sales, if I had to sum up what you just said.

• 39:12Speaker 03

  And it's also about soft selling. I mean, a lot of times, the big asset managers will try to control the message so much because they've tested it over like 45 lawyers, and it comes out just feeling like a pitch. The smaller asset managers are just trying to educate you, engage with you, entertain you a little bit, and in the process, you're like, hey, they seem smart. What's their strategy? As opposed to sort of leveling you with this on-message marketing spiel about why your strategy is so good, and never actually just being human and talking outside of that box. And I think that is major, because that's just, people are just, it's becoming more informal every day, and you can feel it. And I know as somebody who's in the media, and also somebody connected to this asset

• 39:55Speaker 03

  managers, especially on financial Twitter, it definitely influences me. I read up, and some of the people who I feel are smartest and best, I will ask to do different things. I reach out to them, I learn from them. They're giving me a free education in some cases, and I'm really appreciative of that. And ultimately, that is probably going to help them, if you think about it. Where I don't find a lot of that interaction, again, is from the big guys, who tend to just do it through like a PR agency, and it's coming in through this sort of controlled message, and for some reason, it just doesn't connect the same way that it does sort of more in the wild.

• 40:30Speaker 04

  What I've noticed is that in this era of kind of abundant messages and no cost to distribute messages on Twitter and other places, is that if you're not at like the tails of the distribution, no one cares. Like, no one pays any attention, because there's just so much of the same thing. So you've just got to kind of be yourself. And that's, works against like an institutional inertia and apparatus, back to the PR, your opening example of the PR triangle. Like, that's not moving anybody these days.

• 40:55Speaker 03

  Well, when I first went on Twitter at Bloomberg, I went, we actually have a social media department, that's how. That I always find that funny, but now I, well, when it first happened, I was like, really, but now I get it. It's important. And I went and I asked the lady here there who's running at the time, I'm thinking of setting up the handle at Bloomberg ETF. And she said, nah, you know what? Be yourself. People are going to respond to you, not a company better. And she said, you know what? Talk about things you like. Don't blow yourself up. You know, don't go crazy with politics. She gave me really good advice and I've stuck to it. And it's worked. And minus getting into some fights about sports here and there. I'm an Eagles fan and

• 41:31Speaker 04

  I was told to bring up LeBron James with you as the greatest basketball player of all time.

• 41:35Speaker 03

  Oh, come on. You don't want to go there. Look, he's great. He's just not the greatest of all time. All right. You're talking about a guy who grew up with Jordan, six and O, three and five. But anyway, let's move on before this gets ugly. No, it's, it's fun. Sports to me are a much more healthy way to interact in, in like a fun way. Or I live in Philly, I'll send out some stuff. I think 90% of those ETF, people are generally following me for ETF and fun information. But I think it's good to show yourself and show your personality through your ETF coverage. I try to be really colorful, sometimes probably too much, but I find that that's just me. I'm just letting myself out there. It won't please everybody. But by being more human, it helped. And when I saw my Twitter followers grow, the more I just let myself go a little bit and be myself. And I think that's really hard.

• 42:20Speaker 04

  I always love that line that Twitter is where brands go to become people and people go to become brands. Totally, totally true.

• 42:26Speaker 03

  That's pretty good. I like that.

• 42:27Speaker 04

  So there's two other big, common refrains that you hear around ETFs and I'd love to get your take on them. The first, actually you wrote about this recently, and I think the headline grabbed a lot of attention and then people didn't read the body. But this idea that in the next downturn, there could be an enormous, so we've obviously seen flows come out of active, but that there could be an extreme acceleration of that trend in a downturn. So maybe describe that, that idea and that argument.

• 42:51Speaker 03

  Well, there's a big difference between flows and assets. And I think a lot of, that's obvious to a lot of people, but it kind of, I had to wake up to this for a while. Flows are insignificant if assets are growing. And in the financial industry, obviously, if the market goes up, that will completely cover up your outflows and then some. So what's interesting is active mutual fund assets have grown more than ETFs in the past eight years. And you think ETFs are kicking their butt left and right, and they have on an organic growth basis. But because the market's been gangbusters, it doesn't matter.

• 43:24Speaker 04

  And try adjusting that for revenues, too.

• 43:26Speaker 03

  Oh, my God.

• 43:26Speaker 04

  The mutual fund industry's killed the ETF industry.

• 43:28Speaker 03

  Oh, my God. Last I checked, I think if you all in, it's like 70 billion. Then you throw in the trading revenues Wall Street gets from the turnover, and it's like 140 billion. ETFs make about 7 billion, and the turnover they generate by trading a lot is another like 3. And then Vanguard is only... Vanguard's sitting on, what, 5 trillion? They only generate 3.7 billion in fees a year. So as you get... The money's going to where it doesn't make money. Yeah, it is crazy. Believe me, we're all feeding off of this, and it's not good news. But the reason it hasn't mattered, and I think maybe this is also the reason I haven't seen more active mutual fund managers come out, they haven't had to. I mean, yes, they're seeing outflows, but it kind of doesn't matter. So what I was trying to say there, and Deathnail was the editor put it in. What I wanted to write was Perfect Storm.

• 44:13Speaker 03

  What I was trying to say is, a lot of managers will be like, wait till the bear market comes, you're going to see my value. I don't think that's true. I think they should just hope it does never comes. Because if the assets go down, what's been saving them is going to go away. And their revenues could get cut by a third just from the market going down. The problem with that is that then people are going to panic outflow, which always happens, right? Then on top of that, you're going to have the secular shift, where people have an excuse to realize gains, because maybe they wanted to get out of the mutual fund, but they're sitting on a bunch of gains because of this sort of fee structure move. So they're going to be sitting on a triple whammy. And I think that's where you're probably going to find passive is now 35% of all fund assets. That's where passive gains serious market share and goes to 50.

• 44:55Speaker 03

  And I think that's probably where the new equilibrium will sit for a while. Bear markets where this comes out, because the needle's just not moving that much. Last year, ETFs took in $486 billion. Active equity mutual funds, I believe, were flat or down a little, but they grew more in assets. And so the needle, market share-wise, only gets moved if the market goes down heavily. And the other part about active mutual funds that people miss is that they're required to be long in these stocks. And a lot of them, whether they're closet index or not, they're basically long equities. And in a bear market, it's just not going to be, it's very difficult to sidestep that. In 2008, about, only about a third of them outperformed. In other words, the same as always. And so I don't think there's going to be some magic bullet where all of a sudden they

• 45:39Speaker 03

  like predicted the crash two days ahead of time, went to cash. They can't, and it's probably just not going to happen because it's hard to know the future. So those, you add all that up, and that was what I'm seeing. I could be wrong, but I'm not, I don't see a situation where we see people going back to an active equity mutual fund. Now, active debt is a different story. It's an amazing stat. If you look at the last four years, active equity mutual funds have seen a trillion in outflows. Active debt mutual funds have gained about 70 billion. Not a lot, but they're treading water. And it's a fascinating, interesting difference between the way the advisor, Blues, views a stock picker versus a bond manager. I think they think bonds are harder, there's more value there.

• 46:22Speaker 03

  Bond managers maybe are playing like a game of chess versus something that's easier to figure out. For whatever reason, there's a huge dichotomy. So, active to passive, not only is it more nuanced because it's fee structure and all that, but it's more nuanced because debt active is doing okay. It will hold up better, in my opinion, in a bear market, plus bonds will probably go down a less. But the active equity side is what I was talking about. That is where I think there's going to be that sea change in which a new normal is born.

• 46:48Speaker 04

  Fascinating. The second big refrain, and this is often a complaint from active managers who, lo and behold, seem to be underperforming, is that ETFs and kind of passive investing in general is somehow killing price discovery, or altering price discovery in some strange way that's making it so that stocks are not kind of converging on fair value like they used to in the past. So what do you make of this argument of distortions created by ETFs?

• 47:16Speaker 03

  Well, again, we'll bring up that stat that ETFs own about 7% of the stock market. Passive all in owns about 16 to 17% of the stock market. So, right there, you're looking at a very minority owner. However, a lot of money is moving passive. And on the institutional side, we don't really see those assets because they're in separate accounts, but let's just argue that a lot of that money is going more passive. So, let's get up to the majority of the new money. So, I think there's some truth. Actually, look, there's ETF assets going to value ETFs. People forget, they think that all the money going into ETFs is going into the S and P 500 ones. They're also going into value ones, momentum ones, fundamentally weighted ones, bond ones. It's really just a format change. It's not like everybody is buying Amazon and Apple through ETFs.

• 48:00Speaker 03

  So, even though they think that it's all going to create these distortions, a lot of money is going into ETFs that specifically tilt towards cheaper stocks. But, that said, let's say there is a little bit of a rush. I honestly think it's the S and P 500, which has too much power in this world, because I think 25% of the flows in the past several years have gone to S and P 500 ETFs. So, that's a real number, both on the index fund and ETF side. And the S and P 500 is also benchmarked by so many active equity managers who hug it. So, if you think about it, if anything's bubble-ish, in my opinion, it's just the S and P 500 index. Actives just as guilty, though, because they got to buy a lot of the same stocks. And it's got a little momentum in it, and you could argue that it's probably, you know, you could argue that it's

• 48:45Speaker 04

  It's self-perpetuating.

• 48:46Speaker 03

  Yeah, and it's getting set up for a nasty

• 48:48Speaker 04

  Is there empirical data that supports that? So, like, one thought would be, there's a selection committee for the S and P 500 constituents. So, when a name gets added or removed, you might see some price action that supports that idea, or like a basket of stocks that look like the S and P and similar market cap but aren't in the S and P, aren't doing as well. Is there any data like that that corroborates the idea?

• 49:09Speaker 03

  That's a good study. The reason that that data is kind of tough to get is because of the holders data and the float. It's not as easy as it sounds. But, I will say, we've looked at stocks that have literally no representation in passive indexes, and they're awful. I mean, these are stocks that are just down 70% because they get the market cap weighting, they trickle down, or they're new IPOs. So I don't think there's really, because some people say, how can I invest outside this passive bubble? And I'm like, I'm not sure you want to. These are really awful stocks out there. So I think it probably hurts them, but I think it's they hurt themselves to get out of that. It's as they get better and bought up by institutions and households and active funds that they get higher in index. So it's, all this is being led by

• 49:50Speaker 03

  active. Indexes are just riding the coattails. And there's been many cases, and I'll give Todd Rosenbluth credit for this. He pointed this out recently, that GE had that huge sell-off. Well, that was, came at a time when IVV and SPY were taking in so many flows. And that's a big, decent weighting, and it still went down. It's not like the flows into S and P 500 ETF stopped GE going down. So there's been many cases where you look and you're like, nah, but a lot of money is going there. And I don't want to discount people who come out and say that fundamentals are different. It just could also be that just everyone's mindset is different and ETFs reflect that. I always say that ETFs are usually the tip of the iceberg on a trend, like XIV. Everyone blamed XIV for everything,

• 50:32Speaker 03

  but I'm telling you, that had like $600 million or something. Beneath it was this huge short vol trade that was in the, I heard, last I heard, it was like a trillion dollars. So anytime you see something on the ETF, usually it's just this bigger, there's a huge iceberg underneath of just everyone thinking the same thing or doing the same thing in different ways, whether it's through mutual funds or institutions. So the ETF just is something we can all look at and study. But the fact that people are just riding sort of cheap beta, that's not because of SPY. That's just because people want cheap beta. And I bet you dig, you dig deeper, you're going to find that happening on, in other ways, not just through the ETF or passive.

• 51:06Speaker 04

  What trend or idea are you most interested in right now? Like, what are you doing, actively doing work on in the discovery phase?

• 51:12Speaker 03

  One of the things that we're looking into that I think is understudied, but probably going to be a bigger deal, is factors in fixed income. Cliff Asness just went on Bloomberg Television talking about this. He's coming out with a mutual fund that incorporates factors into bonds. Like I said before, so far, they haven't made a dent, but they're newer. And you've got BlackRock, Index IQ, I think JP Morgan's looking at it, in basically trying to repackage the bond manager's brain into an index. And it'll be interesting to see how this plays out. And this debate is interesting to me because bonds just are different. There's a lot of areas that are not investable or you can't index. So how much of it can you index, though? How much of it can you capture with factors? How much of bond manager's

• 51:55Speaker 03

  performance is just them pulling the lever on high yield? And how much can be replicated through ETFs? How much of it is just the image that they are physics professors in terms of their intelligence at figuring this out? And that's going to be something interesting to watch. I think on the stock side, it's that trend is in place. It's going to continue going. Quant is here and it's being packaged and people love it. Can quant work on the debt side? We've studied and so far, it's just been really a tough road. Describing fixed income factor ETFs is also a lot harder. There's less academic research. There's less cutesy terms for it. Like I said, a lot of times you need like this, a term to just capture the zeitgeist of the moment and that hasn't happened.

• 52:37Speaker 03

  But you've got a lot of big issuers behind it and some of the BlackRock fixed income factor and smart beta ETFs are being priced pretty low. You know, 30, 20 basis points. So they got all the makings to be successful, but they just aren't. Another area we're studying is ESG. Why won't this work? Why do people tell you they love ESG? They, the surveys are all good. It reminds me of when Trump was running. His polls were awful because people were embarrassed to admit they were voting for him on the phone.

• 53:05Speaker 04

  It's like the opposite of that.

• 53:06Speaker 03

  The opposite of that, right. It is the exact inverse and you know, ESG gets the best press. I have this sort of informal ratio I do with positive media attention to flows. ESG has the widest ratio ever. On the flip side is something like the iShares Russell 1000 Growth. It's never gotten a story written about it, but it's got like $45 billion, but no one cares because it would bore you to death. So ESG gets all the press, it's laid out, all these, it's getting endorsed right and left by these, just no one cares. Millennials don't have a lot of money, but even they're not really interested. It will remain to be seen whether they have to get cheaper or whether they got to create a shiny object. I'm not sure what could happen there, but we study that as well. What can make ESG ETFs come into their own as well?

• 53:51Speaker 03

  So those are two topics that we've been looking at lately.

• 53:52Speaker 04

  Fascinating. Any big ideas that we've missed in not just ETFs, but in the asset management world that, that you're especially keen on?

• 54:00Speaker 03

  One of the things I'm keen on, which I find interesting is this idea of alpha through beta. And I think this is just beginning where. You know, people are using ETFs to generate that alpha. In other words, you know that

• 54:11Speaker 04

  Tactical asset allocation.

• 54:12Speaker 03

  Exactly. Tactical asset allocation, global macro strategies, that's yet to be packaged and done right. There's been a couple of attempts back in the day, but they were priced too much. They didn't perform that well. You know, we hear a lot about risk parity strategies and all-weather funds. Getting some of that in there, but generally speaking, just people who are really good at timing different asset classes, if they get good at that, I can see that grow. We call them ETF strategists. They have, I think, about 100 billion. That could grow, but also where you might find a lot of that happen isn't the ETF strategist, but it's the advisor. Is the advisor going to be like the new active manager? If they go more and more passive, you're, because, you know, most of your returns come from those asset allocation decisions.

• 54:55Speaker 03

  And if they're going passive within them and killing security selection, are they ultimately going to be the new portfolio manager? And what does that mean? Do they want that responsibility? And that is an interesting trend in the asset management world. And then, as Michael Kitces writes, who I think does some really interesting stuff

• 55:09Speaker 04

  He's great.

• 55:09Speaker 03

  ... disintermediation, fight between asset managers and advisors. I know a lot of them are very friendly with each other and, and it's a great relationship, but it does seem like you've starting to see the initial trickles of asset managers starting to go, well, hey, if you're going to like crunch my fees down to nothing, I'm going to have to go into your business. And they're going to start launching advisors and go, I'm actually going to do it for half the cost. So you've got Vanguard with the PAS, Schwab, and then BlackRock. I mean, if these big asset managers start becoming advisors, that's going to create some uncomfortable relationships because you could argue at the end of this whole sea change down the road, obviously, the financial industry will still exist, but if revenue, if the assets, the flows keep going organically to stuff that doesn't make much money, at

• 55:53Speaker 03

  some point, you could argue, maybe there's just room for half the amount of people. And that would mean that if there's 200 advisors and asset managers, maybe there's only room for 100 of them. So there's this like musical chairs thing that could be a play where they're like, well, we got to think because we cannot live on serving you ETFs for three basis points our whole lives. And that is not a topic you hear a lot about in the media, but I do see it's something that could be gained some ground in the next decade or two.

• 56:18Patrick O'Shaughnessy?

  I love those closing ideas. Really interesting food for thought for everyone that's listening that's in our business. My closing question for everybody is for the kindest thing that anyone's ever done for you.

• 56:27Speaker 03

  The kindest thing that anybody's ever done for me, it's a toss-up between when I was in the 90s in that era, after 9/11, I was just in a rough spot. And I went home and my mom, you know, I went to live with my mom again. It was a little humiliating for me. And I remember I'd gotten a dog in New York and the dog was all over the place. I hadn't trained the dog right. I was, it was just, I was having like a quarter-life crisis. And she took me in, you know, helped me buy a car. And I really, I reformed my life, living in her house for six months. I remember the dog got all muddy and ran through her house. And I really shouldn't have been a 28-year-old back at her house, although now it's normal to live with your parents for a long time. But I gotta say her. I mean, she's just, that was probably the nicest thing, was just to not judge, just helped

• 57:11Speaker 03

  me get back on my feet. So, the other one would be my wife just marrying me. I mean, if that hadn't happened, we wouldn't be sitting here today. The amount of times I bring home some tizzy I'm in, and my wife just sort of like sets me straight, and I don't reply emotionally to some email or something, I can tell you, that has protected me from so many snares. Obviously, our family and all, that's great, too. But just, I cannot understate how amazing that is for me, especially me, because I'm sometimes not good left to my own devices. But I would say those two, it's a toss-up. Maybe that's a little corny to pick those two.

• 57:46Patrick O'Shaughnessy?

  No, it's great.

• 57:47Speaker 03

  But those are the two that come to mind.

• 57:48Patrick O'Shaughnessy?

  Well, this has been a ton of fun. I've learned a lot, so thanks for all your time.

• 57:51Speaker 03

  Thank you.

• 57:52Patrick O'Shaughnessy?

  Hey, everyone. Patrick here again. To find more episodes of Invest Like the Best, go to investorfieldguide.com/podcast. If you're a book lover, you can also sign up for my book club at investorfieldguide.com/bookclub. After you sign up, you'll receive a full investor curriculum right away, and then three to four suggestions of new books every month. You can also follow me on Twitter, @Patrick_OShag, O-S-H-A-G.

• 58:21Patrick O'Shaughnessy?

  If you enjoy the show, please leave a quick review for us on iTunes, which will help more people discover Invest Like the Best. Thanks so much for listening.

• 58:42Patrick O'Shaughnessy?

  You