Animal Spirits Podcast - Talk Your Book: Investing in Moonshots

Episode Date: February 26, 2021

On today's Talk Your Book, we spoke with Direxion's Dave Mazza about the Direxion Moonshot ETF and how to invest in the most innovative companies.   Find complete shownotes on our blogs... Ben Carlson’s A Wealth of Common Sense Michael Batnick’s The Irrelevant Investor Like us on Facebook And feel free to shoot us an email at [e-mail] with any feedback, questions, recommendations, or ideas for future topics of conversation. Learn more about your ad choices. Visit megaphone.fm/adchoices

Today's Animal Spirits Talk Your book is brought to you by Direction. Go to Direction.com and check out their moon ETF, which we're going to be talking about today, the Direction Moonshot Innovators ETF. Again, Direction.com. Welcome to Animal Spirits, a show about markets, life, and investing. Join Michael Batnik and Ben Carlson as they talk about what they're reading, writing, and watching. Michael Battenick and Ben Carlson work for Ritt Holt's wealth management. All opinions expressed by Michael and Ben or any podcast guest. are solely their own opinions and do not reflect the opinion of Ritthold's wealth management. This podcast is for informational purposes only and should not be relied upon for investment decisions. Clients of Rithold's wealth management may maintain positions in the securities discussed in this podcast. So we're in the midst of a bit of a growth stock sell-off, I guess he could say. And on Monday, we talked to Dave Maza from Direction about the

Direction Moonshot Innovators ETF. And he wants to... people. This is a volatile fund, right? It's a growth fund. It's going to have a little bit of a higher beta than the market overall. It's like a microcap growth fund. Yeah, smaller companies have to expect. So we just wanted to check, and we're taping this on Thursday before it goes out on Friday morning. And this thing's seen a nice little sell-off along with all the other growth stocks, which is to be expected. So we think it's important to set some expectations around. And Dave, to his credit, mentioned this and said this is certainly possible. So this ETF that we're going to talk on on the show today, direction moonshot innovators

ETF. You can basically think of it as a smaller company ETF that is investing in some of the most innovative companies that there are. And so those companies are going to be highly highly, not only our small caps. These are like, this is like the prequel to arc, right? Like before they get to that size, they go through the Moonshot ETF. Yep. And so I've been tracking this thing since we talked to Dave.

And it's only a couple months old, which we get into. Yeah. So it's down 13% or so. I think if you're investing in funds like this, you have to look at these things as understanding the volatility and how it works with the rest of your portfolio. And when it does really well and it's up 100% the first couple months after it comes out, you have a rebalancing mechanism. And when it goes down, you have one as well. Right? So you're taking advantage of both sides of the volatility. Yes. So anyway, I think this idea is really interesting. I don't think that I've never seen other funds like this that. go for just the smaller companies because a lot of places. Not in the ETF space. Right. I'm sure there's active managers that are in. Right.

And certainly not in an ETF sort of rules-based approach. So anyway, we wanted to talk about this. This is a highly volatile space and it's interesting to see gross stocks roll over now and see after having these huge gains, if investors will step back in and rebalance into the pain if they can. Your thoughts? I won't hold you to this, but is this it? Is this the end?

The beginning of the end? It doesn't feel like it. I think this is healthy. If there ever was a healthy correction, I said earlier this week, I think we needed one. And I think this is a good thing. You can't have stocks go to the moon, pun intended, just day after day and seeing huge gains. So I think this is healthy. It shakes out some of the weak hands, potentially. People who have the diamond hands can stick around or whatever. I guess, sorry, I didn't mean to be a boomer. It's paper hands now, right? Shake out some of the paper hands. Diamond hands can hold on. People can rebalance into the pain. I mean, interest rates are rising and people are worried about that, but I don't see this

as being the end yet. Hold me to this if I'm wrong. I certainly will. All right, and please enjoy our conversation with Dave Mazza from Direction. We're joined today by Dave Mazza head of product for direction. Dave, thanks for coming on today. Thanks for having me. So, all right, sometimes there's, not sometimes, always, there's a lot of luck involved in terms of product launches. You know, you can't controlled the environment that you launched into. But man, this was pretty good timing. So this thing came out of the gate in November of 2020, and it's already at almost $200 million. That is impressive. Yeah, I've worked at large issuers, mid-sized issuers, small issuers. And I think anyone would say in this environment, launching a new ETF organically, that's raised that much of assets

in a short period of time. It's an impressive feat. We said that luck helps. And certainly that's part of this story here is since the launch of this thing, we've got the S&P 500 up 10%. I guess your closest competitor, you might not say this, but I guess I will, is ARKK up 59% since you launched, not so bad, but directions moonshot innovators ETF up 93% since November. So if you could just promise to annualize that for us, we're going to be good. Yeah, well, I mean, look, as we know, past performance is. and a guarantee of future results. However, when you find yourself with such strong performance in a short period of time, logical question is, why is that the case and can it be repeated to some way,

shape, or form? I believe that based off of how we've designed this particular fund, that it can be, certainly the uniqueness that we see in this particular market environment has helped with that, but I think it's also resilient to not necessarily needing growth to be in favor. That's what's really unique about the CETF. By its nameplate, Moonshot Innovators, you think it would be only growth in tech. But that's not the case. And in fact, as we have seen this value rotation materialize a bit as yields have risen, the Moonshot ETF continues to do well. I was actually surprised looking at the top holdings of this. I didn't recognize a lot of these names. It wasn't like a list of names that you see in the news all the time. You have a list of some of the thematic subsectors

you look at. And the description just says it's 50 companies deemed to have the highest early stage composite innovation scores. So why don't you tell us a little bit about how you came up with these scores, and you have two different ones that you use. So walk us through how this process works. I'll be quite frank. Part of the intention is that there shouldn't be so many household names in this particular fund. We really wanted it to be focused on early stage innovation. And so what does that mean, to your point? That means that it's really at reconstitution, at rebalance, meaning when we identify the names, it's all small and midcap companies. In fact, it yields smaller to microcap. So you're going to find names that you're not as familiar with. The way we actually

find them is pretty unique, too. So you can measure innovation a lot of ways. Certainly, on one hand, you could have a team of fundamental analysts trying to identify companies that are most innovative, or you could have kind of a purely quantitative metric. We try to systematize a bit of both of those worlds. When we think of the innovation composite scores, two things. It's first and foremost, does a company have an innovation of mission and culture, meaning in their particular thematic sector or GIC sector or industry group, wherever we want to think about, it's pure universal. first. If they're biotech or if they're industrials, do they focus more on innovation than their peers? So, of course, what's innovative and biotech is different with innovative

and finance, innovative with industrials companies. But we actually scan their SEC statements, their 10Ks and 10 Q's, to see if they're using words that historically are connected with innovation in that particular group. So that's how we say, among their peers, are they talking to talk? Do they focus on innovation at their core from a mission? cultural standpoint. I read that. How did you come up with that? That's where a lot of research kind of went into it with our partners at S&P, Ken Show. So for those that aren't familiar, I think everyone knows S&P, but Ken Show was really a financials technology company, and they have these tools and techniques. It's called natural language processing, big multiple

there. It went back through time to identify what historically has been most focused on innovation in a particular group. So very, very unique, impressive means of coming up with those terms. And now those could change through time. That's the other thing about these techniques, kind of advanced and sophisticated, but what was innovative 20 years ago is not going to be innovative in the future. So that's very helpful. But that's just talking to talk. That would be the one knock on this product. Well, you guys are just scanning documents to find words that are innovative. How do you know if they're innovative or not? That's where the quantitative component comes in. So we actually also measure do companies spend more on research and

development relative to their sales than their peers. So if you're both talking to talk, talking about innovation, and then you're spending your top line revenue on R&D, that's how we identify this unique basket of 50 companies that span all these really interesting, disruptive areas that's changing the way the world works today and tomorrow. So we've got 80% of this basket is in the United States. The next is 7% with Israel. they tend to be pretty aggressive with technology. Then looking at the sub-themes, you've got 19% genetic engineering. So that's things like cyberdine from Terminator 2. You've got cybersecurity at 17% clean technology, digital communities. But again, going back to Ben's point of looking at

these names, microvision is a $3 billion company, nano-dimension is a $3 billion company, Veronis is $7 billion, Vuzix. I mean, these are names that are not familiar to me, but I'm just looking at a chart and all of these have gone vertical in the last six months or so. So what's happening? Why are these working now? There are other names in the portfolio that spent years with middling performance. Plug power is a good example. Plugs were kind of a favorite for the retail community. But that was a $2 stock for decades. And then of course, recently as they've begun to make some progress commercializing hydrogen fuel cells, that's also done well. But to your point, you could name a handful of other stocks that have gone vertical of late.

Part of it is the fact that we find ourselves, in my opinion, this really interesting juncture. Certainly we know we've been living with the COVID-19 pandemic. It's changed the way the world works. It changed the way people works. It changed the way people interact. But what it actually really did, in my opinion, is just accelerate some longer-term trends. One of the longer-term trends that we have is that we are in this second machine age or the fourth industrial revolution.

And what that means is that the way the world operates is going through massive acceleration, whether we know it or not. Remote work is one of those trends, but it's also cloud computing. It's cybersecurity needs. It's remote communications. It's also what's going on in the biotech space. Look at the COVID-19 vaccines. The two that are most successful at the highest efficacy are using a technology that was never

used before. Those names are not in this particular portfolio, but it's a good example, a good tangible example of what's happening in biotech with MNRA and things of that nature that had never happened before. So as investors begin to especially, look away from just this mega cap growth dominance of the fang stocks and say, what else can complement my portfolio? And if you're going to dip down the cap spectrum, it makes a lot of sense to combine disruptive growth that's not as associated with pure market cap growth and do

so in a way systematically, which this fund is really intended to do. If you're an advisor or an individual who's putting this in your portfolio, how do you look at this in terms of pays your portfolio because obviously if you have a fund that's up a ton, that's a good problem to have. But how do you look at it from a portfolio management perspective? This is definitely a compliment position to longer term, whether you're a long term buy and hold investor with very, very low cost, broad-based market cap funds, or increasingly, I think we are seeing investors realize that it can make a lot of sense to complement those long-term positions with five, 10 percent of your portfolio to funds like this that are going to give you something you're not

going to find anywhere else. That's a key component about Moon. Again, when we could go through the top 10 list, and there's really only a handful of names that people are going to know in the portfolio. Plug power, workforce, those are somewhat household names. There's Virgin Galactic in here. That's barely a household name. So to me, I would use this alongside whatever you're already doing in the core part of your portfolio. But at the same time, I think this fund can be beneficial for people who, as opposed to trying to go find some of these stocks on their own. We're Choosing stocks that have gone up 100% in a short period of time, there's some stocks in this fund that have not done that. If you had put all of your money or most of your money in those

stocks, you certainly wouldn't be as happy as you would be with the diversification of 50 innovative companies than just one or two. Yeah. So I've got a several part comment on that. Looking at ARC, another thematic ETF that has just been phenomenally successful by literally any measure changing the landscape, frankly. You look at their top 10 holdings of ARKKK. It's Tesla, Roku, Square, Teladok, By-Doo, Spotify, Zilla, Krisper, Invitay, and Shopify, all very, very much household names. Some of these are mega-caps at this point, versus the Top Ten Holdings. Again, not to knock on Kathy, what they're doing, but you could sort of replicate that on your own if you were so inclined. With what you're doing, there's just no way.

Again, the Top Ten Holdings, Vuezik, Microvision, Tenable, Fuel Cell, Nano. There's a company called ADPMUN. That does not roll off the tongue. Adpamun? What is that? Is that foreign? Yes. Let me just jump in here because you're raising a good point.

What language is that, by the way? Is that Klingon? If you're already interested, obviously they've had successful growth, successful performance, because they identified some of these names that have become mega caps, that have disrupted the way we listen to music in a social way, the way the future might be from electronic vehicles or would have you, or the way payments work. But there's another leg of that. Those companies have already begun to see their massive trajectory.

This fund moon is about finding those names before that happens. And in fact, we're going to sell them when they become large caps because I want to recycle those earnings back into a name that is a microcap that's just doing maybe one thing in the biotech space or one or two things. So you have some constraints on rebalancing in terms of market caps? Yes. So basically, effectively, any company that would have a market cap that is going to be north of what the S&P 400's market cap is, so the mid-caps it up, would be excluded from the portfolio.

So a great example is we launched the fund back in November and we actually had its rebalance in December. We already sold Neo because it became a $50 billion market cap company. Now, you could argue would I want to stay holding that name forever? Maybe. But that's not what this fund is supposed to do. It's supposed to take advantage of that excellent performance. And as it graduates out, go then find the.

next company. That's why it's systematic in this way to only always focus on small and mid-cats. So it sounds like this is not necessarily a danger, but these companies you're buying are small, like really small. And if you're already 186 million or whatever it is, what happens if you get to a billion or two billion? Obviously, it's a great problem to have, but does that change the nature of what fish you could swim in? I'm sorry, what pond you can fish in. Yeah, we can swim in fish or, yeah, you're usually fishing in the pond. So, yeah, when we're fishing in the pond, I will tell you in building this fund, and this is not to knock on anything else I've ever done the past, or maybe it is, but I've never spent more time judging just that, saying, this is

great. We've built something that is really cool. JFK created the term Moonshot. Now, obviously, it's being used on Wall Street Fats and Twitter and all that. How do I find these stocks, but do so in a way that I'm going to be able to manage an open-ended fund? We believe we have capacity up into the billions and billions of dollars because of the fact that we are equal weighting the portfolio at Rebalance, but taking into account liquidity and trading at that time. So it's modify equal weighting. But again, I did not want a market cap weight these. At Rebalance, if a company, even if it's a $1 billion company and the next one is a $10 billion company, I want them all to have the same contribution when we identify them. But we do, of course,

tilted a bit if a stock doesn't trade very much. So how are they weighted? It's effectively modified, equal weighted, but it's modified based off of not just its trading volume, but the impact our trading would have on that name on any given day. We'll upweight a company that has more volume and downweight one that has less. So among the 50, one might become three percent at rebalance and one would be one and a half percent, for example. What sort of growth are we seeing in these names, like fundamental business growth. Where are these companies out in their life cycle? They're all at the very early, really stage. So that's why we're very, very clear. So some of these companies might not necessarily have positive earnings for some time. And that's okay. But they're

growing their top lines markedly. So on average, these stocks have EPS growth estimates of well north of 25%. However, what's unique here, and I will caveat that number, some of these companies only have one or two analysts covering them. So it's not like you're saying, give me the EPS estimates for Apple or Tesla, where there's tens, 20s of analysts publishing next quarter EPS. So we have to be a little bit careful when looking at the data in this case. But again, regardless of if you're looking at plug power or Virgin Galactic, they certainly have expectations for very positive growth over the next 12 months. But it's more, what could they do? Will their valuation start to increase before that growth even materializes? And then we'll likely sell out of them because they become

a large-cap company. We said some of the companies might not be household names. Can you look through some of these themes and sub-sectors that you're investing in? Because I think that would be interesting to hear where you got some of those and things that are happening in these. Yeah, no, it's a great point. So some of that is a fallout of simply the process. So when you're moving this far down in cap and you're taking effectively a small and mid-cap universe and trying to identify those 50 most innovative companies, you're going to end up with some really, really unique themes that are happening today. So of course, I think most people are familiar with going on with cybersecurity. Cyber has seen significant growth over the past few years. Again, the COVID-19

pandemic is going to accelerate that because now we have employees in disparate locations. Cyber threats have gone up markedly and companies as they're moving toward the cloud need more protection for that data. So that's kind of an obvious theme to understand. Other things are drones. Other things are smart cities. What does that mean? How is the grid interconnected? So not just thinking about EVs in and of themselves, but what's needed to make an EVs? V work. Of course, you need batteries, but you need sensors and lasers and radars to make sure that the car actually can drive effectively. So there's names in the portfolio that do just that, providing the infrastructure to make EVs work in the bigger picture way. In addition, in the genetic engineering sub-theme, which is in the portfolio, that's where we're getting a lot of very different types of biotech companies. A great example is Anovio. Anovio is, of course, focused on vaccines for different types of diseases. But what they're really focusing on is how do I deliver that vaccine as opposed to just simply an injection that needs to go through your bloodstream. What if you have

a liver problem? Imagine if I were to rub a vaccine or something of that nature directly on to your liver in some way, shape, or form. Seems crazy. But that's what they're doing and they're beginning to commercialize technologies to make it easier and more efficient for doctors, nurses, and scientists to be able to solve other problems by thinking not just about churing the problem, but how do I actually deliver that in a way that might actually be more beneficial for the human body? This sounds like venture capital investing in a way. What's the average age of these companies?

It's funny. There are names that are older. Plug power has been around for decades, plugging away at high, excuse my dad joke, but many of them are new. They've IPOed in the last three to five years. Again, in the biotech space, they may only have one or two drugs that could be commercially viable in the next three to five years, if not 10 years. So you do have this interesting mix, but most of them are younger. One of the ways I think about this fund is how can I do venture capital

in the public equity markets? It's with an ETF like this. You're probably a little biased here. So maybe this is a softball, but do you think thematic funds like this are just going to be the new types of active for a lot of people? I'm super biased. Let's make that clear. But I think whether you're doing it like ARC is doing with true active management or whether you're trying to system a it. To me, thematic investing is the new active investing, hands down. But I'm now empowered as a retail investor or an advisor to make those decisions. So again, I'm personally biased. I spent 12 years at State Street. As you guys would imagine, most of my portfolio is in low-cost index funds. But I complement that with funds like this that I think are doing things either disruptive or

important to me over the long run. So I think thematic investing is finally going to kind of see the light of day. It's been around for some time. Also, I actually think thematic investing is very disruptive against traditional sector industry rotation. Nothing wrong with that, meaning I want to be in financials or energy versus tech. Why don't I actually get more prescriptive? Because if you want to buy tech, maybe you just want to buy cloud and cyber. Or if you want to buy financials, maybe you don't necessarily just want to go buy the money center banks. You want to buy disruptive type financials, too. So to me, I think this type of investing has a lot of legs to it because of all the different applications.

How do you guys think about, since you're playing in a newish space, how do you think about a lot of the companies that are coming public via SPAC? Does that impact at all what you're going to do? Are those companies being screened out? I mean, obviously, I guess you have one with Virgin Galactic, but how do you think about that? We don't necessarily have anything that says a company that went public via SPAC can or can't come in the portfolio because we're more focused on the metrics of how you got there.

If you chose to list with a direct listing, if you chose to risk with a SPAC or with an IPO, that's fine for this portfolio as long as you, again, within your peer group, having the most innovative culture and spending the most on research and development relative to sales. What did you find in your research on that research and development? I found that interesting because so many people for so many years of thought, well, it's stock buybacks propping up the market. I don't think people realize how much these companies still are in many ways investing back in themselves. And that's why a lot of these companies probably don't have a lot of

profit right now too. What did you find in your research for that? It's an aggregate measure. This is a bit dated. We know R&D went down in the market, but some of that was coming from really the energy complex. But if you actually peel that away, to your point, there has been companies who are reinvesting back in their business. I think that's super important going forward. Why? Because historically, companies would just spend on property plan and equipment. This is more, what are companies going to do to booster their technology? What are companies going to do to make it easier for their workers to communicate and collaborate with one another. So to me, future spending, again, at the enterprise level is going to change.

But then even if we peel that back into particular subsectors, if you are, especially in the biotech space, spending money on trying to solve problems and build drugs as opposed to spending it on marketing, it yields you much better results from a stock performance perspective. So again, that's more kind of the quantitative results. I also think about that from the qualitative component of how interesting and potent the potential can be for companies that are reinvesting in their businesses today, as opposed to just returning capital of shareholders. What do we think about volatility in an aims like this?

Is this something that if the market was down, I know you don't have live data so we could just speculate if the market was down 35% in March, who knows what this would have done, but are we expecting like double the losses of the S&P or not quite as? I mean, what should an investor prepare themselves mentally for here? You need to expect a fund is up 93% since it launched in November. It's going to be more volatile than the broader market. It's going to be more volatile than even the NASDAQ. It is small cap companies that are intended to be focused on disruption and innovation.

The live data is short in this particular regard. But what's interesting is because you have such a unique basket and because the active share, not to get, throw that term that no one's talked about for 10 years now out there, But it's so different than any index you choose. Even if you choose the Russell 2000, your correlation to the broader market is actually lower than you would expect. So your beta is going to actually behave differently depending upon the market. So what we've seen, again, is that you're less dependent upon what is happening with

large cap value or large cap growth than nearly any other fund in the market just by the nature of what its holdings are. There's some thought out there that the rising interest rates that we've experienced experience over the past few weeks and months. If that continues, it's going to hit large cap growth names, or just growth names in general, because the cost of capital goes up, whatever. I mean, a million different reasons. Do you think that that would play any role in these names? Is this just a completely different animal altogether? As you guys know, you've probably written on it, pick your poison of why that's the case,

but that's what it has always done. When rates rise, it's a good environment for value relative to growth, whether it's inflation, whether it's cost of capital, the discount rate, et cetera. I feel, again, we don't have the data to prove this, but again, because these companies are a bit insulated by nature of their uniqueness in their particular business models, you would not see nearly the same impact. With that being said, if there were days where there's a broad-based momentum sell-off, broad-based growth sell-off, I would expect this fund to underperform the broader market. But at least from launch, even as we've seen, and even last week when we did see the 10-year move up pretty significantly, this fund still continue to do well. So again, short time period, but some evidence, its uniqueness does bolster its potential from being less impacted by the macro.

And this gets rebalanced quarterly? So it gets rebalanced twice a year, but it has a reconstitution where we truly try to find those next names on an annual basis every December. Dave, could you maybe help people overcome the fact that just this general idea that somehow total assets in an ETF matter today and talk about like liquidity and creation redemption and why somebody shouldn't necessarily look at volume, for example, as a metric of how liquid this security trades? It's a common misperception and it's something which even someone who's been doing

ETS for as long as I have can still fall into the trap of saying this fund's not going to be liquid, right? it doesn't trade like spy, but very few securities in the world trade like that. So for an investor in this fund, you should especially know the holding. They're not large cap names. So the bid a spread, although it's been very, very tight since launch, because it's seen such strong growth, has made it easy to get in and out of the fund if you're interested in that. Volume is not indicative of what the underlying liquidity is.

And in fact, because of the unique ability for ETFs to have in-kind creation and redemption, the actual underlying liquidity in this ETF as a vehicle is likely going to be better than some of the names individually in this particular portfolio. So for any ETF, whether it's from direction or any provider, don't always be scared off from it if it has $50 million in assets and it only trades a million shares a day. Now, if it trades one share a day, may be different. So this is not an official endorsement. Everybody, please do their own due diligence.

This fund is going to be incredibly volatile. It is new. But that being said, Ben did slack me. I'm going to DCA the shit out of this fun. I've never used an emoji in my life, but if I did, I would use the moonshot for this one. It's only apt, right? It's appropriate. And it's funny.

Again, when I first started thinking about this, I was thinking back to history class, right? The famous JFK speech, the reason it's called moonshots is getting to the moon was hard. We just got a rover on Mars now. It's not easy. So these companies are solving problems and changing the world. that's a real challenge. Some of them aren't going to work out. Others of them are going to work out really, really well. And to me, the systemization that we put into of saying, if it becomes a large cap effectively, let's move on and focus on the next batch of early stage innovation makes this

fund, in my opinion, really beneficial to complement, again, what people might already be doing with thematics or might already be doing with their single stocks or low cost passive. Dave, this is great. Thank you so much. Thank you. Thanks for having me. All right. Animal Spiritspot at gmail.com. We'll see you next time.