ETF Edge - 2025: Bring “thematic” back? 12/2/24

Episode Date: December 2, 2024

As investors look to broaden market exposure, could thematic ETFs come back into the spotlight? Here are some new ways to play.        Hosted by Simplecast, an AdsWizz company. See pcm.adswizz.com for information about our collection and use of personal data for advertising.

The ETF Edge podcast is sponsored by Invesco QQQ, proud provider of access to innovation for the last 25 years. Investco Distributors, Inc. Welcome to ETF Edge, the podcast. If you're looking to learn the latest insights on all things, exchange, traded funds, you are in the right place. Every week, we're bringing you interviews, market analysis, and breaking down what it all means for investors.

I am your host, Bob Bassani. Will thematic ETF see a resurgence in 2025 as investors look to broaden their exposure? Here is my conversation with J.J. Jacobs, US head of thematics and active equity ETFs at BlackRock, along with financial futurist and ETF expert Dave Notic. Jay, one big theme you had for ETFs in 2025, acceleration of the AI infrastructure phase that we're in.

I know that sounds fancy folks, but we're now entering an additional phase where AI is going to be much more integrated into consumer enterprise applications and eventually new business models are going to emerge. Tell us all about that and what ETFs might be applicable here. Sure. Well, it's still very early in the the AI adoption cycle. We've seen hundreds of billions of dollars invested in AI by some of these

Mag7 mega-cap tech names, but adoption still will take time. For me to use it in my everyday you and Dave, it takes time for people to change their habits. So the stage that we're in today is this $250 billion annual investment from mega-cap tech stocks to build out data centers, to buy the latest chips, to train their models with bigger and bigger data sets. And all of that is really leading up to making AI more and more powerful to the point where we can't ignore it anymore. We have to use it in our everyday lives because it's such a powerful tool. And of course there's ETFs for that. BlackRock has them.

What a surprise. So the way we have to think about this is from the entire value chain perspective, that it's not just about MegaCAP tech names. There's other semiconductor companies. There's other data center companies. There's other software companies that are benefiting from the rise of this theme. That's where we see funds like R-D, which is an index-based artificial intelligence. ARTY.

ARTY. ARTY, or BAI, where we have a portfolio manager picking individual stocks for who could be the winners in AI going forward. So one's active, one's index-based. Exactly. Yeah. Now, as the whole mega force, I don't know what you call it, for AI evolves, investments in cybersecurity

can become more important. I know this is one of your themes that you've been talking about. Tell us about that and what ETS we've got for that. So if you think about what AI is doing, it's taking data and making it more valuable, because we can interact with it, we can learn from it, we create new things based off of that data. As data gets more valuable, companies that own that data

or people that own that data are gonna spend more money to protect it. So just like if you had a more expensive house, you buy more insurance, if you think about your data, you wanna spend more on cybersecurity as it gets more valuable. So we think this is really gonna benefit the cybersecurity software community,

which is seeing very rapid revenue growth based off of this AI. And of course, Cleverly, IHack is there. And just show us, there we go, thank you. There's your largest whole. central one, fortinet. Any theme here about how you're picking the selections here? A lot of it is about the larger, getting larger. You know, the big cybersecurity names tend to benefit from their own bigger data,

their own bigger client bases. They are at the leading edge of how cybersecurity is defending data, and so they tend to get more and more clients going forward and grow their top line revenue. Dave, your thoughts on all this? How is AI going to shape ETF investing? I feel like there's another shooter drop on this, so sure, we're going to have this we're going to have this middle area where we can see the build out in the AI companies themselves, in the software companies themselves. I think it's really interesting to think about the tails

of that industry, which I would call infrastructure, things down to power, water. We're seeing huge inputs into the power sector, real innovation happening there. These companies now making major allocations for their own generation capability. I think that's a trend we're going to see much more of going forward because it's only getting it hungrier. And then on the other end, those companies that take the work those AI companies are doing and really bring them to retail. You said it's going to take some time before this is part of your day-to-day life. When it's on your phone and you're talking to it all day, that's when it's going to matter. So I would really look towards those retail names that we're used to thinking about,

say, an Apple or even a Samsung, folks that are making those devices. When you see the integration really work there, that's something to pay attention to. Your thoughts on that? I mean, Apple's such an obvious choice here from the beneficiary point. I have the new iPhone and they're already telling me about how I can integrate my email and they'll summarize every single word on the emails for me for on AI infrastructure. I couldn't agree more with Dave on the infrastructure side of things. You know, if you look at the last 15 years in the United States, you had zero electricity

demand growth. You had population growth, you had economic growth, but we didn't need more electricity because we were actually getting more efficient with electricity. And we weren't getting a lot of household formations to the other than a lot of household formation. All of a sudden, because of AI, because of electric vehicles, because of a growth in manufacturing again in the United States. You have a lot more electricity demand. And that, you know, if you think about a utility going from zero growth to 2% growth,

that's actually a complete shift in how they have to think about their capital expenditure planning, where they're going to get funding. Who would have thought utilities would be an AI play? And yet that's what happened this year. It's not just, we can't say they're just interest rate sensitive plays. They're AI plays. I think what people forget is as kind of magical as technology is, there's real physical things on the ground that run that technology, whether it's power, whether it's data centers and real estate,

whether it's chips. It's not just something that lives in the ether, in the cloud. There's real physical things that have to happen. And that means energy, that means more materials like copper, that means more real estate. You really have to think about kind of the physical infrastructure that underlies it. Yeah. I want to just move on here. You've also jumped into the mega cap exposure business here.

You've launched an ETF that holds the top 20 ETFs and, excuse me, top 20 stocks in the S&P 500. We launched another one, the top 30, NASDAQ 100. So NASDAQ 100 is not enough. Now we have the NASDAQ 30 that you launched. I know mega-cap tech concentration has paid off, but why do you think the public is going to keep pouring more and more money into the biggest companies? What's still, I mean, it seems like this is a late play to me, but maybe I'm wrong. What is your thing?

There's kind of two different things happening. One is, if you look at the end investor space, a lot of people in the United States still just don't have stock exposure. They don't know where to start. And I think if you can bring out a fund, that gives them exposure to names they know, that they understand, maybe they interact with in their everyday lives, that's gonna give them comfort to step into the markets as a stepping stone into ultimately building a broader portfolio.

So in some ways, it's a non-ramp to ETF investing. The other angle is looking at professional investors who frankly over-diversified and have missed out a lot of this Mag 7 rally because they have so many other exposures beyond it, they want a precision tool to dial up and down their Mega Cap exposure. And this is a very efficient tool for them to do so. But is Mega Cap really an asset class, like,

But like tech is an asset class, mega-cap tech dominates it, but is Lily and, you know, Berkshire, you know, is it an asset class? So it is in the sense that they do tend to have performance characteristics as a group. And so for that reason, I'm with you on that you need a really sharp tool. If you're an allocator at an institution, and you want to fine-tune that mega-cap exposure up or down, long or short, totally with you. I'm not sure I buy the on-ramp to ETF investing. just because we're talking about a very under diversified portfolio. The math would suggest going back hundreds of years, something like 25 to 30 stocks is the minimum requirement for a diversified portfolio, but that assumes that you're agnostic across

industry. You can't say that about the mag 20 or the mag 30 here. Because it's so hyperconcentrate in tech. Very hyper concentrated in tech. So is the average investor too concentrated? I mean, this is sort of a broad intellectual question. If you read things like the subreddit for each, you're very much. ETFs, you will find people absolutely want to get very concentrated because they're really

speculating. They're not thinking about their 10-year time horizon. They're thinking about their two-month time horizon. And absolutely, these kinds of products are great for making those kind of speculative bets. I'm reluctant to tell a lot of people their initial 401k effort or their initial IRAs should be into something that's 20 stocks versus, say, 500 or ITOT and buy the market. Well, for sure, they're giving people, BlackRock's giving people what they want. I mean, the The flows have still been great. Of course. It's not like everybody's abandoning big cap.

And if I could comment on that for a second, you know, what you've seen is 20 years ago, the entire U.S. equity markets were about $15 trillion. Now that's the top eight companies alone. And what you see is a lot of these top eight companies are web services companies. They're also consumer discretionary companies. There's cell phone companies. They're also services companies. When you buy into this top 20, you're actually getting a really wide range of companies

and services. They also have their own corporate development arms that are investing in a lot of smaller companies, you're getting diversification in these top names. What it's helping is a lot of investors who are either, A, not invested, or if they are investing, they're picking one of these names. And it moves them into a much better portfolio. The basic idea is the bigger getting bigger and continue to get bigger, except historically it's been hard to stay in that top 20 and top 30. Yeah, so math would tell us that if you've had a really great run at the top of the index, you're headed for pain. That's just how that's worked over time. I do think it's worth thinking

that it might be different this time. We're in a very different. regulatory regime, we're in a very different political regime. Corporate power is more relevant than it's ever been up and down the regulatory food chain. So betting against mega caps I think is a tough tough thing to do. I'm not sure going even more into mega caps is the right call. It's a different world, isn't it, than 20 or 30 years ago. It's an asset light business now. These companies, it's software that they own an intellectual property like Lilly has. It's not, you know, giant industrial, you know, pieces of machinery and things. things like that. The whole nature, this is why I think like it's possible for the S&P to have a

higher PE ratio, 22, whatever it is going forward now than it was, you know, 20 years ago, maybe 15 was the average. Maybe we can have a higher PE ratio if you have an asset light series of big companies now that whose primary ownership is software and intellectual property and not, you know, machinery for example. So I think that's been true since the dot com boom, right? That's when we first saw intangible value being what drove PE and now we've got, you know, micro strategy. the 2000 PE. So there's no question that innovation tends to drag that PE higher. Okay, so let me move on. We've had a couple of themes here, AI, talking about top 20.

How about infrastructure investment? This is one of your themes. BlackRock's had it as a theme for 2025. The Infrastructure Investment and Jobs Act, remember that one? In 2021, that was the largest infrastructure investment project in US history. One point two trillion dollars to build and repair bridges, airports, waterways, public transit. Tell us about, I know this is one of your themes. You have ETFs for that. Do you think that's going to continue? It seems so because most of the money hasn't been spent yet in this bill.

That's a big part of it. So the bill passed in 2021, but you think about they have to identify the infrastructure projects, do some design work, do some environmental work, and then you get the green light to start putting shovels in the ground. That can take years. When the shovels are in the ground, that's when a lot of the money is being spent. So we're starting to see a lot of these projects, really start to enter that construction phase where a lot of dollars are going to be spent,

building new infrastructure, repairing existing infrastructure. What I would say, though, is a lot of people want to kind of tie this to election results. Infrastructure is one of the areas that has some of the most political consensus. And this is important because infrastructure is not just about the president or at the federal level. This happens at the local level, this happens at the state level, and it happens at the federal level, and it happens with public-private partnerships, where you have private companies involved too. So you really need a lot of consensus up and down. the government and with corporations to support infrastructure.

That's a good point. I mean, nobody's going to argue to repeal the Infrastructure and Jobs Act. Well, they don't think there's going to be a lot of support to do that. They will for political points, but they'll just rebrand it and we'll do the same thing. So I'm with you. I think that we're going to continue to see this kind of investment. It's not really an option. We all know how desperately needed.

I mean, it was a joke for years. It was Infrastructure Week for 12 years or something, right? So we know we need the investment. We've got the pathways now to get those picks in the ground. I think the money will be spent. I think it's a great place to look for a little bit of a targeted thematic investment. Now, explain the differences here. We're putting up, if you could put back that full screen of the three ETFs.

We obviously asked for investments here. Can you make the distinction here of what's going on? Are these active or passive, index-based? And what do you own? Just very briefly with each. Yeah, so these are all index-based ETFs, and they're touching on different parts of the physical economy. So you have infrastructure where you're building new roads and highways and airports.

You have manufacturing, which is building more. more factories that can build goods in the United States. Think about we're building some fabs to build semiconductors in the US. And that's made, here it is. And then finally you have ITB, which is the home construction. You have a huge demographic tailwind with the rise of millennials and them earning their peak earnings years that want to buy homes. 86% of renters say they would like to own a home but can't afford it.

So you have a lot of just construction happening around the country right now, whether it's infrastructure, factories, or houses. Okay, so we've talked about AI. We've talked about cybersecurity. We talked to a mega cap exposure. We talked about infrastructure. Let me move on here. I haven't talked about Bitcoin yet.

We're 15 minutes into the show. I haven't mentioned Bitcoin yet. We're coming up, you know this, right? The one year anniversary of the Bitcoin ETF launch, that's in January. We'll talk about it in January. But I just want to mention, IS shares, Bitcoin ETF, that's I-BIT,

is the market leader. It's amazing. We have $100 billion in Bitcoin ETFs. You have half of my big $48 billion. That's really quite impressive since launching. This is one of the most successful ETF launches of all time, generically, Bitcoin ETFs. Dave can talk about this. But what is going to be the main driver of Bitcoin in 2025? You don't have to be bullish or

bearish. Just tell me what you think is going to drive it. I think there's a few different factors. You know, one is what happens in the interest rate world because we saw rates start getting cut this year. If you look at a lot of professional investors that are looking at Bitcoin as an asset class to include alongside stocks and bonds, they look at it relative to what's the income I get from Bitcoin versus something like treasuries, very different asset. As rates come down, Bitcoin can become more attractive, just like gold. What's also going to change, though, is kind of expectations around the main fundamental drivers of Bitcoin, which is what is the inflationary environment around the world and what

is the kind of geopolitical risk index around the world looking like as well. If we enter a period where inflation is stickier or there's more fragmentation around the world, that could drive more fundamental belief in Bitcoin as well. I don't want to get into philosophical discussion on Bitcoin, but Dave, do you think Bitcoin is meeting what was the original use case? as a global monetary alternative. That's sort of, has it really met that use case? I'm sorry to be, you know, ask it obvious question.

I think it's met the digital gold use case and that people are using it as a digital store of value. It's not being used as a transactional system. We all know that. There are solutions for that. The level two solutions work. They're viable. What we've seen, though, is the institutionalization

of Bitcoin as its own asset that is unique and disparate from crypto. So Bitcoin by itself is not Ethereum and Solisome. or any of these other things. Bitcoin is unique. As such, I think what we're going to see in 2025 is the dynamic of Bitcoin, what it's worth, how it's trading, how volatile it is, is going to actually start being driven by exchange-traded products and less by on-chain people trading crypto.

We've already seen that. The volumes in Ibit are phenomenal. I mean, I don't know what they are at the top of my head, but I would not be surprised if there are days in which the complex of Bitcoin ETFs trades more notional than trades on-chain directly. The volumes are insane. Because of that, you have to expect more price discovery is going to move. You're talking about the volumes now, not assets and demand. You're talking about the volume, just the amount trading. With the options running, I mean, I'd love to hear your thoughts on that. With the options on Ibit now trading, that cracks open the asset class to all sorts of investment

strategies that were basically imposterous. Has volumes increased? By the way, folks, in case you don't know, options on Ibit were trading just recently, about two weeks ago? Yeah, and they were were very successful. Does options trading generally lead to more trading of the underlying? Absolutely, because people need to hedge out that delta. They need to hedge out the underlying security. Right, the options dealers don't want to be long or short anything. So they're always going to be using the underlying as a way to get out or into those positions. Ibit's already extraordinarily liquid. They don't need to go to another asset class. They don't need to go on chain to get that exposed. What have you seen with your trading in IBIT since the options? This was two weeks

ago, the options on Ibit, the Bitcoin, their Bitcoin. We've had a tremendous amount of volume. I think part of it is a lot of people can really customize their risk, their income, their upside potential with these options. So if you think about people who maybe have made a lot of money in Bitcoin, they want to maybe protect some of those games, people who are holding a lot of Bitcoin and not drawing any income from it. Maybe they want to sell covered calls on top of that to generate some income with that Bitcoin. So it just expands the ways that people can own this asset and have it play a role in their portfolio, which gives people a lot more customization and a lot more kind of ability to hold it in the

portfolio. But have you seen more, I mean, it seems like you would have seen more volume since the options came in, but it also corresponds with the election, too. It gets a little complicated doing a cause and effect here. But the short answer is, yes, we've seen more volume. I'm asking. We've seen volume. We've seen volumes increase. We've seen inflows increase. But you're right, there's multiple factors at play here, whether it's, you know, the volatility in the price, whether it's the regulatory environment, whether it's the options. All of these things have kind of And not to be cynical or weird, but how did you get half the volume? We've got $100 billion in assets under management in Bitcoin ETFs.

That's a lot. That's a very successful launch. I don't know if it's the most successful in history. But BlackRock has, I think, $48 billion, half of that. There's eight or nine Bitcoin ETFs out there. I mean, and they're all essentially the same product. You're owning Bitcoin. I mean, go ahead and touch yourself a little bit.

How did you get half the product? We see consistency across all different client types that they are looking for quality behind this. product. They want to go with a brand that they trust is going to deliver the price returns of Bitcoin. And being able to invest in a BlackRock product by trading in an exchange, holding it in your brokerage account next to your stocks and bonds, just makes quality very accessible with I bet. You know, it reminds me of Schwab. Remember when Schwab entered the ETF business, they had these plain vanilla and nothing ETFs and everybody said, nobody's going to, there's nothing new here. And yet they powered themselves right in because they had the pipelines, the distribution

network for people to instantly pick it up. Is that a factor here? I think I'm trying to figure out why. Brand really matters. I think brand matters even more when you're in a new asset class or a new area of doing something. You know, whether you love or hate BlackRock, one thing you can say from this, they tend to stick by their products. They don't shut down half their product line every week or two. They're willing to put a product on the menu and say, no, no, we're committed to this. This is how investors should think about an asset class. I think that's part of the reason for it is the brand for I shares is you're the ETF folks, you've been there from the beginning. I think that's hard to compete again.

Now it's time to round out the conversation with some analysis and perspective to help you better understand ETFs. This is the Markets 102 portion of the podcast. Financial Futurist and ETF expert. Dave Nautic continues our conversation now. Dave, we had a great discussion with Jay Jacobs at BlackRock about trends in 2025. But we are closing out one of the all-time great years. talking about record inflows, we're going to hit a trillion dollars. I think we're at $950 billion coming into December. Yes. More than 10 trillion in assets under management.

We started the year, I said with 3,000 ETFs, we seem to be heading towards 4,000. This seems to be the amazing thing to me. There's just more stuff coming out. You think we'd already invented everything, and they keep finding things out. What sticks out to you this year? Well, so the big trends in terms of launches, I mean, active management, right? we've had hundreds of active management products launched. A lot of it comes from traditional folks in the space,

putting their sort of marker in to try to get into the ETF action. For the most part, I think that's a good thing. I think active management should be in an ETF wrapper, let investors evaluate it. I don't have a problem with that at all. The other big category of launches we've seen have really been what I would call retail speculation products. Those are things like the single stock ETFs,

the single stock leverage and inverse ETFs, Some of the options products, I would put things like even things like options on Bitcoin, go into that category. These are largely funds that are designed for people with short time horizons who are looking to capitalize on a quick move. We all know that that's not long-term investing. It's a different thing you can do in markets. It's fine. Most people in the world are actually long-term investors. They need to be long because that's how they're going to fund their retirement.

It's how they're going to fund their kids' education. It's how they're going to buy a house. We haven't seen a lot of products launched that help people do that. And that makes me a little bit concerned. It's not a washout. I'll highlight one example at the top of my head. The Lifex funds just launched. They're basically bond ladders with dates on them.

You want a bond ladder that is done in 2052? You can buy a bond ladder that ends in 2052. Sounds very simple, but it's a convenience wrapper that an actual long-term investor or allocation. Well, that solves a real problem. Why do I have to go out and build a bond ladder? want to buy two's, five, and tens. I just want to be able to give you a million dollars and now I'm going to get $6,000 a month for however many years and I never have to think about whether it moves or not

because I own the underlying bonds. That's the point of bond letters. You don't have to care about interest rates anymore. You just get your cash. So there are some of those products solving some of those problems. Right. But the majority- And who had the bond letters out recently? Lifex is the money of funds.

And from Stone Ridge asset management, newer firm. The challenge, though, is that there's just not a lot out there for somebody just trying to invest for the long term. And maybe there doesn't need to be anything new. Maybe all of that. Well, why shouldn't there be? I mean, I love it when you go all Jack Bogle on me. Bogle, for those of you don't know, was the founder of Vanguard and was very suspicious of day trading type products, which is what's happening here. Which is what he was skeptical about ETFs for exactly that reason, because he was worried people were going to overtrate their portfolios.

So am I. So, yes, but is it any surprise, given how we have saturated the market? They're looking, I mean, the ETF industry is in this paradoxical situation where they never had more assets under management, and there's never been more pressure on them due to fee compression. So they've desperately trying to figure out how do they, how can they increase the basis points for the services they charge? That's basically, how do you move that number? And all that retail product charges very high fees. Like a lot of it's 1% or a little bit higher because the assumption is the people,

who are owning these things are owning them for weeks not years right and if I they don't care you it's going to cost you 1% a year to rent something for me for a week you'd be like okay that's pennies I don't care right if I told you it's going to cost you 1% a year for the rest of your life you'd be like wait a minute I don't like that at all so the pricing sort of follows the use case so of course what we've seen is a lot of the intelligentsia of the ETF industry has now moved towards these yolo 1% So why don't we have enough, why isn't there enough academic research, or maybe there is, actually, we're not publicizing it right, that says these products suck?

Why is there, there are products that say you're a fool if you start trading too much options products? A two-x micro-strategy fund that does what it says it's going to do doesn't suck. It's a, it's a sharp tool. Well, why isn't there where academic reason says you will lose money trading these things, you know, the vast majority will lose money? I think that there is an education gap. And unfortunately, for most of our careers, by. That education gap has mostly been to financial advisors.

They've been the gatekeeper for most significant wealth. And we educated the advisors as best we could. And I think they got the message. Most of them used model portfolios and pretty straightforward products now. Much harder to do that when we're talking about mass retail, the kind of mass retail that showed up in the pandemic with Robin Hood accounts, learning how to trade for the first time, maybe being in crypto. There's a whole new level of education that really has to happen.

And it's not like you're ever done, right? I have to remind myself that every time. Sometimes I do a presentation on like, ETF creation and redemption, and I'm like, oh, my God, I've done this a thousand times. But I haven't done it a thousand times for the 22-year-olds in the audience because they were 16 last time I did it, you know, at that show or whatever. So that, I think, is a perpetual problem.

And as we get more ETFs, you said we have a thousand launch this year, I'm guaranteeing we'll get a thousand launch next year because every interesting security in the country is going to end up with a single stock, levered and inverse and options. But a lot of them failed. Like there was a Pfizer one. I don't think that succeeded very well because there's not enough volatility, right? Well, what we're going to see is those things, somebody's going to stick with them, right?

So we've seen things like the Yield Max series, which is a couple dozen funds and a handful of stocks. Those are going to be there for a while, whether or not Tesla falls off the wagon or this, you know, Pfizer falls off the wagon. We're going to see those stick. I mean, not all of them will, but somebody is going to end up with a thousand of these products. on their balance sheet. And that's going to be an education challenge to teach people what those products do and what they don't do in a portfolio.

But where do we... I know I sound curmudgeonly, but where do we get the education that it's not a good idea for you to have two times leveraged Tesla sitting on your... Not unless you're watching it every minute. Yeah, right? I mean, that's a trading tool.

Don't you notice, I mean, we've talked about this for years, you and I, how people cannot get their head around a daily expiration and a daily reset. They just can't get it. Well, and combine it with the fact that in the most volatile cases, micro-strategy is the case and point here, they can't even run these funds the way we run a normal S&P levered fund because nobody will write the swaps.

So they're effectively managing an options portfolio of calls to try to use that leverage. And they still have all the daily reset problems, but now you've got all the slippage of the options. So we're in up market and everybody looks like a genius. Would it take a down market to wash some of this to tamp down some of this speculative activity? A grinding, horrible down 10% year as opposed to like a bad five days, which is what down markets look like these days. A really bad year would absolutely flush

some of these products out. But remember, most of these products have inverse versions too. So, you know, on the day that Microstrategy goes down 15 or 20%, you're going to look like a hero for being in the short side. All right. Dave, always a pleasure. Of course, we'll have you back in 2025. and thank you for your observations through 2024. Really appreciate it very much. That does it for ETF Edge, the podcast. Thank you for listening.

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