ETF Edge - “Active”-ation: new way to bring new types of active management to market 3/28/24

Episode Date: March 28, 2024

The definition of “active management” is changing… and so is the way novel approaches are being developed for the ETF industy 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 InvescoQQQQ, supporting the innovators changing the world. Investco Distributors, Inc. Welcome to ETF Edge, the podcast. If you're looking to learn the latest insights on all things exchanged traded funds, you are in the right place. Every week we're bringing you interviews and market analysis and breaking down what it all means for investors. I'm your host, Bob Fazzani. The very definition of active investing is changing, and a new wave of related funds are coming online to a novel. conduit. Here's my conversation with Steve Sacks, C.O.O. of Goldman Sachs, E.T.F. Accelerator and Todd

Sone, ETF and technical strategist at Stratigas. Steve's, we know ETFs are, you know, mostly index base, but active seems to be having a moment. Why is that? Yeah, no, without a doubt, Bob, and that, you know, it's a little bit of a myth still in the market and that ETFs are passive. What really started to happen, you know, a few years ago, and quite frankly, more than a few, first active ETF in the market in 2008. But what's really happened rather quietly in the last three to four years is this growth of active strategies. Traditional, I think bottoms up, fundamental stock picking strategies that are coming to market in the ETF wrapper in the active form. Still transparent, still daily liquidity on the exchange, minute-by-minute liquidity,

but essentially, you know, active strategies as opposed to the pure passive that we're used to. And the growth has really been tremendous over the last few years in particular. Three years ago, Active ETF assets represented less than 1% of overall ETF assets. ETF assets have continued to grown. Active now represents nearly 7% of all ETF AUM in the U.S. You know, Todd, we've talked about this before. Active stock picking isn't quite what we used to think it is, though.

It's evolving, right? I mean, you and I think old school means alpha-generating stock picking, but it's changing. There are active definitions today where you can be defined as using option overlays to protect on the downside, like JetB, for example, it was very successful. Is it fair to characterize that as active? The market's certainly evolving. It's quasi-active, isn't it? What would you call? Yeah, to Steve's point about the growth in assets, active is now in this kind of different shade, right? You still have your traditional bottom-up stock

picking. That's still very much prevalent. But now you also have active hands at the wheel in terms of the option overlay strategies, right? And that's a very sophisticated strategy. I don't think the common investor really knows about. And that provides a different approach, right? It could be downside protection, it could just be monthly in type of income. You still have a very high conviction, thematic active,

right? That's your arc type strategies too that I think will still exist in some form or another. But I think this is all part of the active umbrella now. It's not just a singular star money manager. It is going all sorts of different investing and I think that's going to continue to tribute to the growth of the AUM. Yeah, I like to think of certain forms of act that we're talking about sort of almost index plus. I have my friends at Dimensional Funds.

I talk to them and they consider themselves active managers. But there's an indexing, but then there's a slight active management component on top of it. I think it's all great. It's all part of the evolution of the business here. What I am surprised at is, Steve, about how many old-fashioned socialsons. stock pickers there are out there that are turning to the ETF wrapper. Now, I know they helped, Goldman helped Jeremy Grantham, a GMO, start his first ETF. That was, I think, November of last year. He's a very famous stock picker. He started a quality ETF, QLTY. Brandis, one of the big stock

picking value firms that's out there, launched three ETFs in November. You help with that. as well, there they are up on the screen for you, and there's the GMO. That's Grantham's ETF. It seems, Steve, like the lower fees, the passive ETF industry is charging, is sort of forcing the hands of the old fund managers, aren't they? I mean, they're charging the lower fee here. To a certain extent, and it's interesting, and yeah, the third one we just launched, a third client,

it was Eagle Capital, EAGL is the ticker, just launched this week actually listed here at NYSC, 1.77, billion in assets on day one. So it's interesting when you think about really across, you know, all three of those organizations that we've partnered with at the ETF Accelerator, first and foremost, the use case across all of them was largely the same. How do we deliver our particular brand of investment strategy and be wrapper agnostic to our client, both to the react to the existing client base, but more importantly and just as importantly, the demographics are changing. I mean, right? You talk about this all the time, the generational wealth transfer

that's taking place in this country. The next generation investor prefers the ETF wrapper, right? And it goes back to a little bit of what you're saying about, you know, passive versus active. Here's what you need to remember on an active ETF. It trades still trades on an exchange, like the New York Stock Exchange. It is still transparent and it is still liquid at all times of the day. And ultimately, right, what we've been seen from an asset manager perspective is not necessarily always reacting to lower fees, but essentially the more streamlined efficient wrapper of an ETF doesn't typically have the layers of fees that the traditional 40 Act Mutual Fund has. Plus, obviously, here in the U.S., a big driver is just the tax efficiency of the wrapper itself.

And being able to employ truly bottoms up fundamental stock picking or fixed income credit selection in the act of ETF wrapper is where we're just seeing all the demand now. Well, this is a good thing, right? I think money goes where it's treated best, whether it's in the form of sector investing or just, There's global asset allocation, and the ETF is that form in the fund industry. You get the tax efficiency, it's lower cost, it's transparent. You can get the liquidity you need, as Steve mentioned, and investors like that, especially the younger generations now. That's really important.

You know, but not to be cynical, and you and I have talked about this before, if you're a mediocre stock picker folks in a mutual fund wrapper, you're still going to be a, you're not suddenly going to turn it with superior stock picker in an ETF wrapper, right? Active trading is still on this. defensive, I think, especially now that we've had very long-term studies like the S&Ps, the Spiva report. I always do that every year. That indicates the vast majority of active managers do not outperform their benchmarks. You should check it out, folks, if you don't see that

before. But you know, you understand my point. I think it's terrific that the lower fees help the performance. I mean, this is one of Bogle's big insights 50 years ago that much of the alpha that is generated by the small minority of active managers that do outperform is destroyed by the cost of the fees. So if you can reduce those fees in an ETF wrapper, that might significantly help. The lower fees absolutely help. And I think the proposition for an active manager, depending on what the strategy is, you have an SMP 500 that has five stocks at over 25% of the index. That has benefited massively for passive investing right now, but it may get a little speed bump at some point. And having that active hand at the wheel or having an option

overlay for the strategy may help at some point. I think that's also a key thing to keep in mind. The business is evolving. You know, it's one of the things you've been here, you're a veteran in this business. I've been covering ETFs for 20 years. And what's amazing is to see, besides the fads that you go through, the pot ETFs or crypto ETFs or even thematic tech, you know, they jump on the bandwagon, Bitcoin ETFs now. They keep coming and going. It's like a constant popularity contest, and ETFs are very good at that. But the other things, but the industry is maturing, and it's fun to watch that mature. Money still comes in every year. A lot of it's still passive and indexed, but it's fun to watch active management. It's fun to watch

higher-priced mutual fund managers move into the more efficient ETF space. It's part of a natural evolution. Yeah, and I love that word. You said it earlier, and I actually love what you said, Todd, relative to right, money flows to, you know, what is the most efficient strategy. And fees absolutely have something to do with. And I agree. The evolution of being right. And I appreciate you calling me a veteran, not just old. I appreciate the quasi-compliment. I usually get called old. Yeah, exactly. So look, I think, you know, all of those things are true. It is an evolution. When you think about not just the ETF wrapper, I said this recently, when do we get to stop calling this the ETF industry, right? The ETF is the wrapper. It's the delivery mechanism. And it happens to be one of the most,

if not the most commingled, you know, highly regulated delivery vehicle for asset management strategies, whether they be passive or now, whether they be active. And so fees certainly matter, but the other aspect, again, what's the other aspect of ETFs, you know, from an efficiency perspective, tax efficiency. It's a very interesting white paper out there that talks about and makes the comparison between a S&P 500 index mutual fund versus a ETF. And the actual tax differential, or alpha, if you will, is nearly 92 basis points a year. That's a big difference as well. When you think about the relative performance rankings, it's not just fees, but the difference between being a top decile manager and something below that? It is 90 basis points easily.

Less than that would be. So that's huge. But it is an industry, and you're part of that, the industry. You think folks that all the firms that want to start an ETF would be already out there. I mean, we've been doing this for 20 years. But it's amazing. There's still hundreds still in the wings. Now, Goldman formed an accelerator unit.

You're the guy running it to help create ETS. Tell us about this accelerator unit. What do you do? Yeah, well, I appreciate that compliment. One of many. So I'm the global CEO of the ETF accelerator. And it really came out of the whole idea for the business. Actually came out of my previous role at Goldman,

where I was ending up with a lot of meetings on my calendar, others in the organization the same way. Our core institutional clients were calling and asking, how do we get into this ETF space? How do we deliver our strategy, active, and otherwise in an ETF wrapper. And ultimately, we were helping them how we could, free consulting essentially,

and then obviously supporting them through the capital markets function as we do. And the idea was the drumbeat got so loud that essentially the idea was, why couldn't we do something more? So what did we do? We launched the ETF Accelerator, which is a platform that allows our clients to come in,

launch, list, and manage their own ETF, but do it off of the technology, infrastructure, and risk management expertise that goal Goldman's known for and essentially get to market faster and cheaper than they could do it on their own. And I think that's what's resonated again to date, as we talked earlier, GMO, Brandis, Eagle Capital, all felt that the journey to build it on their own would be too expensive and too long. And they didn't want to miss the opportunity cost of not delivering their investment strategies in their app. It's sort of like a turnkey operation in a way.

So I have an idea for an ETF. I come to you. You help launch it and list it, but I still manage, essentially manage it. That's sort of the limit's what you do. You basically help get the thing out the door. You are the advisor. It is your investment strategy. It is your intellectual property.

It is your brand. It is your name on the fund. But what we're doing in the background, both initially, to get the fund listed and in the marketplace, and in an ongoing basis, is actually doing all of the things that are infrastructure-related, related relative to the you would need to build out years of expertise, head count, bodies, and all of that risk management framework. The idea is that we do both services around listing and getting your ETF the market, but ongoing management services of it as well. We help you do what you already do, which is pick stocks and, you know, raise assets. I mean, like I said before,

you'd think like all these ideas who are at there or all these companies that want to go public or, excuse me, want to set up ETF structures, have already done it. But, in fact, you know, fact, there aren't. Is there a real ongoing business here? It's a leading question because you wouldn't have set up the accelerator if there was no, but tell us a little bit more about what potential business there still is out there. Yeah, it's interesting. It's a great question, Bob. So ultimately going back to, and look, there were a number of things that I would say coalesced in the asset management industry that brought us to this point, not the least of which was 611, the ETF rule that was passed in 2019. While we wouldn't call that a big boom, it was certainly a catalyst. And the idea

was it made it easier to launch an ETF, but it didn't make it easy. So really, ultimately, going back to why we started it, at one point we had more than 41 clients that had called us with exactly the same problem. How do I do this? How do I move quickly? And can you help us? And I'll be honest with you, it's, you know, ultimately pretty rare for 41 of Goldman's, you know, institutional clients to call us with the exact same problem. So, right, what does Goldman Sachs at our core? We are advisors to our clients first and foremost. And the idea is that we wanted to be able to solve a problem for them. Sometimes we solve those problems for short periods of time, i.e. liquidity in the capital markets. Other times we solve them for longer periods of time by

providing them longer-term solutions around infrastructure. But honestly, you know, that was three years ago and the demand and drumbeat has not stopped relative to the not just traditional asset managers, mutual fund managers and like, but the number of hedge funds, family offices, RIA. Are they ticket of getting into ETF? Hedge funds? Family offices. So it's not just like, see, Brandis doesn't surprise me. That's a famous value firm. They've never been, they're a mutual fund company,

but are there a lot of brandis is out there still that, you know, in the mutual fund business that are looking at this. I mean, we know how many tens of thousands of mutual funds are out there. We like to make fun of ETFs because there's gimmicky ones out there. There's no doubt about that. And they close up shop within 12 months, but there are double the amount of mutual funds in ETFs. So that's a lot.

of runway, plus all the separately managed accounts that are out there from some family offices that may find a use case in converting. Yeah, but it's interesting, Todd, right? You know this stat. Last year, there were nearly 500 ETFs launched in the U.S. alone. There were less than 200 mutual funds launched last year, and I don't think that number was much better the year before we were. Yeah.

So you think we'll see hedge funds launch ETFs? We do. We do, definitely. I mean, based on the number of conversations that we're having with our client-based, And then not just that, but when you think about the use case, I mean, right, what's one of the things that the ETF gives you, for lack of a better way to put it, you're tickerizing your portfolio, but right, what you're doing is you're actually also broadening your distribution footprint. And by that I mean access, right? You're democratizing access to your strategy. Do I think that we'll necessarily see the very esoteric or highly sophisticated strategies that are deployed in certain hedge funds today? No, but I think that there's some very good portions of those strategies. strategies, whether that be long, only, long, short, that actually do make sense for these hedge funds to essentially do what everybody else wants to do in the asset management industry. Again, what do you want to do? You want to be wrapper agnostic. More and more of their clients, particularly institutional clients, prefer liquid vehicles side by side with gated or, you know, LP type vehicles. And what I find interest is you don't necessarily have to be brilliantly innovative. I mean, Brands is the three funds you launch with Brandis.

They're one's a value fund, one's an international, one's a small cap value. You might say, don't we have enough small cap value funds in the world? But they're stock pickers. They have a slightly different interpretation of what they're going to be holding because they're active. They're not indexed guys. So you can say, here is our philosophy in an ETF wrapper. And you might get just fine in terms of assets under management to keep things going.

What you don't want is to have those people leave, that mutual fund, to go to another place where they think they can get the same thing, a lot of cheap. cheaper. That's what you don't want, I think. You certainly don't want that as, again, the business that you're in is asset management, right, and that is a for-profit business. But it's interesting. I think any number of our clients would tell you the opportunity cost of not doing it is greater, because if you don't have the wrapper, what's going to happen? Eventually, those assets are going to leave and go to a competitor. That's my point. It's a competitive business here. Exactly. I want to move on and just pick your

brain, because we're approaching the end of an astonishing quarter here. We're up 10% on the S&P. 25% in five months. That is really, really rare, folks. It's happened only, I think, seven times. It's 1950. So a lot of people complain, you know about this. The concentration risk, the people say, 30% of the S&P 500s in 10 stocks. Is this a real concern about this? And if so, where should investors turn? I hear all sorts of other ideas, but is, I don't know, is returned? to the mean or mean reversion necessarily going to happen? It does not have to. We all go back to the tech bubble as the historical miss of the dataset,

but when you get momentum like this, it begets more momentum. It's consistent with major market lows back in a year and a half off the October 2020 low. And for example, you spend much of the 90s in a similar scenario where you had these types of momentum returns, and it just kept going eventually until the economic. conditions really deteriorated in 2000. But if you're worried about the concentration risk, and we get a lot of questions about this, you can either, A, go the active approach

where you're going to have a more balanced sector skew or equalate your portfolio. And there are plenty of solutions out there now from the ETF industry to equalate the SMP or use a fundamental factor to equalate. And that way you're getting less tech exposure and you're getting more of the bench, more energy, industrial, materials.

In order to at least balance things out, you may still get hit on a major decline, but at least it may not be a very as bad as if the tech names and the communication type names get hit. What I find interesting is, after a run like this, everybody is calling me up, and everyone is in the imminent pullback business, you know? Well, Bob, come on. You don't really expect this to be up another 10%.

The second quarter can't happen. Now it doesn't go. Trees don't go to the sky, all this. And yet, your point is well taken. I looked at this, and the seven times this has happened since 1950, the S&P was hired six out of the last seven. And that's because in most of the cases, the momentum was really powerful. The advanced decline line was really strong in these situations.

It wasn't just, you know, eight stocks moving the whole planet. And the AD line has been really good. 70% of the SP is up this quarter. This is as much, those stock, the eight stocks, not however many, they influence the benchmark the most. So it feels like it's just them. Yeah. But the bench, as I like to call it, small caps are starting to get their mojo, energy,

industrials. those all work, and that reflects a more confident market, and you're going to have FOMO set in. I guess what I try to use this for is a teaching moment, because the implication is these people are saying, well, of course, it's got to be a pullback. Well, yes, maybe, but you think you know what to do with market timing, and that's the problem philosophically that I have. We know that market timing is a very, very poor way to invest in the stock market. And you think you know when to go in and go out, but you've got to be right going in and going out. And we all know how hard that is.

You can't do it very well. Be right twice. Yeah. It's just a really difficult thing to do. So I always try, and this is my Trader Talk today, folks, if you want to go to it, tradertalk.c.com is don't worry about market time, particularly when you've got something like this. And so play against this trope.

Oh, there's got to be a pullback, wow. Of course. Maybe. And maybe we'll be down five or, you know, eight or nine percent sometime in the spring. But the odds right now are that will be higher six months from now. Exactly. So now what do you do? You've got to be right market timing going in and then go back in and then you're not,

you're going to make yourself crazy here. This is why I became a Jack Bogle, the cycle, because I couldn't figure out how to do market timing. And I finally realized Bogle was right. Forget. Stop doing that. It's a silly way to make money. This has been a great conversation. Thank you, Steve.

Thank you, Todd. Thank you very much. Really appreciate it. Now it's time to round out the conversation with some analysis and perspective to help you better understand ETF. This is the market's 102 portion of the podcast. Todd Sone, ETF and Technical Strategist. Strategist continues the conversation with us, and thanks for sticking around. I appreciate it.

We're at the end of a remarkable quarter. Everyone likes to say, oh, we're up 10% because a few tech stocks are moving and not much else. But that's not true at all. Tell me about, let's just talk flows. Where has money been going in ETS? Talk like sector-wise this quarter. Sector-wise has been all about tech, and rightfully so. Technology stocks.

I've done extremely well, whether it's year-to-date since the October low, going all the way back to the summer during the Fed pause, all in on tech. And a lot of the other sectors really haven't seen that much love. So am I a pinch concerned about it? The sectors haven't seen that much flow. That's a little disconcerting, considering how well other sectors have done.

So the flow is not exactly following the returns very well. It's not reflective of what industrials have done. industrials have been magnificent, right? Super strong. They just don't get the attention that magnificent seven types. And energy's done great. Energy's coming back, and there are outflows from there. Healthcare is trying to improve, too, and there's been outflows from the health care.

What is it, you know, I've been struggling this for 20 years, looking at outflows and trying to figure out what, if anything, it means. When do you think watching outflows become important and what did they tell you, or should we not even bother at all with that? I don't view flows as a signal. It's not a, oh, here's what's happening, buy or sell. But I view them as a great lens into psychology of investor attitudes. So if I see outflows from a sector that's actually starting to go up and prove and even start to lead on a relative basis, that's interesting to me. It tells me maybe the crowd and the herd is not there yet and that there's room to run.

Whereas I look at what's going on with tech, tech has a lot of momentum, but there is definitely aggressive attitudes towards that space. So I would just be a little bit mindful of that, maybe be aware of a speed bump in the second quarter. Let's talk about bonds. It seems like we've sent inflows, too. Corporate have seen inflows. I think short-term treasuries, I think have seen outflows. That makes some sense.

Some people are betting, you know, maybe intermediate term or longer term has better staying power. There's a mad dash to keep that 4 to 5% yield going. Investors are loving their 4 to 5% yield going. are 11, they're 4 to 5%, because they haven't had it in so long. It's a candy bowl you haven't had in ages, right? So the cash part, I think there's a little bit worry about a cut at some point this year or more cuts. So you're going to want to get out of that short duration.

But the issue with longer duration, whether it's the TLT or a similar type of product, is it comes with immense volatility. You're adding basically stock-like volatility to a portfolio. So that's why I think you're seeing all this money go towards the belly of the curve, especially among corporates, right? That's a little bit more juice in terms of return, but less duration sensitive, far less duration sensitive. I think that's a comfortable spot for a lot of people in their portfolios. Yeah, yeah.

Well, in terms of everything else, how about some alternative play? Japan's been doing well, emerging markets have been doing well, ex-China ETSs, you know, emerging markets. If you could take China out, people seem to like that now. Ex-China is a big theme. I don't love China for an investment. You and I have talked about this plenty. It's, you know, lighten money on fire. Yeah, maybe they're just a trade there for a quarter or so.

But Europe doesn't get any love, despite new all-time highs there. Why is that? I think investors have been burned by it so much. You know, same old Europe. And same thing with Japan, too. Allocations are up, but it's not this craze that we saw a decade ago when Japan really introduced this monetary easing and the markets took off there. But why do you, for example, you think that there's not much interest in Europe?

I mean, it can't just be because of the war in Europe. were in Ukraine, you know, when I look at the composition of Europe, it's really tech light, you know, and I think that is the major problem. There just isn't much there. When Microsoft and NVIDIA are helping push the S&P, no one's going to care about European financials and European energy, right? It's just not enticing enough. But what I will say about Europe and Japan is that they have a good share of industrials, and those have worked globally. So if you needed to lighten up or water down your tech exposure, then that's where you go. You go internationally. And I can't, I'm a show passed without mentioning spot Bitcoin ETS, of course. How would you access

the flows here? Part of the problem is you kind of have to take grayscale a little bit out of the equation. Looking at the other nine that are out there, what's the total flows in those other nine? You're looking at about 25 billion for the quarter. And when you break down categories, including sectors, including different durations of bonds. Spot Bitcoin X-grayscale is the top category. I think that's really impressive. Issuers don't want to miss out on this asset class. They know the access to it is so important,

and you're seeing that reflected in the flows and volumes too, right? It's not just grayscale seeing all the trading liquidity. It's fidelity and eye shares, too, and then followed up by BitWise and ARC product as well. So issuers realize this is too big of a chance to miss. When you say $25 billion, Is this including, are you just talking about the nine? The nine, yeah.

The nine. And gray scale has had outflows, though. It had, what, $27 billion initially? Yeah, so you take outgrayscale, which has about $12 or $13 billion outflows, which is basically the most of any ETF ever at this point, basically, two months. Then you're at $12, $13 billion net, which is still really impressive, though, for a quarter. Yeah, no. I think that's an important point.

How about the losers out there? It seems like nobody's interested in gold. No. I don't know what that says about anything, even though gold was a new highs. Yeah, I can't quite put my finger on it. Inflation will see if that becomes a problem in the next year or so, TBD. I think with gold, you have gold at an all-time high, but you have so many other options available. Equities have been strong, crypto's been strong, and now you have income-producing assets from bonds.

So I think gold just gets left out in the gold there. A lot of competition. Yeah, that's to me the simplest example. maybe there's something else involved there. No, I think, look, I think it's a competitor for a certain extent to alternative asset classes with Bitcoin. I have never understood the argument. It's a hedge against inflation. I do understand that central banks have been big buyers of gold recently the way to diversify their dollar assets. But, you know, there's a lot of competition for the dollars.

That's simply a simple way to understand. And you have more and more solutions available from every angle of ETS. Todd, thanks very much. Appreciate it. That does it for this week's ETF. the podcast. Thanks for listening. Join us again next week. Or go over to etfedge.cnbc.com. InvescoQQQ believes new innovations create new opportunities.

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