ETF Edge - Bitcoin ETF Bust

Episode Date: November 15, 2021

CNBC's Bob Pisani spoke with Anna Paglia, Global Head of ETFs and Indexed Strategies at Invesco, Dave Nadig, Director of ETF Research at ETF Trends, and James Davolos of Horizon Kinetics. They discussed how ETF investors can hope to play the rising tide of inflation, whether it be through key sectors, commodities or bonds, along with the never-ending crypto conundrum. What was behind the SEC’s rejection of the latest pure-play bitcoin ETF proposal? And is the crypto community any more optimistic about 2022? In the ‘Markets 102’ portion of the podcast, Bob continues the conversation with Dave Nadig from ETF Trends. Hosted by Simplecast, an AdsWizz company. See https://pcm.adswizz.com for information about our collection and use of personal data for advertising.

Welcome to ETF Edge, the podcast. If you're looking to learn the latest insights on all things, exchange-traded funds, you're in the right place. Every week we're bringing you interviews, market analysis, and breaking down what it all means for investors. I'm your host, Bob Pisani. Today on the show will be big on inflation, how ETF investors can hope to play the rising tide of inflation, whether it's through key sectors, commodities or bonds, along with the never-ending crypto-conundrum, what was behind the SEC's rejection of the latest pure play. a Bitcoin ETF proposal and is the crypto community. Any more optimistic about 2022? Here's my conversation with Annapaglia.

She's the global head of ETFs and index strategies at Invesco. Dave Naughtick is the director of ETF research at ETF trends. And James Davilos is with Horizon Kinetics. Anna, on Friday, the SEC rejected a pure play Bitcoin ETF. Now, we know there's two Bitcoin futures, ETF's trading. Another one's going to come this week. But a short while ago, Invesco decided to withdraw its Bitcoin futures application. Can you tell us why you made that decision?

Sure, thank Bob. We made that decision because after studying the market for Bitcoin futures and looking at the current market environment, we just concluded that it is not the right time to bring a product like that to market. As you may appreciate the market for Bitcoin futures is in Contango, which means it's really expensive towards the futures. We did A rough back on the envelope mat, in Mayerode 60 to 80 to 90 basis points of performance when we rolled up futures. And we just thought, unless you can align the returns of the funds to the returns of the underlying commodity, this is probably something that is not right for the market today. This is what's over our decision, but we are fully committed to the pure play.

You know, Dave Van Eck is launching their Bitcoin Futures ETF this, week. I mean, that's three Bitcoin futures ETF we have now. Is Anna right? Is that more than enough players? I mean, Anna's concerns about costs and tracking issues, they certainly seem to be sound to me. Well, if all we're going to do is get beta one exposure to something like the front month futures, we don't need 10 products doing that. I think there's plenty of room for a little price competition. That's what the Van NAC product is. It's 30 basis points cheaper than the two that launched a little bit earlier last month. So, yeah, a little price competition, I think, is a good thing. But we definitely don't need another 10 of these. So a little caution here is probably warranted.

You know, Dave, the SEC rejected the pure play Bitcoin ETF on the exact same grounds they always have. They can't prevent fraudulent and manipulative acts, is the standard quote. Is there anything that can cure this complaint, this longstanding complaint? Sure, comprehensive crypto regulation, but I don't think we're going to get there in a real hurry. Coinbase came out with what I thought was a pretty solid proposal a couple weeks ago, really asking Washington to give them a single regulator, probably a new regulator that's not the SEC, that's not the CFTC. Now, whether we get that or something else, I think until we get clear regulation of the underlying coin markets themselves for U.S. investors, I just don't think

we're going to cross that hurdle. So I think a real solid, you know, physical Bitcoin ETF is probably at least a year off at this point. Yeah, Dave's pretty pessimistic, but I have to say everything so far indicates Gensler is not going to do anything absent clear regulatory control over important areas of the crypto space, Anna. So your thoughts on this? What are the chances for a pure play Bitcoin ETF in 2022? Well, I believe that the 2020 is going to be the year for the pureplay Bitcoin ETF.

So for no reason other than it is a matter of. of customer protection, investor protection. You cannot really limit the access to markets by investors. And today, investors can buy pure play Bitcoin ETS in the private market. They can buy it in Europe, they can buy it in Canada. So with holding that type of access here in the US does not do anything to protect the same investors

that the SEC is worried about. So I do believe in regulation. I do believe that Gensler is a question. committed to providing an environment in which all those risks are going to be listed. And I do think that 2020 is going to be the year for a pure place. And it's probably wishful thinking. I guess the problem is you take Gensler at his face value. If he's not going to get comprehensive legislation that clearly indicate who controls what,

it's unlikely he's going to move. I think we're at an impasse here. and we need comprehensive legislation. I'm in Dave's camp on this one. I want to move on to talk about inflation, though. Jim, since launching the inflation beneficiaries ETF in January, again, the symbol's INFL, your assets have gone straight up. I see you're approaching a billion dollars right now in assets under management.

In this, you own land. I understand that. You own energy, and you own exchanges. That's what's curious to me. You own the Deutsche Borges. Australian stock exchange is very big. Walk us through what you own here. and the breakdown, land, energy, and stock exchange

seem to be the main theme here. Sure. So the unifying theme across everything that we own is capital light. So we want to remove a lot of the risk that a lot of other types of strategies and conventional inflation-oriented equities take through the capital intensity, the working capital, the balance sheet, leverage, the cyclicality. And we expressed that through these capital-light businesses that have very high operating margins, a lot of scale,

and so you can really compound through a full inflation cycle. Our exposure, we do it through financial exchanges. We do it through royalties and energy. We do it through royalties in precious metals and base metals. We do it through brokerage firms. Brokages in insurance, commercial real estate, shipping. We do it through agricultural processing companies where, again, they're benefiting from the throughput,

data and research, where you can touch industrials, automotives, health care, a lot of industries that you don't get in these conventional funds and conventional allocations, but here you're getting into these niches of inflation where you're seeing a lot more inflationary forces, but here you really benefit from being kind of in that middleman or tall-boot type of role where you get a lot of the benefits of inflation

without the detriments of a lot of businesses that are directly upstream in the sectors or sub-sections. Yeah, and it's a fairly concentrated portfolio. The top 10 is a very large part of the overall holdings. But I see Charles River Lab, but we've discussed this before. This is a pharmaceutical lab research companies. Your number one holding at about 6% of the assets. Explain the rationale between holding a pharmaceutical lab research company. Sure. So I think health care is one of the pretty hard to dispute areas of inflation over the last five, seven, ten years. You can kind of argue how the BLS massages data in other areas, but everybody's seen health care inflation. But it's really tough to access it, whether you go through a biotech or a pharma, because of all the capitalized expenditures and what it really takes to create the next blockbuster drug.

And when you go into kind of the HMOs, the insurance, the skilled nursing, again, you're really captive to kind of what the administration is going to do, and you have a lot of exposure to different. areas within the cost curve. Charles River, their main business is contract research. So basically, they're benefiting from doing the safety and discovery assessment of very early stage of a lot of biologics, pharmaceuticals, and therapeutics. But by virtue of their network of labs, their databases, and their processes, they can do everything faster and cheaper than the leading biotech, governments, and academic institutions. So they can really scale that business and benefit tremendously. from the quality and pricing pressure within the health care ecosystem, again, without being that directly exposed to rising costs, whether it be wages or reinvestment or debt or all these other kind of areas that are more, if better, more, affecting the upstream players.

You know, Anna, it seems like you're seeing something very similar. Investors are reacting to inflation concerns by adding commodity ETFs as an inflation hedge. Now, you've seen increased inflows. into your commodity index tracking ETS, DBC, and P.DBC. Tell us a little bit about these and what did they own. Sure, Bob, you're absolutely right. We are observing this trend today, but it's not the first time. Every time that there are concerns about inflation, investors turn to commodities and use commodities as a hedge. PDBC and DBC invest in a broad basket of the 14 most heavily traded commodities.

They span across energy, metal, agriculture, so you understand why if there are concerns about the rising prices and inflation, you want to have access to this type of commodities. It is the same index used across the two products. They are very similar in the portfolio. It's just a different legal entity structure with different tax consequences, but we have seen significant of flows coming into the plans. BDBC started with $2.5 billion. This year is now about to cross $7 billion. BBC went from $1 to $3 billion. And we believe that this flows will continue to drive assets into these plans

as concerns about inflation continue to persist in this market. Yeah, you know, commodities make a lot of sense to me as an inflation hedge. Energy has always been considered an inflation hedge. You can always raise oil prices and gasoline. prices. But because inflation also affects interest rates, it looks to me like investors and are adding to their portfolios fixed income ETFs that maybe can generate yield while hedging against the negative impact of rising rates. I'm very intrigued by your senior loan ETF, BKLN, which has had inflows recently. So this is an index of senior loans issued by bank corporation. Tell us a little bit

about what does that own, and why would you consider that an inflation hedge? Sure, sure. That's a good question, Bob, because while investment in commodities is very intuitive as an inflation hedge, BKLN senior loans are not. But if you think about the BKLN portfolio and how it's structured, you will drive a connection between inflation, a rising interest rates and bank loans. So the portfolio of BKLN is comprised of the 100 largest institutional leverage loans. They are issued by banks to corporations.

And if you look at the list of the top of holdings of the fund, you will find very familiar names, and they include United Airlines, Burger King, Western Digital, and these bank loans have a floating-rate coupon. So if you think about an environment in which there is a concern about rising interest rate, this portfolio is something that may be attractive to you. BKLN has attracted to $3 billion here today. Today is the largest single-blown ETF with over $7 billion in assets. You know, you've also seen inflows. I'm hitting some interesting inflation hedges here into the preferred ETF market.

And Investco has a PGX, which is the preferring. Why are, and I want you to do this sort of an education moment for the viewers, why are owning preferred shares a bit of an inflation hedge? They are a little bit of an inflation hedge because again, it's the same connection to rising interest rates that is driving the flows into BKLN. These funds, and they are PGX and VRP, they invest in fixed rate preferred and variable rate preferred, and they provide income. They provide income. So for those investors who are looking for income in their portfolio in the face of rising interest rates, these are securities, and this is an asset class

that is definitely going to be attractive to you. FGX, that includes a fixed rate preferred as added $600 million this year. VRP that offers a variable rate preferred as has had the $15 million this year. So again, is the correlation between inflation concerns and rising interest rates that makes this particular investment incredibly compelling as part of your portfolio. You know, Dave, most of the inflation strategies that you hear about, the viewers write in for, the knee-jerk strategy is, oh, I'll buy tips, you know, Treasury inflation protected securities. But, you know, looking at these various strategies, like commodities, for example, like even bank loans,

or prefers, is tips really a good way to hedge against inflation? It doesn't seem to have much upside to it in my head, in my head, at least. The old story is by the time you thought about investing in tips, you're probably too late. And I think that that's really true right now. The break-even on 10-year tips right now is about 2.7%. That means you need to believe that for the next 10 years, average inflation is going to be north of 2.7 for it to make sense to not just buy a 10-year Treasury. And frankly, a lot of people don't even want to get that far out on the duration curve right now, because as you point out, we're heading into a rising interest rate environment. It's never been more clear. So what we're seeing is people really bring their duration in.

And if they're going into tips, they're going in that one to five year bucket, which I sort of consider cash parking, not really investing. Yeah. Jim, just give us your overall view on inflation. Of course, the big debate in the world I live in, which is the stock market, and the debate about peak inflation, peak earnings. Are we at peak inflation concerns, and how closely tied is that to the supply chain issues? I don't think we're anywhere near peak, but I do think it's going to ebb and flow quite a bit over the next one, three, five, seven years. But I'm distinctly in the camp that we are in a secular inflation environment.

And obviously, there's a little bit that has to do with supply chain issues today. But a lot more has to do is that we global governments have created. and stimulated a lot of artificial demand, and that is basically colliding with underinvestment and malinvestment in a lot of the areas where this demand is flowing into, which is resulting in a structural supply shortage that's just being exacerbated right now by supply chain issues. So, again, I think the biggest thing is that there's going to be a lot of fits and starts, but the overall trend is going to be higher. And as you alluded to in equity markets, the multi-trillion dollar question is going to be,

will that affect the yield curve? Because the yield curve is basically interest rates or gravity to financial asset prices. And if the long-evident curve really moves up and surprises people as it moves up, it's going to be a lead weight on equities, especially these really long-duration, highly-valued tech stocks that have really been

the engine powering the market higher. And so that battle between interest rate sensitivity and then real, not to be mistaken, with nominal growth, is going to really be the most important narrative for probably all investors over the next one, three, five, even seven years. Yeah, and I agree. The history indicates that moderate inflation stock market does fine.

When you get suddenly unexpected inflation, like in the 1970s, it tends to underperform on an inflation-adjusted basis. I want to move on and just ask you, Anna, about this whole ESG business, which always fascinates me. You've struck a bit of a nerve, Invesco has, with broadening out the triple-Qs, the NASDAQ 100. You've got a whole family of products around the NASDAQ 100. Besides just covering that, you have the next-gen NASDAQ 100, which is the, I guess, 101-200-largest non-financials in the NASDAQ. You've got a NASDAQ-E-F and the next-gen-ESG-ETF. It seems like the perfect storm here between demand for technology, which is the NASDAQ 100, and demand for ESG at the same time. So, Bob, it's the first time that I hear struck a nerve and perfect storm in the same sentence together with QQQ, QQQ, QQ, and next gen.

So this is great. Yes, we created an innovation suite for everything QQQ, everything NASDAQ 100. If you look at how technology has performed over the last two years, I don't think anybody would be surprised to hear that the QQQQ went from $66 billion in assets in 19 to crossing the $200 billion just a few weeks ago. Performance has been incredibly strong. The QQQ2 outperformed the SMP 500 11 years out of the last 13 years. So we have answered investor demand by creating an innovation suite.

That includes the QQQQ, obviously, our flagship product, QQQM. It also includes the next gen. So what's better than owning Facebook is owning Facebook before it becomes Facebook. So the next 100 companies by market cap, we believe, are going to provide the benefits for our investors. And to maintain optionality, we brought in the ESG versions of those indices, where performance is incredibly aligned with the mother index, so to speak, the next-gen, QQQQQ, and the QQQQ, but companies are rewarded for exhibiting good ESG behavior. So we do believe that the innovation suite is resonating with clients.

QQQQQQM and QQQQJ have raised the $4 billion combined over the last 12 months, and we do have a high confidence in the ESG versions as well. So, Dave, here's the cynical question on ESG all the time. Is there really room for this continuing tidal wave of ESG? First off, you watch the flows very well. You're one of the great experts. Is there really capturing assets undermining? We've got $800 billion coming into ETFs this.

year is ESG capturing a significant amount of that, number one. And number two, go ahead. Answer the question. I want to answer to follow. I was going to say, it's capturing a little, right? So it's definitely been the strongest year for ESG we've seen in quite some time. By the time we get to the end of the year, I imagine will be something like four or five percent of the flows will have been into ESG-related products.

Now, at the same time, we have just a flood of new products. So it's understandable that you're a little bit skeptical with the rash of new products here. But remember, a lot of these products are coming to market at the request of institutions that are making large allocations. Many of these launches this year have come out of the gate with big assets from institutions. So whether you as a retail investor are interested in these products is up to you. The institutional market, they're voting with their wallet. Yeah, you know, 4 to 5% of the inflows, given the PR that ESG is, I mean, it's incredible the amount of interest around this space. 4 to 5% is still pretty small.

Let me ask about the SEC. Gensler is getting a little nastier about this. He's made very pointed comments about, I want to know, and I want these people to justify exactly what is in this stuff, and I want to be able to better and more sharply define it. Do you think there could be some issues around what is ESG from the SEC in 2022? You know, I think this is pretty well-covered territory. I mean, you've got the UNPRI, which is a pretty exhaustive list of fundamental principles

for ESG investing. It's understandable that regulators may want to be able to put some boundaries around marketing. That happens all the time. You know, that there's all these rules now about what you can and can't put in the title of your fund. But I do think we'll probably see some regulation around, very light-touch regulation around what you can and can't call ESG. I actually really prefer it when we actually get really specific with this stuff, whether it's a climate change thing, whether it's a specific social or governance angle. I think there's room in this market to not just have the big broad brushes, but a lot of building blocks as well. Yeah, Anna, you got the last word here.

Is ESG, the title wave, you still see gathering assets under management, right? Do you see any regulatory issues for ESG in 2022? I don't see any regulatory issues. I think that this market is evolving and is maturing as we speak. We have seen how it's played out in Europe, where today 81% of new flows in to products went into sustainable products, ETFs or mutual funds. We think that the US market is going to mature as well.

I mean, to me, it's all about truth in advertisement. I like what they said about, you know, not just painting broad-stroke brushes, but being much more focused on what these products are all about. But as long as we continue to be truthful in the way we describe our strategies, I think we are going to be okay. I think this is a market that is going to continue to grow because it is attractive to the institutional audience and the retail audience today.

So I see the U.S. following the same trend as Europe just delayed by a little bit. Now it's time to round out the conversation with some analysis and perspective to help you better understand ETS. This is the Market's 102 portion of the podcast. Today we'll be continuing the conversation with Dave Nautic from ETF Trends. Dave, thanks for sticking around. I can't help but notice that we've got record inflows continuing here. We're at $800, I think $800 billion. We're hitting $7 trillion in the ETF business.

And what's amazing to me is the title wave into just plain vanilla ETFs. The vast majority of it's just going into the S&P 500 and the Russell 2000. Of course, I love this being a Jack Bogle disciple, being an index guy. I think it's wonderful. surprised, though, that actively managed is still fairly small level in terms of inflows,

and even ESG, as we were talking about on the show, still a fairly small level of inflows. So what's your thoughts on seeing this tidal wave of money come in this year? Yeah, I mean, so it's an 80-20 rule. So 80% of the money is going into cheap beta of some variety or another across

asset classes. That cheap beta is going into the ag. It's going to the S&P 500. And, you know, it's even going into the cheapest, most boring commodities funds as well, even though those seem a little bit more exciting. So it is definitely still this absolute victory lap for cheap beta. The things that you're talking about, you know, the ESG stuff, the active non-transparent or just the plain old active funds that have come in, a lot of the funds focused on things like innovation or some of the thematic funds. They've all had good years, right? In most years, we would be looking at the, you know,

100 to 200 billion that that class overall has probably pulled in of those sort of interesting different things. And we'd be pretty excited that that was pulling in a couple hundred million dollars. But on the backdrop of what, you know, started out as looking like a trillion-dollar flows year, we probably won't get there unless December's really, you know, insane. It to me still feels like a really strong year for a lot of those sort of newfangled alternative products. it's just being dwarfed by this flood of cheap beta money. And that cheap beta money has been coming in ever since the March drawdown in 2020. Right. Where is that cheap beta money coming from?

Are people pulling money out of continuing to pull money out of mutual funds to put it in? Is it new money? Do we have a sense of where it's coming from? So the flow out of traditionally actively managed mutual funds, particularly on the equity side of the balance sheet, has just been as strong as it's ever been. I mean, every single month, that's, you know, 100 billion flows out over there and 80 billion flows in over on the ETF side. And that's just been the case forever and ever. It's accelerated every time we get volatility. And we know that historically. Every time we get volatility, everybody sells all their active, underperforming mutual funds.

They go buy cheap beta on the ETF side of the balance sheet. We are seeing for the first time in a while, though, even at Vanguard, people moving from the cheap index funds into cheap index ETF. So there is like the second wave that's coming of money from one side of the sheet to the other, but still staying in cheap beta. Yeah. It's quite remarkable to see all of the active managers who claim when we hit volatility, you wait, we're going to be able to outperform. And we saw Morningstar, you know, our friend Ben Johnson had his report out recently.

It didn't happen in 2020. All these guys who said, oh, wait a little things really get crazy, we'll be able to react fast. they didn't outperform. Their numbers were not higher than they historically have been. But let me just ask about the markets, and be a market guy for a moment. You have said before that this is like a super risk on market. It certainly seems that way. Is that reflected in the flows into the markets? I mean, people are wildly still, it seems bullish on stocks. That seems to be reflected in the flows, right? Yeah, absolutely. We had a little bit of a pause in September. But what I tend to look at is just really gross things like the ratio of equity to

fixed income flows. That can usually tell you something pretty good about where people are feeling the risk is in the market. And with the exception of September, it's been about five to one all year. Like if you look at the overall numbers, it's been about, I'm looking about 550 on the equity side, about 170 on the fixed income side. That's actually going up, right? The last month has shown that to be even more equity, right? Even more. more going in that direction. And when you look at things like, you know, leverage versus inverse, we're starting to see people put leverage plays on again for the first time in a while. That's a reversal from what we saw in September. So honestly, every corner of the market that I look at looks

more risk on than I expect. Yeah. And the same thing with growth versus value. You know, the old argument, you know, the Fama French two-factor model, that in the long run, small caps outperform big caps and value outperforms growth and small cap value does the best sorely tested. We're going into our fourth year now where that's just not even close to working. If you would have moved into a growth fund in the last 10 years, but particularly the last four or five years, you'd be doing remarkably well. And a lot of people keep asking me about that mean reversion. It's got to go back, right, Bob?

Well, it doesn't. Does it? Like, what's the reason? Like, in this market where we have this relentless bid from 401K plans, we have this constant, you know, beating on the S&P because that's where all the derivative activity is, you've got target date funds with really well understood drawdown, so that's not going to tank the market anytime soon. So what's the catalyst for small cap value to all of a sudden show up? You need to have investor money chase those stocks for a reason. And at the moment, we haven't seen a reason. So I think we're in this slightly bizarre phase of the market. Why has growth, one?

I mean, there's a lot of cheap stuff out there. I mean, that is the reason to buy value. If the economy is continuing to expand, small caps should do pretty well. It's not an irrational idea. And yet the public seems to have very little interest in buying stuff cheap. They just want to buy growth. They want to buy companies whose earnings are growing fast, even though they're paying ridiculous prices for it.

Are ridiculous. Is the public delusional about its interest in growth? Or is there a rational reason? Is growth really scarce to come by? What's the rationale for continuing to just keep buying growth despite the evaluations? When I talk to advisors and particularly younger advisors and the pool of investors that they serve, which tends to be younger millennial money that's either done very well in the corporate world or maybe they've made money in crypto, when you talk to them about what their interest

in investing in, they're investing in the future. They are not investing in the present. So part of the reason for this focus on tech and growth stocks and Web 3.0 and crypto and all of these things, which steal all of the air out of the room, is that there is this class of younger investor, many of whom are extraordinarily wealthy. This is not just mom and pop retail investors. This is wealthy investors who happen to be younger. They're not interested in owning 3M and utilities companies because they might hang on to some of their wealth longer. They're interested in building a future. And coming out of the pandemic, that looks like a lot of these unicorn companies. It looks like Web 3.0. It looks like crypto. And that's

the reason I think for a lot of this focus. It's just a focus on the future. Yeah. And of course, the cynic says it looks like pets.com in 1999. And look how that played out. I don't think some of I don't think we're in that kind of shape that we were in 1999 with virtually no profits. There are some. I don't think it's quite as bad as that. But I do think the valuations. I don't know. Look at the IPO market, Bob. It's ridiculous. Some of it's insane. Some of the electric car companies coming out with zero revenue in $100 billion valuations. I mean, if that doesn't feel a little bit in 1999, I don't know what does. I guess we've got to queue up the print soundtrack. I think they will look back on the Rivian IPO as the IPO top of

2021, the great IPO run, and that will probably be it. But I agree, a million dollars in sales and a hundred billion dollar market cap. You can't even, you know, you're not only discounting the next five years, you're discounting the hereafter as some punitive was said a long time. Perhaps. Yeah. Thanks. I would have to leave it there. Dave Nautic, thanks very much, old friends. Dave's the CIO and the director of research of ETF trends. And everybody, thank you for joining us on the ETF Edge podcast.