ETF Edge - Crypto Chaos Aftermath – Post-FTX Impact on ETFs 11/14/22

Episode Date: November 14, 2022

CNBC’s Bob Pisani spoke with Deborah Fuhr, Founder and Managing Partner of ETFGI – along with Simeon Hyman, Global Investment Strategist at ProShares. They dove headfirst into last week’s crypto chaos – including the fallout from the collapse of embattled crypto exchange FTX and the titanic trading volume in bitcoin futures ETFs as a result. With crypto facing a true crisis of confidence, how can investors hope to weather the storm and regain faith in digital currencies after a massive blow-up like that? In the Markets ‘102’ portion of the podcast, Bob continues the conversation with Simeon Hyman from ProShares. Hosted by Simplecast, an AdsWizz company. See https://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, exchange traded funds, you're in the right place every week. We're bringing you interviews, market analysis, breaking down what it means for investors. I'm your host, Bob Pazani. Today on the show, we'll dive headfirst into last week's crypto chaos, the fallout, from the collapse of unbattle crypto exchange.

F-TX and Titanic trading volume we saw in Bitcoin futures ETFs as a result. Is crypto facing a real crisis of confidence right now? How can investors hope to weather the storm and regain faith in digital currencies after a blow-up like this one? Here's my conversation with Deborah Fuhr. She's the founder and managing partner of ETFGI, along with Simeon, Global Investment Strategist at ProShares. Simeon, lack of regulation over FTX is just driving.

and everybody crazy at this point. But we did have one thing that really stood out to me. We have an entity that traded Bitcoin, Bitcoin futures, in the futures market, record volume. This is your product operated officially. The prices collapsed, but if you wanted to get in or out at any time, you were able to do that. Absolutely. So we have BITO, which is the long Bitcoin strategy ETF using Bitcoin futures. we also have B-I-T-I on the short side.

Both saw tons of volume, both traded well, spreads tight, in a tumultuous market. Yeah. And you know what's amazing to me, Deborah, is regardless of the debate on what crypto assets are worth, and some people argue they're not worth anything,

and this is a stunning collapse, the E-T-F market function fine here. Another example of really high stress and the ETF market function as it was supposed to. Yeah, and that's not surprising, because think back to the time of COVID and high volatility, people thought fixed income ETFs weren't going to work, and they did, right? So the ETF wrapper works really well.

And why does it work so well? What makes it so efficient? You know, people say that about the bond market. You know, oh, you have these specialty bond offerings, you know, you know, bond any kind of bank notes, for example, or various offerings of, limited bond trades that were available, and the minute the market gets panicky, the underlines are not going to be able to trade, and the ETL will freeze up.

And it turns out that wasn't true. None of that is true. Actually, the ETF was the price leader over the underlying. That seems to be the real brilliant insight here that we've gained from the ETF business. So I think it goes back to there is a whole ecosystem, and ETFs are highly regulated, right? They're funds that have the added benefit of being listed and traded. on exchange. So what's inside of it is highly regulated. And then the authorized participants, the market makers, the trading desks all work together to make sure they work. And they go out

and find prices. So that's what happened during the fixed income volatility during COVID. The APs go out and find real-time prices to be able to trade. And that's why ETSs were more efficient in pricing than mutual funds. Yeah. And remember also, you, in a lot of cases, you're not trading the underlying. You're just trading the ETF as a product. That's- Important way to look at it. So there was enormous pressure on the SEC and on Gensler, Gary Gensler, and his predecessor to approve a Bitcoin ETF. He has not been willing to do that.

He has said there are aspects of this that are unregulated still, particularly the exchanges. There are this fraud and corruption charges out there. He's looking pretty good right now, at least in my opinion. I mean, he's stalling. It looks like it was the right thing to do at this point. What does it do for the chances of a Bitcoin ETF sometime? in the future and what have we learned about this?

Well, I think it is important though to look outside the US. So in Canada, we have spot Bitcoin, we have Ethereum, we have Ether, we have Ether, we have a bunch of products in Europe, in Brazil and other markets, and they've all worked well, right? So I do think that the crypto market has moved on from the initial time back in 2013 when the Twins wanted to launch a Bitcoin product, right? So I think that it probably would have worked well, but I think right now there's not an appetite to bring it forward. And I don't think during his commission, we're likely to see a Bitcoin, a spot Bitcoin products.

Well, that's a good point. But what about her point? I mean, they've got this elsewhere. It seems to be working, even if the market's collapsing. Is there less regulation in Canada, more regulation? I mean, I think there's two points that I make. First, FTX, a special situation. But remember, the exchange system as a whole for Bitcoin and cryptocurrency is still not mature.

You know, even if you don't have an F-TX thing, there's still the issue of lack of segregation in any Bitcoin exchange in the event of bankruptcy. So there's still maturation that needs to happen there. The other thing that's really important is that the futures market itself has matured very quickly. So everybody wanted to talk about the role costs when we launched BITO. You know what? They've come down 80 percent, and they're converging right to the textbook solution, which is this is a financial future. You don't have to store oil and tankers, so therefore, the roll cost should equal short-term financing costs. By the way, Biddo holds cash to be quote-unquote fully collateralized, and therefore the roll cost offset by the earnings on the cash,

and we've been tracking spot Bitcoin very, very closely. So, you know, there's a little downside to the futures contract. Right. Well, this is a very important point about this is the problem with owning futures contracts. when you roll into them, the commodities have storage costs, you get hit with that, and you get decay over time holding the asset. But here, there's nothing to store. There's no, it's just an electronic ledger item, literally. So in the future is a cash settled. But is there actually a roll cost involved in this? There is, but what the textbook says is that the roll cost should be right around that short-term near-risk-free lending rate.

That's the no-arbitrised condition. And Biddo is just, it's not a levered strategy so you hold enough cash such that the return should be approximately spot bitcoin and therefore that role cost is offset by the earnings on the cash and that's what we've been seeing this year as biddo has tracked spot bitcoin very very well uh... i want to distinguish people

ask me what's going on with f t x i want to distinguish here between the blockchain concept which i am very personally think has tremendous future reduces financial friction, smart contracts, decentralized finance, I think have tremendous potential as a financial disruptor, as a technological disruptor, and what's going on here? There's really two other things going on. One is what's the value of cryptocurrencies in general, which obviously don't have intrinsic values, so go up and down dramatically.

But the other is what's going on with FTX, which may or may not involve fraudulent activity. we don't know. So there's very specific situation going on here that's confusing everybody. Would you agree with the idea, though, that this is definitely a ding on cryptocurrencies, but doesn't destroy the viability of the blockchain concept? Oh, absolutely not. I mean, we're in the early stages. There's clearly going to be a period of maturation.

But to your point, blockchain and defy is absolutely here to stay. And Bitcoin, for it's either a feature or a bug, depending on your point of view, is the pure play. It doesn't have utility on the blockchain, but it's a store of value. And look, if you want to have the sort of extreme view of things, there's no gold standard for the dollar either anymore. Yeah. Well, yes. However, I would like to back the full faith and credit of the United States over the full faith and credit of Bitcoin, of which there is none as far as I'm aware, other than a belief system around it. Deborah, I'm wondering how this might affect crypto-ETF flows.

This is your data. At the end of October, 162 products listed globally, 7.5 billion. This is crypto products. Are we going to see that change, or does this change this? I think people are concerned, but I think you're right. We have to differentiate crypto products from the blockchain and smart contracts because we are seeing that being used for many things, including tokenizing private equity and allowing retail access, right?

There's a project in Europe where creations and redemptions for ETFs are being done by ETP link using smart contracts, where before they were being used using emails. So I think there are definitely applications, and the technology is very different than crypto. Yeah. I want to go back to your point earlier about the fact that there are Bitcoin ETFs elsewhere. There's in Canada, for example. How are the authorities handling it there? I mean, Gensler says, I need more control over exchanges.

I have no regulatory authority. What is the status of the regulatory system there? So basically they went to the regulator in Canada and said the ETF wrapper is better than other ways of allowing investors to have access. And the regulator bought into that idea. And just like in fixed income, the crypto ETPs or ETFs in Canada have worked as well as they would if they were. And they're regulated by the Canadian authorities. And presumably they're regulated. So they operate under a set of rules and regulations, obviously.

Similar to Fortyac funds here. There's a set of regulations in Canada. Canada actually has had ETS for 33 years. We've had it here for 30. Yeah. So Canada. So is there some argument that could be, I'm just trying to flip this on its head and say, well, look, it is operating over there.

Nobody's going to necessarily protect anyone from price declines. I think the problem here that Gensler is afraid of, which makes sense, is if this thing collapses, if Bitcoin goes to $1,000 or $500, five years from now, somebody's going to haul those people in front of Congress saying, did you approve Bitcoin for Grandma? Because this is essentially making it available to the masses. And whether or not it's tested as a real asset class, or should that be the standard? I don't know. And I think it's interesting you point out. Canadians are working on this. They're doing it. I think the challenge is normally regulations in the U.S. are about disclosure, right? So you tell what type of disclosure needs to be

available and then people decide if they're going to invest, right? And that's the whole thing with FINRA talking about complex product. What is a complex product? Well, I think with respect to Bitcoin and cryptocurrency, what happens if Bitcoin goes to a thousand? The issue isn't so much that we have disclosure rules. People can lose money and we have the ITI. You could take the short side. The question is, what stress would that put on the exchanges if you were invested in the same? You were invested in the stock market, excuse me, in the Bitcoin exchange itself. And look, the money's coming out of the exchanges right now. People are worried about the co-mingling of assets, and they're going back to these cold wallets where I have my flash drive. But the ETF fixes a lot of that, particularly when it's

belt and suspenders with the futures market. Yeah. I want to turn to a different topic, Samian, that pro-shares is very involved in. And that is, and I get questions on this all the time. These incredible volumes in the pro shares long and short NASDAQ 100 and S&P 500 ETFs. It's an amazing business that you've got going here. Every day, every day I look at the heaviest volume ETS by dollar value and just sheer volume. And these show up every time. Pro shares ultra pro QQQ here. We're listing them here.

This is three times leverage, the first one. And the ultra pro short QQQQ, the pro shares, ultra-pro short QQQ. So these are amazing. The ultra-short Pro-Q-Q-QQQQ-Q-I-D. They don't have the symbols here. It's two times the inverse. The short S&P, which is S-H, is just a simple inverse.

Every day they have the biggest volumes here. And we've talked often about these leverage and inverse products, how they reset every day, how retail and investors should be careful. Can you tell us a little bit who's using these products exactly? I mean, the volume is so titanic that I want to see a use case for this. We tell retail investors probably shouldn't do this and hold them for long periods of time, but somebody's trading these things like crazy. Well, there are a range of uses. We always talk about this. We're super proud to offer the toolkit to investors, both sides of the trade, depending on your point of view.

I think when you look at a volatile market like this, one of the things that I'm sure that you notice is the divergence of views. This is a time when there's some people who think this is, they see the CPI print and they think that's only the beginning of the bull run. And then there's some other folks that say, man, I'm going to sell this after this rally. So I think that divergence of rule of views prompts folks to use these tools at a little more volume. And even in this environment, their uses that are particular, right now. And this time of year, as an example, tax loss harvesting. What if I'm about to harvest some losses on my high-flying tech fund? Well, I go harvest the losses. I can use a pro-share's long QQQQQ, and I can have my exposure to the end of the year and figure things out later.

Maybe, yeah. I guess I've, you know what I would like to do? I'd like to bring some big active traders on and show how they use this, because there's got to be some relationship between, say, owning a sector like the NASDAQ 100, owning options, and having different positions. There's a clear trading vehicle that's possible here. And I would like to see a clear use case because the volume is so big that this isn't just a bunch of retail people, you know, suddenly deciding they want to own game stock on a day when game stops of 3%. This is very systematic.

And there's a clear, there's some kind of trade. methodology that exists. And I understand why some people don't want to tell us about it, but it's very obvious. But also simply the fact that, you know, we forget the democratization is important, but also the fact that it's efficient. Even folks who could replicate that using the unlined instruments can often find, you know, our vehicles to be very efficient. And, of course, they trade all day long in tight spreads. So that makes it efficient for a wide range of folks. I try to get this out of him every time I bring him on. And he always just talks to me about the diversity of people using the place.

Okay. So we have often talked about, I call it the increased complexification of the ETF structure. I'm a Jack Vogel. I loved ETS because indexing, it made indexing possible for the masses. Indexing was important than they came first,

that understanding back in the 70s, and then in the early 90s, we started getting a way to get those indexes through ETS. So that's why I like ETSs. lower cost, tax benefits, just better for the average investor. But things have been getting increasingly complex. As the industry has matured, they're looking for other sources of revenue. So pro-shares has been the leader in leverage in inverse ETFs.

You can argue, do I need three times leveraged S&P or triple Q's? Does the world really need that? Well, he's made a pretty good business out of doing that. Does the world really need three times leverage oil funds? I don't think so, but there are people who, think they can make a money, a business out of it. I don't know. Should we prevent that from happening? What would be the criteria if it was some kind of threat to the system, for example, if it was a systemic threat? I don't know. Is there a standard that we should use about

complexification of ETFs? And single-stock ETFs, another example. I mean, it's a great question. So FINRA did a consultation back in May to figure out how they should look at complex products. They want to think about how they should be defined, should there be sales practices? Should investors have to attest to understanding the product before they buy? Should they have to have a certain level of assets? So right now that consultation is ongoing. I heard the head of FINRA speak recently, and he said,

likely if they were going to move forward and do something, they would not specify exactly what they are, but there would be probably three more consultations before something was passed. So I think it is an ongoing issue that many of the regulators want to define this. What complexification is? What a complex product is. Should we separate, say, leverage and inverse products from regular ETFs? Many things.

Into a different product category. Yeah, many think that should happen. I mean, in Hong Kong, they are different. So they don't call them ETFs. They call them LNI products. So regulators around the world have different views on many types of products. How would you feel about that? Should there be a different asset class?

Not an asset class. Should it be a different category? Yeah. We're a disclosure-based system. You know, there are lots of things and lots of ETS. and mutual funds. We were just talking about bond ETFs. Many of them use derivatives to get their positions,

so disclosure is an important way to go. Another standard to me in line that I keep getting. Despite stock, I love it. He stares at me. He stares at me. We get the same answer. Despite stocks down 20% this year, let me turn to you as our ETF expert, and bonds are down.

The U.S. ETF industry. Folks, you know this. It keeps breaking in assets. It never loses. We have 3,000 ETFs now. in the United States, 3,000. We have assets of $6.3 trillion. This is Deborah's numbers, by the way.

And we have 266 providers. You know how I know that? Because they all write to me. Stop writing to me, please. It's remarkable. And it's not just mutual funds converting to ETS. We still see that happening, but it still comes in. Well, I think there was an interesting study that Charles Schwab did,

where they said that 15% of investors in the stock market a year ago were new investors. So you're seeing new people come into the market. I think many because of your show, right? During the pandemic, most people were watching CNBC, what's going up or down? And you were showing ETFs, right? People became familiar with them or putting money into them. I think the other driver is, as people get close to retirement, and about 10,000 people do that every day in the U.S., they look at how they should be investing going forward. They go to robos. They usually don't put their money into the robo, but they use that to become familiar with ETFs, asset allocation, low cost. Then they call an advisor.

and invest money, typically in ETFs. So I think there's a number of drivers, but the biggest driver has been institutions using ETFs. If you look around the world, many countries will tell their pension funds when you want exposure outside of our own country, Mexico, Chile, Peru, Brazil, invests in ETFs because they're low-cost, easy to use, easy to get in and out of,

and that's been a real driver for assets globally. I've seen that, Simeon, with the RIA business. I go to these conferences and you've got a lot of guys who are quitting Morgan Stanley and setting up their own shop and they want to find the most efficient way to set up shop and keep the cost as low as possible. If you want to get below 100 basis points on a client, that's not easy to do. But you can theoretically pull that in and there's a lot of RAs. They want 100 basis points. They want to charge. They don't want to charge 200 basis points.

And they use ETS. So the structure makes complete sense to me. and it's no, I'm not surprised that this keeps happening. No, if you go back, you know, 10 or 15 years and you were talking to an RAA, financial advisor, and you'd ask the question, are you using ETS? We don't ask that question anymore. It's not a question. Everybody has converted their book to, if not entirely, but directionally towards ETS.

Let me ask you about your biggest asset or your single biggest holding, which is Noble, the symbol, folks, which is the S&P dividend. aristocrats index, I guess you would call it. This tracks the, a basket of companies that are increasing their dividend year after year. Why is this the best strategy to own dividends and not just let's buy something that has the highest dividend yielding companies? It's an elegant strategy because all you got to do is look for the companies that have consistently grown their dividends and Noble tracks the S&P 500 dividend aristocrats. That's 25 years in a row. And I'll give you two reasons. One, because the dividends grow, which sounds total logical, but that's the key.

It is the quintessential inflation hedge. Those dividends have been growing 12 to 14% a year since the inception of that index. Number two is the high quality. If you look at Q3 earnings, they were non-disastrous. Top line S&P, 11%, bottom line 3. Noble's Index, top line 17, bottom line 26. they are delivering margin expansion in an inflationary environment because they got pricing power. That's a big one-two punch, and that's why they've attracted a lot of assets.

Yeah, and I keep explaining this. Like people say, if the S&P has a less than 2% dividend yield, who cares? I said, let me tell you something. Historically, there is a big difference between a company that has a 1.5% dividend yield and a 2.5% over many, many years. Bogle used to do this in his books, say, this is, one and a half percent difference in a return over 30 years. When you started getting into hundreds of thousand dollars, you get into the beauty of compounded interest,

which is the greatest invention in the history of the world, which is that in the early days, it doesn't look like anything. And then when you get older, all of a sudden you're 65 or 70 years old, and that difference is enormous. And it's very, this is a simple way I explain it to people. The other words, people say, give us the highest dividends. You know, I want to buy the top five dividend. I said, those are not safe.

you know, a company that's paying you 9% dividend yield right now is probably in a somewhat precarious position. You better be real careful. And even if it's five and it doesn't grow, you know what it is? It's a fixed coupon bond totally exposed to inflation and any residual increase in rising rates we might see. It's a good point. I know we've wandered around a little bit here today, but we've got three experts on, two experts, excuse me, on big, big topics. So that's why we have the best people here from the ETF business, folks. 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. Today we'll be continuing the conversation with Simeon Hyman from ProShare.

Symean, thanks for sticking around and chatting with us. There's one little point you brought up around some of the strategies we were talking about today, and that is the possibility of tax loss harvesting using ETFs. Now, for the viewers who aren't sure what's going on, we've got big losses this year. So there's a chance here that people will have some losses they could possibly offset against gains, which is tax loss harvesting. Explain this briefly and how ETFs can be used in this manner. Sure, Bob. There's two pieces here. One is the straightforward one, which you just described.

I've got some losses, and I can take that as a credit on my taxes, sell those. But if I want to be still invested in the market, I want to reinvest those. Now, you have to make sure you don't invoke the wash sale rule, but you have to buy something a little bit different. But indeed, you can reinvest those in an ETF. So as an example, you might have had a long equity strategy that's lost some money. This might be a great time to harvest some losses and consider something like we've been talking about. Ticker N-O-BL, the S&P-500 dividend aristocrats, as a lot. a nice place to have a growing dividend stream, and that way you can offset the tax, you can take

the tax loss and then reinvest that in an ETF strategy. The other piece that's important, too, is if you are invested in mutual funds, they may have distributions before the end of the year, even if they're down. And that's kind of a weird thing, but it does happen in mutual fund land. You could be down for the year and actually have a distribution you have to pay taxes on. Particularly if the fund was actively trading. That's exactly right. Right. Yeah, I mean, that's not going to save you. If they're trading a lot, you have capital gains on... And there may be an opportunity for some folks to not only harvest those taxes, but sell in advance of those distributions. Is this going to be a real story? Do you think the mutual fund... We're going to be awash in stories in a few weeks about people who are going to be shocked to find out in a year where their portfolio is down 20 percent?

They're going to have additional capital gains distributions? I don't think we're going to have shocking headlines, but I think if you're listening to this podcast, take a look and talk and take a peek and see if that might be happening to some of your holdings. So I think it will not be rare, but I don't know that it's going to be the big headline story. ProShares has been very successful in a very niche part of the world, even though the dividend aristocrats, Noble, is your largest single holding. cumulatively, you really are very big in the long and short S&P and triple Qs. That is the bulk of your assets at this point.

It's been phenomenally successful. Is there anything else out there that can replicate that? I mean, obviously you've gone where traders are going, and traders are interested in volatility. They're interested in QQQQs, big liquid, S&P 500, big liquid. What other opportunities might be out there in the future? Well, we're always looking to innovate. As you noted, we've got a toolkit of leverage and inverse ETFs. We have buying old strategies like the dividend growers,

and we have, of course, our cryptocurrency ETFs, BidO and Biddy, and a growing suite of thematic ETF. So we're always looking to innovate across all of those dimensions. I like this, you know, people brought up to me a couple, weeks ago, they said, look at this BITO, which is the one that you run, of course, Bitcoin Futures. It's a disaster. It's down 75% since they introduced it. And I said, well, first off, it is a disaster from an investor point of view. Yes, if you bought and held, obviously it's a terrible return. However, from the point of view of the ETF issuer, it's been hugely successful.

It's enormous product. It had enormous liquidity. Fairly expensive, too. So I don't mean to sound cynical about this, but you can have a product that is, in fact, not great from an investment point of view, but in fact, it's something that everybody wanted and was very successful from a product point of view. Well, look, nothing goes straight up for sure. We look at the – you can't really know who's holding an ETF per se, but we don't. do get the sense that there's a robust ecosystem of folks with different time horizons. Certainly from the amount of assets in the fund, we know that there have been inflows as

as Bitcoin has declined. And we also know a couple of things about the way it's performed. Number one, we of course know that the volumes and the spreads have been tight. So that means if you do have a short-term time horizon, both biddo on the long side and bidding on the short have been very effective. But we also know, you and I have talked about the role cost, the cost of if you're holding BITO over time, the cost of rolling into those futures contracts in the futures market, that regulated futures market, has gotten mature and the roll cost have come down about 80%. They're now pretty much offset by the earnings on the cash in BITO, and it's tracking spot very well. So we know that it's tracking spot for longer term folks.

We know that it's trading real well for people with short-term horizons, and look, bitty's there too, you're still bearish. Yeah, I think it's, you know, I have to say, I've had differences of opinion on the value of these leverage and long, leverage and inverse ETFs over time, but you've been very successful in bringing out the products that people seem to want. And it was with BITO and BITI, regardless of the price movement, it was the right product at the right time. It came in. Simian, thank you very much for joining us. Always a pleasure to talk with you. Simian Hyman, folks, ProShare's Global Investment Strategist. And thank you, everyone.

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