ETF Edge - Finding “Freedom” Overseas? 2/19/25

Episode Date: February 19, 2025

In general, international markets are surging ahead of U.S indices. However, finding quality opportunities overseas can be tricky. Find out how one fund is setting itself apart by reassessing investing “freedoms”.    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 InvescoQQQ. Let's rethink possibility. Investco Distributors, Inc. Welcome to ETF Edge, the podcast. If you are 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 and market analysis and breaking down what it all means for investors.

I am your host, Bob Vizani, overseas markets surging ahead of U.S. indices this year, but international investing opportunities can be tricky. How do you find the best opportunities? Here's my conversation with Perth Toll, she's the founder and CEO of Life Plus Liberty Indexes, and Tom Leiden, former head of Better 5. Earth, good to see you again, always a pleasure. There is a spate of interest in investing overseas. Europe and China have outperformed the U.S. this year.

Your own freedom, ETF, is up 10% this year. It's also outperforming. Emerging markets countries like Poland, South Africa, Mexico, or all acting better? What's going on? Why is the sudden interest in global investing? but even emerging markets as well. Well, I think it's all cyclical, right? So sometimes the U.S. does better, sometimes international does better.

Emerging markets has not had a good run last year, so this year they're doing much better. The freer countries always recover faster. So in a recovery like you're seeing now, the freer markets tend to outperform, and that's what we're seeing today. Yeah, you know, Tom, it's great international investing is getting some love. But, you know, international investing has underperformed.

She said the last year, it's 20 years almost, seriously. And seriously, folks, almost 20 years, the allocations on international are really low because nobody's been doing it for a long time. Is there really something here other than this mean reversion trade that we all believe in, but is there something else more fundamental? Eventually, Bob, as you know, even though we've got a lot of years in this business, the pendulum does swing. It does. And if you look at valuations with Europe and emerging markets, China, India, it's half of what the S&P is. You look at small caps. it's even half of that.

So eventually things do change. However, as you look at your individual portfolio and especially advisors that are allocating for their clients, it's painful to be diversified, isn't it? Yeah, so are they going to get calls now? They used to get calls saying, why am I not all in the SP 500 or all in the US? Who wants to be overseas?

Are they going to start getting calls saying, why aren't I in Poland? Why aren't emerging markets all of a sudden? How come they're doing better and why I'm not there? It's not happening yet because you see the flows, even though we've seen great numbers so far year to date, we're still seeing outflows in all these areas if you look at the ETF flows. However, during pessimistic times, new uptrends do develop. And if it gets really ugly enough, that's an area to look at.

We always say flows follow prices. Like people are trend followers. So prices go up. All of a sudden, everybody notices. Prices are up. I'm going to buy this. So the flow's increased. I mean, but we have to see that a little more consistently than two or three or

three months since the Trump. And if you look at flow so far this year, just like last year, where's it going? SPY, VOO, it's going into the major bond indexes, just the major pillars in the industry continue to get that money. So it's a little bit lopsided as far as the diversification standpoint. I want you to explain a little bit more about the ethos, the rationale behind the whole indexes that you run here. So you invested emerging market countries with what you call high freedom metrics.

So these are countries like Taiwan, Chile, South Korea, Poland, Brazil. Tell us about these freedom metrics and how do they help countries get ahead. Why is that important? Yeah, thanks, Bob. So basically one of the reasons why people don't invest in emerging markets is because it's so full of autocracies. We don't want to be supporting terrorism or any of these things that go on in these countries that are not free. So because China, Russia, Saudi Arabia historically has had very high weight in these indices that are market. capitalization weighted, what we do is we freedom wait instead of market capitalization

weight to get a freer country set. That way we have countries that are, it's akin to like a quality factor on the country level. We have countries that have stronger institutions, better rule of law, more protections for personal economic freedoms, and these are the countries that grow more sustainably, they recover faster and they use their capital more efficiently. So that's where we want to be in the emerging market space. So this is a lot. You mentioned 86 variables here we're putting up the screen here and it's weighted by personal economic freedom. I know, in important, Importantly, companies with 20% or more state ownership are excluded.

This includes a huge swath of China, obviously. And I don't think you have any China staffs. Yeah, we don't have any allocation to China because of their overall freedom scores. So we look at personal and economic freedom scores from a third party think tanks at the Cato Institute and the Fraser Institute. They rate countries on 86 variables on both personal and economic freedoms. So you're talking about things like, let's be specific, pro trade, um, um, freedom of movement of people and capital. You rate countries highly who have IP intellectual property

and property rights protections, currency stability. Here's countries that are, so pro-trade, low tariffs, Chile, Poland, people and capital freedom of movement, Chile and Poland, Taiwan and South Korea, strong intellectual property and property rights protections and currency stability in South Korea, Malaysia. Is it your point that when you have these things, It helps countries be more successful economically

and in turn helps the stock market. That's the investing thesis, right? So to be clear, those things are part of the free trade metric, which is part of the 86 overall freedom metrics that our data providers are looking at. And we only had all 86 metrics. So that includes things like terrorism, trafficking, torture, it includes things like freedom of speech, media expression,

and it includes things like free trade, business regulations, soundness of monetary policy and so forth. So it's both personal and economic freedoms. And those things added together, provide a foundation for growth, especially in the emerging markets where you're coming from a low base or you're coming from lower valuations. And it's a way to capture the markets that have the highest growth potential for real growth, not just government mandated or debt-driven growth. How does the United States rate on this scale? It's about 15 out of 165. So it's relatively high, the top 10%.

Yeah, but I think that's a good point. You know, there's no 100% free country, even the United States, is not 100% free. It's all relative. So these are just, you know, relatively freer emerging market. Well, let's just ask the simple question. Why has the U.S. outperform for the last 15 years or so? Do these freedom metrics have something to do? It has to have them to do with the rule of law, court systems. I'm trying to tie your thesis in with, for example, does it, can we show something like the United States? Frank's high here. This is one of the reasons. I think the United States does have a very strong capitalist system. It does have strong rule of law.

It has, you know, strong protections for most personal. and economic freedoms. Hopefully we are always going to be kind of a beacon in the world in that respect. And I think that has definitely helped our capital markets. So that's undeniable. So, you know, absolutely the economic freedoms and the personal freedoms that we enjoy. This makes sense. I believe this myself. I believe the access to a court of law, for example, that enforces contracts, things that you don't think of, like contract law and ability to start up a company easily. and hire and fire people as well. You know, all of this makes the system more dynamic.

So will that support higher prices down the road? I mean, we've had for a long time here in the U.S. a lot higher prices than we've had around the world. And it seems like growth is continuing to be able to demand people pay those prices. Would that continue? What about value? Is value going to be dead for another 10 years? That, I don't know.

Value is going to be dead for another 10 years. I think everything is cyclical. So value is, you know, poised for a run. I think Bob brings up a good point that the value guys also don't market capitalization weight. So those guys in our, you know, we're kindred spirits. I want to go to that, but I want to ask, we're all debating this whole tariff thing right now. And I want to know how you come down on this. So on tariffs, you've noted we put the screen up, Chile and Poland, for example, have low tariffs.

But India does not. India has high tariffs, actually. So what does this mean? Do tariffs help or hurt an economy or help or hurt the stock market, or is there a right way to look at tariffs in general? Yeah. So again, tariffs are part of that free trade metric that we look at. Free trade is such a big component of economic freedom. Economic freedom is such a big component of our fund. So absolutely, you know, any kind of constraint on trade like a tariff is negative in our view for the growth of that economy. India has high tariffs, for example, though. but it's been relatively successful, despite the high tariffs, your point being though, right?

India has historically had very high tariffs and non-tariff kind of trade protections on their economy, but they're a consumer-driven economy, and their internal consumer market is huge, and their population just surpassed China's. And there's a very highly educated English-speaking population. So their demographics are very favorable. Their internally consumer-driven economy

has helped them succeed. Also, in the last, couple of years with all the capital flows foreign capital flows out of China a lot of that has gone into India because let's face it most emerging markets investors only know the brics so it's either China or India Russia's gone at this point so I think they've benefited from a lot of that but if they can become less protectionist I think they would do even better is it gonna catch up with them toll I mean you would mention earlier if you're in India and you buy a Harley Davidson from the US

what's the tariff on that It's 100%. So you have to pay double. It's 100% on motorcycles. Yeah, the motorcycle tears from the US. Is that because the motorcycle industry is protecting itself? I don't know. Yeah, it's 100%.

So you ding India on that, and yet on other metrics, it ranks relatively high. Well, India has a low weight in our index because a lot of those protectionist policies, but also they have some personal freedom issues as well. But they are one of the included countries, which means they are above average in the emerging markets. Yeah, I know Taiwan is your largest country holding, 20%, Chile is 19%, South Korea, 16, Poland, 14, Brazil, 7, South Africa. Here's the list right here. And then there's Malaysia, Indonesia, Mexico. So India's really far down there.

It's, you know, somewhere tiny piece here in the everywhere else category. But it is included, so I want to, yeah. Yeah, yeah, but it's interesting. Quick question on Taiwan. There's a lot of saber rattling about China and what if they were to ever get really serious about invading? How would that affect your score? I mean, I haven't been in this as long as you have Tom, but have you... Thanks.

Almost nobody has. Do you remember a time when there was not saber rattling about China invading Taiwan? Because I don't. You know, for Taiwanese people, this is a way of life, right? There's always saber rattling about it. But I think as investors, you know, we're in a position of power and privilege to be able to be able to. to allocate assets, whether it be your own assets or other people's assets. So if you can affect outcomes by the way you allocate assets and you're concerned about, you know,

China invading Taiwan, I think let's support the freer country that is, you know, encouraging freedom in the world versus the saber-rattling terrorism. I just want to get a sense of what you own in this because we're talking about countries here, but here's your biggest holdings. You own Samsung, which is a big South Korean company. Taiwan Semi, which is in Taiwan, obviously. Banko de Chile, Bank Polska, which is the biggest bank of Poland. Hinex, there's a tech name here.

Fairly broad group of stocks here. It's not particularly sector specific. There's Latin America Airlines, Latam, a big airline in Latin America, media tech. Han Hai, they're in Taiwan, but they're huge in China where they make Apple phones, for example. Anything you can tell us about, it's an interesting mix.

Thematically, there's nothing coherent about it, but what holds it all together, your index? Yeah, I mean, just a little bit of how we get to that is we take the top 10 largest, most liquid securities in each included country. And those are market cap weighted within their freedom weighted country weights. So there are going to be companies like Hong Hai, which is Foxcon, who do a lot of production in China. We don't penalize that trade. Again, free trade is very important to us. And we want to encourage trade.

It's the ownership that matters. Do they, are they owned in Taiwan where they are free to put their own best interest before? that of the state. If you're a Chinese company and you're in China, if you're Jack Ma, there are certain things you can't say. There's certain things you can't do, but you have to put the state's interest first. We want companies that are free to put their own stakeholders interest first before those of the state. And if you trade with an unfree market, that's okay. You can change that if you want, but as long as it's your choice. I'm curious how you got to this discussion and these metrics here. You were a private

wealth advisor at Fidelity and at one point you lived and worked in Beijing and in Hong Kong and that sort of led to you to explore this relationship between freedom and markets we had talked about this number of years ago just tell us briefly about that how did you come to this conclusion that this free certain freedom metrics really didn't matter a lot yeah i started a fidelity in 2004 and back then all of my clients wanted to be in china i had just come back from a year in hong kong where i i saw the difference that freedom had made in the Hong Kong market versus Chinese mainland market versus the U.S. market. And I didn't want to personally be investing in China at that point, but everyone else did.

And then I had clients from Russia who said, I don't want to invest in Russia because it's like funding terrorism. And look how prescient that is today. So my own experience and those of some of my clients led me to this idea in the end. And a lot of my colleagues at Fidelity as well, so were helpful. And I think it was just the right product for the right time. fortunate have been in a space where we were able to provide an emerging markets product that had no China, that had no Russia for the last five years. In addition, it had a lot of exposure to the freer markets that don't get a lot of play in the cap-weighted indices like Poland and Chile,

which have done well. So I think the freedom story has played out really well. I came in with no expectations. Obviously, long-term, we expect freedom to outperform. But in the short-term, anything could have happened. And so I think we're just- I want to go back, Tom, to a point you were making earlier that it's for years, the global investing community has recommended investing by market capitalization. You and I were doing 10 years ago, that's what everybody said. If China was 20% or 10% of global markets, you would own that in a global fund. They would have 10 or 20%. But that's being challenged.

The only other group was the old value guys who used to say if China trades below 14 times forward by it. Other than that, it was investing by market capitalization. Now, in the last 10 years, now we've seen Xi Jinping, the head of China, his hostility to capitalism, seems to have reversed a lot of that positive sentiment on China investing. So we've been all rethinking China as an investment, for example, and ideas that Perth has been championing for a while. Now, wait a minute, we need to consider other metrics other than just blindly investing on market capitalization when you're dealing globally has come to forward. here. So it's really interesting in the last, really it's happened in the last five or six years to see how this argument, this discussion has evolved from, oh, we're just investing by market cap to now we have other kind of potential metrics that we ought to consider.

Yeah, long-term investing has gotten a lot shorter, Bob, because you're judged all the time. You think about all the 400,000 financial advisors that are out there, if they are properly diversified the way you read it in the textbooks, they don't have much of a bit of business. business because you have to be in those areas that are performing. So today, a lot of it is large cap US or even in the US. But not only emerging markets, but areas like small cap. The diversification just hasn't made sense and fewer and fewer advisors have allocations in areas not just EM but also small cap as well.

But valuations justify that. The big question is, are they going to have a run? Is this move that we've seen recently so far year to date actually going to come to fruition? Right. But irrespective of the price moves, there is a broader philosophical discussion about this that you helped institute a number of years ago about are we just blind capitalists and investing anywhere where diversity without any regard for ideology at all? I mean, Ging Jinping seems implacably hostile to the kind of capitalism we, we probably

we practice and want globally. Talk about democracy, talk about political system versus economic systems, for example. I'm trying to drag this into a broader philosophical question other than just, you know, do we just invest? Is he eventually going to step in line? This is the big, that's the question. This is the source of the whole, the nexus of the whole conversation or not. Should we actually consider these issues that we never did consider before, frankly? I've been doing this for 30 years. Well, when you end up changing the rule book? all of a sudden, the last rule all of a sudden kicks in. That's a very logical pushback to what I was just saying.

So I think everything that we do, whether it's value investing, whether it was ESG, whether it's small caps, large caps, any kind of other factors, you first have to have the foundations in place. So personal and economic freedoms are so basic to us in the United States. Like you said, the United States markets are used to it. When we're looking at overseas markets, we don't think about that. First, we have to have that in place, and then we can talk about all of these other factors. So I think that it's not so much a rule change, but a recognition that at the basis,

that the foundation for all the rules that would use have to be there before we can add other rules to it. Is there a distinction? Now, I'm talking about a political system versus economic system. Is there a distinction between freedom and democracy, for example? I mean, we used to say, well, all right, so China, under Deng Xiaoping, okay, it was not a democracy, and yet it had some capitalism. as an economic system. So politically, it was an autocracy.

Economically, what would you call it? State capitalism? I don't know what you would call it, but it wasn't the kind of capital we had. But today, obviously, they're moving away from even state capitalism, it seems like, towards total control of the economy, essentially. And that's different than things were before.

So I guess my question is, we used to think you couldn't have capitalism without democracy. And they've shown that you can have some capitalism without democracy, essentially. Is there a distinction between freedom and democracy? Well, I think the thinking used to be that their capitalism would lead to democracy. And so economic freedom is a necessary,

but not sufficient precondition for personal freedom. And I love the analogy that Jim Gortney, who passed away last year, he was one of the grandfathers of economic freedom thinking for our data providers at Cato and Frazier, he said all freedoms work like parts of an automobile. You can't have a transmission without a steering wheel. The car still won't run. So all of these freedoms work together to provide this basis for an economy. And without that, the economy is

going to be constrained. So we want to be in the places where the economy is not constrained, where companies are not constrained. So your point is keeping the automobile is your best automobile, the best transmission, the best motor humming in the right way, is that. that these freedom, these freedom metrics. The foundations of the freedoms have to be there. Yeah, I get that point. Tom, we're still in this game here, the whole, it's still working, the global investing idea. I mean, your point is, I guess the problem with this game, like it hasn't worked for the last 15 years,

now it's going to work, right? So reversion to the mean is going to be very, very real for everybody. Well, if you look at emerging markets and what toll's done by not being in China, from a performance standpoint, it's provided less volatility and better performance. So to a degree, she's proven that out. I mean, knocking on a billion dollars, congratulations. I mean, this whole ETF business is very easy, isn't it? Wasn't it from the start?

Right, right from the beginning. Yeah. Yeah, you were there from the start, Tom. Actually, Tom was one of the first people I talked to in the business. I think you gave me a discount to your boot camp conference. So thank you for that. I was my first conference. I thought you snuck in the back and didn't pay.

No, I probably did, actually. She probably did. That's possible. Yeah. Well, the point here is that reversion to the mean is very real and diversification, I think still matters. I don't understand people who say, oh, well, the U.S. is outperformed for the last few years, therefore we're abandoned.

That's exactly the wrong thinking, right? Throwing all your money and abandoning diversification, that's when it actually goes back to the mean. Yeah. When you say, oh, the U.S. is outperformed for the last several years, therefore it must outperform. That's recency bias. Yeah. That's a classic.

behavioral economics mistake. I know when you invest your own money, you have a certain allocation, you stick to it. And you probably have some allocations in your portfolio that's stinky poo. It's just, it's not that great. I'm one of the few people that actually publish

what I own in my book. Shut up and keep talking. And I have a 10% allocation to international. I have had for years. And because of that, I've underperformed. If I just own the S&P 500, I've underperforming. Every year I look at it, I said, well, I underperform the S&P again. And you keep adding to it.

But you know long term, it's going to end up paying up. I've been buying small caps the last couple of years, and I keep banging my head against the wall. But, you know, eventually it's going to happen. Now it's time to round out the conversation with some analysis and perspective to help you better understand ETFs. This is the Market's 102 portion of the podcast, Tom Lydden, former head of Vetify and an ETF industry investor now. It continues with us. Now you're an ETF industry investor. Whoa.

That sounds very important. I want to just point out, we had a little bit of a horse race this week. The Vanguard S&P 500 now is essentially neck and neck with its biggest competitor, which is the Spider, SPY, the I Shares S&P ETF, which is the biggest ETF forever and ever. They're both essentially $630 billion. So let's not quibble about a billion or so. So does that mean anything in any way other than the fact that big index funds continue to win? But does that mean anything that they're now neck and neck?

It's a great story. I mean, Bob, you were back in 1993 when Spy started, Jim Ross and the crew over at State Street. It wasn't meant to be what it ended up being, but it really gave a launch to a wonderful industry that you've embraced in love for a long period of time. and I have two. What does it show, even though it was the first and it garnered billions of dollars over an extended period of time, everything can have competition. In this case, it was price. So when you have an expense ratio, even though spies were small, you know, we had VOO, it's got, you know, one third of that expense ratio. So we're talking about teeny tiny basis points. But if you ask the people over at State Street, they would say it's not the expense

ratio solely, it's the trading and making sure that it's always really tight from a spread standpoint. The key point, though, I want to make here is it doesn't make that much different. I mean, Spy has been losing assets for years because it has nine basis points. They have a, I shares has a cheaper version that is three basis points, as I recall. And Vanguard, their three basis points. So long-term investors slowly take money out and put it into cheaper ones, even though they're essentially the same, they track the same index at this point. I think the story behind the scenes is this.

It's really tough to beat the S&P 500. Yeah. And you've got a lot of choices, and they're not just these ETF, but they're other spy-related ETFs. But the point here is inflows of largely passive index ETFs still predominate. No matter what anybody tells you about active or doing this or that, most of the money is still going into passive S&P 500 to a lesser extent, NASDAQ 100 style indexes at this point.

So we're seeing. some, I know the very small, noisy subgroup of active investors. So it is interesting to me to see leverage in inverse ETFs continue to be strong. Direction and pro shares, every day you look at volume and dollar volume of trading on ETFs. Those leverage ones are usually, directions semiconductor, usually up in the top there three times, usually. There is a small but very noisy co-holt. cohort, a lot of them are retail investors that want to play lottery-like behavior and make a bet, almost on a daily basis on these. I always used to say the problem with them, they're a tiny

part of the volume, but often a large part of the issues around it. And a lot of people have logically asked, do we need three times leverage and inverse whatever oil or anything at this point? But there seems to be some kind of demand for that product. Yeah. And you were, on this early. You weren't a big fan. You question whether it was actually needed. And from a regulatory standpoint, the SEC was looking at this group very, very closely. They did the best job they could from a disclosure standpoint to say, hey, this is not a long-term investment. This is something that's traded. And guess what? Here we are today. They're not under the microscope. It's the single-stock ETFs that are triple leverage and that type of thing. Or cryptocurrency

currency ETFs that are getting more of the heat from the regulators in the new administration. Are we in the sea as much heat? Probably not. Bottom line is they're well accepted. And the other thing is the directions of the pro shares of the world are no longer focusing on the institutions and financial advisors where the chunks of money tend to come from historically. They're going, as you say, to individual investors who have turned away from individual stocks to find different sectors of the market where they may be able to capture. So there seems to be a subgroup of people who like engaging in lottery-like behavior, who are willing to take very large risk.

Of course, this looks great in an up market because people generally are trend follows. What happens when we have a down market? Well, that's like the Robin Hood story, right? When all these kids were in buying meme stocks, and I don't mean to use the word kid, because there are a lot of older investors that are doing the same thing.

People, when the market's going well, get a lot of positive interaction with the market, especially if their accounts are going up. And wouldn't that period of time? More people are making money these days than losing money, and we're going to continue to see cab drivers give stock tips and that type of thing. One thing that seems very clear is the market for Bitcoin ETF keeps expanding. There's a lot of, it seems like a lot of pressure on advisors now to start allowing some asset allocation.

And I love to watch the industry make this argument to the asset allocators, or to the advisors, the RIAs of the world. Well, just start out with 1%, because if it's 1%, and it blows up, you only lost 1%. But if it doubles, then you have 2%. This is a sort of, I call this the pretzel logic of Wall Street. But it does have, that's how it's working.

That's how you worm your way in as an asset class. Okay, you're not sure if it's an asset class? Just start with 1%. Yeah, it's hardly a bold allocation at this point. And that argument seems to have some currency, particularly with a regulatory friendly regime that we're going to see in the Trump administration on crypto. Yeah. Well, you know, Matt Hogan, the folks bitwise at VETify, and they do this every year. Matt and I started this survey years ago with surveying financial advisors about their involvement in cryptocurrency,

their clients' involvement in cryptocurrency, and if, in fact, they're making allocations. And what happened is over time they found that their clients were making allocations off the reservation themselves. And the advisors weren't controlling that because they didn't have a proper tool that they felt comfortable with. Now, fast forward to today, you can buy Bitcoin and so many different ETFs that are out there. And you have to justify a position because if you don't and cryptocurrency continues to advance. But is it your argument that we are going to get over the suitability? problem that the advisors have had for a long time? Like how do you determine the suitability of your client for this? It gets tricky here. It's easier to do with stocks. It's easy with

stocks and bonds. I'm still not sure, based on the RIAs I talk to, many of them still not comfortable, doesn't feel it passes the suitability requirement yet. How do you change that? That's a big question. At the same time, you can make the argument if you're properly diversified across the globe and you're in areas like China or other areas that maybe have cratered in the last 10 years when in fact, cryptocurrencies have done pretty well, was that the right thing to do as well? The question is, is today cryptocurrency an asset class? Is it a diversified asset class?

Is it something that finds its way into the average client portfolio? This is something that the regulatory authorities and advisors, are struggling with. And I think we're leaning towards us continuing to see as long as things hold up, that that's going to continue to happen. All right. Always a pleasure to see you, Tom. Thank you for coming by. That does it for ETF Edge, the podcast. My thanks to Tom Lighten. And thank you for listening. Join us again next week. Remember, you can see all the shows on our website, etfedge.cc.com. How does InvescoQQQQ-Q-Rethink possibility? By rethinking access to innovation and the NASDAQ-100, Let's rethink possibility in Vesco Distributors, Inc.