ETF Edge - Leveraged & Inverse ETFs, Work From Home Winners

Episode Date: July 6, 2020

CNBC’s Bob Pisani speaks with Tom Lydon, CEO of ETF Trends and ETF Database, and David Mazza, head of product at Direxion. They discussed Direxion’s new work-from-home ETF and up-and-coming buy-and-hold ETF strategies. In the 'Markets 102' section, Bob discusses the mechanics behind leveraged and inverse ETFs. Hosted by Simplecast, an AdsWizz company. See 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 in all things exchange traded funds, you're in the right place. Every week, we're bringing you compelling interviews, thoughtful market analysis, and breaking down what it all means for investors. I'm your host, Bob Pisani, and today on the show we'll dive into major ETF trends to keep an eye on for the second half of the year. And look under the hood of some of the hottest new product launches in the ETF market. Here's my conversation with Tom Leiden, the CEO of ETF Trends, and Dave, Dave, Mata, head of product at Direxion. Tom, let me start with you.

July seems to me like a continuation of June in terms of some of the trends. I see growth ETFs at historic highs. I see some thematic-oriented tech-thematic-oriented ETFs hitting new highs today. I'm talking about the cloud computing ETFs, the social media, the Internet, the cyber security ETFs, all new highs as they benefit from work from home. And finally, I see these China ETFs. hitting two-year highs as the country's leadership tries to keep jaw-boning the stock market up, and it looks like it's succeeding. Give me your 30,000-foot view, Tom, of where we are right now.

No, Bob, you're absolutely right. We've been talking about fang stocks or fomang stocks, if you put Microsoft in there for the last 10 years that have really held the market, held the S&P to a great degree, as they collectively represent more than 20% of the market cap there. But they've also worked out to be the entertainment, the communication, the work from home stocks, too, that have really embraced this new environment that we're in. So it's been more of the same, and I think investors have benefited from that. Yeah, Dave, you know, I noticed I was looking at some of the big ETF movers. Direction Daily China Internet bull two times. You get twice this market move. That's what it means, folks. One of the best performing ETFs of the year, you're up nearly 60%. Just give me your 20-second

thoughts on China investing. It does seem like the authorities there are trying to jawbone the market up, and they're actually succeeding, actually. Yeah, no, it's interesting, Bob. That is one of our funds which is targeted for tactical traders. But the underlying exposure there is names like 10, Alibaba, each over 9% of the index. In the last week, China A was up nearly 7%. And it's year-to-day performance. I think some people may have not realized this is 8%. It's at the high. level of the broad market since July 2015. Turnover has increased, to your point, now the authorities are sort of encouraging Chinese retail to get involved with the stock market again,

which has sort of been a sleepy exposure for a little while. So now seeing China come back is getting very interesting from an equity market perspective. And we've seen some of these work from home stocks do fairly well recently. We've seen Akamai hit new highs cloud computing names like Akamai hit new. high's, your PayPal, hitting new highs. And Dave, I know that you've got a new thematic ETF out there, the work from home. It's really fun to watch ETFs essentially kind of tackle memes these days. We saw the cybersecurity craze, and now they're tackling work from home. You just launched one recently, symbol WFH. Tell us a little bit about what's in this and how it's

been received. Yeah, WFH was launched last week, but we've already seen a significant increase in assets in trading volume. as investors begin to embrace the fact that it's not just about stay-at-home trade or work-from-home trade. This is a long-term theme that's beginning to play it in the market. And by that, I mean societal acceptance of having greater remote work and the ability to work from anywhere. So the names that we constructed in this portfolio cover four technological pillars that are driving the ability for people to work from home. So this is your cloud technologies. So these are names like Microsoft and Amazon.

Then your cybersecurity, so names like Fortinet, Octa, or in the portfolio. And then another pillar which is important for work from home is your project and document management. So names like Box and Dropbox are in that pillar. And then lastly, which I think is the poster child for remote work, is your remote communication. So there is going to be a name like Zoom, but also a name like 8x8 or Twilio, which some people may not be as familiar with. But Tullio is really interesting. That company is actually powering the contact tracing system that New York City is using to track COVID-19. Yeah.

Tom, you and I have been talking about thematic ETFs for many, many years. It's a lot of fun to watch ETS pick up on the memes that are out there, and that's literally what they are, memes. I guess the question is, is there any reason to believe that work from home is a meme with more staying power than, remember, cannabis? ETFs, for example, or remember how crazy we were four years ago about Bitcoin ETFs and trying to stuff companies that had very incremental revenues from Bitcoin into a Bitcoin ETF? Give me your thoughts on this work from home, meaning I'm calling it and whether it's not staying power. It's definitely not a fad. Bob, you and I, you know, we've been around for a while. We try to be tech savvy. I think we've up our game in this environment. It doesn't mean when we're past the coronavirus that we're

going to get back to our old ways. Everybody in America and around the world is embracing technology and stocks are benefiting from that. And one important thing here I think we need to make is we're all big fans of ETFs and you talk about the fang stocks and their overall weight with major market indices. That's important. The question is, what are the future fang stocks going to be? And if you look at some of these work from home stocks that Dave just mentioned, some of them may be there. So we have to ask ourselves, when you look at your portfolio, what percentage, and many have them very highly correlated to the S&P 500, are going to work well into the future? And how do I get out of some of those industries that may continue to be challenged? You know, leisure and entertainment, the energy area, banks are going to be challenged maybe for a while here.

So we have opportunities with these new creative ETFs that are out there. Look at the underlying, as you always say, Bob, lift up the hood, understand what you're buying. Some of these stocks you maybe have never heard before, but the ETF companies like direction, do a great job in talking about the underlying stocks and really why they might be different from other holdings that you have in your portfolio. Yeah. You know, and this is for both of you guys. That's a good point.

But Tom and Dave, do you really think some of these stocks that you had your Twilio and CrowdStrike and Zoom and Elastic? Do you really think they have the potential to enter the mega-cap space like a Microsoft? Microsoft appeals across many categories. It's a monster in cloud computing. It's big in hardware. It's really big in consumer software. Kind of hard to imagine. I mean, can you make an argument that these smaller names we're talking about could potentially become really big,

mega-cap names the way the fang stocks are? We are seeing a name like Doom. You know, recently we've added to the NASDAQ. Again, that's the poster child for remote communications. And again, many of these might not displace the Microsoft or displaced in Amazon just because of their influence and pervasiveness across so many pillars that we use as consumers that we use as part of our day-to-day business now. But I think the broader point is that when we begin.

to think about what are the themes that are going to have legs in the new normal. To me, one of those is all the potential to, again, to empower us to be productive, to be efficient, whether that's working partially in an office, collaborating with people that are socially distanced from us there, or collaborating where some of us are in the office, some of us are at our homes, or some of us, maybe in other places. So, you know, one of the lasting themes I believe we're going to see from this pandemic is, again, greater acceptance of that. people can work anywhere. Yeah.

And to add to that, Bob, you think about a company like Tesla that hasn't even made it in the S&P 500 so far. So when you want to diversify outside of major market indexes, which is important today, although the S&P 500's done great in the last 10 years, it's made up of a lot of big stocks. You look at RSP, which is the equal weight S&P 500 ETF, that's still down 10,000. percent year today. So it's been those big stocks that have kind of carried the day. But there are also other stocks that are growing that haven't yet made it into those indexes. You can buy them within other them thematic ETFs that might make sense to, again, have a satellite in your portfolio. Yeah. Let me stay on this growth ETF, Dave, because you also launched another product recently.

The high growth ETF, the symbol is HIPR. HIP is an HIP. P is an M.I.R. HIP is a and Peter R that tracks the investment results of the Russell 1000, what's called the hyper-growth index. Now, I'm curious about what is in this index and the methodology behind it, Dave. So maybe you can enlighten us. What's in this and explain the methodology. How do you become a hyper-growth growth and get into this? Yeah, what Hyper is really about it, how do I find those high-growth companies, those hyper-growth companies that have the potential for sustained growth going forward? It's very easy just to take a screen of what companies have had the highest sales growth or earnings growth in the past or maybe even forecast.

But what we do for this particular fund is we combine a screen of companies that have grown sales in the past, have high expected earnings growth, but also maybe most importantly high expected cash flow growth. But we also look at a company's balance sheet to ensure that they're not over-leveraging or taking on significant debt just to pay for that growth. And then lastly, taking a look at stocks that have had positive momentum. So our research showed that this combination, so top line, bottom line, growth, momentum, and high quality leads you to a universe of stocks that have shown great growth in the past, but really the potential for growth going forward. So in this fund right now, Apple has a healthy weight of 13% in the portfolio.

Amazon 7%, but then a name like Vertic Pharmaceuticals is also close to 7%. So you're going to see names in here that you know, again, your Apple, Amazon, Facebook, Microsoft, but also you're going to see names you might not be as familiar with. Yeah, so Tom, this checks, we've been doing this a while, you and I as well, this checks all the factor, you know, the right check marks. You've got growth, you've got quality, and you got momentum. I mean, that's your big three right there. It's sort of ingenious to be able to combine them in the right way.

the question is how do they all put together and what's the what's the what's the what's the waiting of each one but what could go wrong with the idea i mean you know conventional indexes have done fine but we're going to probably be in a period of time bob where uh certain factors are going to be challenged certain sectors are going to be challenged so uh what we're finding in interviewing and surveying advisors all the time they're moving and shifting a little bit away from low-cost pure beta strategies, and they don't mind paying up a little bit more for more intelligence strategies. And, you know, folks like Direction and many other companies are rolling out more of these intelligence strategies. Yeah. Let me move on here. Dave, Direxion is very well known for its

leverage and inverse ETFs. In fact, your biggest ETFs in terms of assets under management are leveraged in inverse ETFs. Credit Suisse recently closed several of their leverage. And inverse exchange traded notes, not ETFs, but notes. But given that these leverage and inverse ETFs are reset daily, what place do they have in an overall investor portfolio? This has been a topic of discussion for many years, but give us your thoughts. Yeah, no, certainly. And as a provider of leverage and inverse ETF, we want to ensure that folks are using them appropriately and correctly, and they're really intended to be for traders for folks that have the ability and potential you pay keen attention to their portfolios because they're intended to provide either the two

times or three times full or bare exposure on a daily basis. But again, for investors who use them appropriately, many of them can find them to be helpful, again, as part of some part of their overall strategy. But they're not intended to be long-term buy and hold investment vehicles, like a work-from-home ETF or like the high-growth ETS that we mentioned. Yeah, Tom, you know, there seems to be an effort in the ETF community to assign these leverage in ETFs a sort of separate place, even ETFs, not just ETSs, but ETFs, a sort of a separate risk profile and maybe even separate from the overall ETF universe. How do you feel about that? I mean, I think they've made a very good point about laying out the risks here and why you need to be a very active trader to understand them. Where do you feel they fit in, if at all? You and I have talked about this for years. Inversive leverage, you're not for everybody.

A little bit more sophisticated investors, as Dave pointed out, a trader. Early on, they did require a little bit more education. They're not play toys. So now they are an integral part of the ETF ecosystem. And this recent campaign was not put out by the SEC. It's put out by other ETF issuers who don't have a dog in the hunt. They don't have inverse and leverage or a little bit more complicated strategies out there. So is it really for the benefit of the investors, possibly?

Is it also a competitive move? That might be it, too. But the horses definitely left the barn here. Investors, if they want to shoot themselves in the foot, probably are not going to turn to ETFs. They're probably going to go to the future. of the options market or penny stocks or something like that. But really, we've been way past the point where inverse and leverage and other a little bit more sophisticated ETFs really round out our overall offering and been a big part

of the growth of the ETF industry. Yeah. I agree with your point. I think the problem is you need a very sophisticated investor to understand this, just like we had the problem with the oil ETFs and explore. people backcredation and contango and the rollo over in futures contracts. You can explain it 50 times to Sunday and put it on the top of any, you know, ETF fact sheet that's looking into and say, you can lose money here and your futures contract can go negative. D. They did. But people still do it. And here you can say until you're blue in the face, these things reset daily. If you think you're going to get two times the S&P 500 after a month of holding this, you're probably going to be wrong. It's not going to work out that way because of the daily reset.

And you can walk them through the math of a daily reset and show them how it's different on a daily basis. And yet we still get problems with it. I'm not in favor of banning these lever to inverse ETS. I'm just sort of after 20 years of doing this, Tom, I'm sort of like, gosh, we tell people about the problems of owning futures contracts and owning them in an ETF format. And there were still problems.

And we kept telling people about leverage and inverse ETS, and there's still people who don't. So I guess you either throw up your hands and say, okay, you know, you've done your due diligence. You put it right at the top of the damn thing. Be careful with these and people still don't listen enough. Well, that's the thing. So I'm sort of unsure what to do at this point. Yeah, there's a small amount of investors who just act emotionally and they don't do their homework. And unfortunately, if these check systems have to be put in place, if all of a sudden you want to buy an inverse and leverage GTF and you go in your Charles Schwab account and you try to buy it, now skull and crossbones shows up, is that really good for the industry when most people are doing their homework?

I think what we have to do is look at everything as a whole, and we're going to continue to have educational barriers that will be out there. But do we want to throw all these types of ETS, not just including inversional leverage, but others that might have futures contracts or might have options overlays and things like that all into one bucket and say these are more sophisticated, really not sure. I think this is one thing we're going to continue to talk about. And that's a great thing about the industry. It's very democratic. Well, Dave, you've had discussions with regulators about this. There have been efforts to sort of assign these leveraged products and even exchange trade as a sort of a separate category in the market.

Where does Derexion come down on that? Well, again, to some of Tom's points, at this stage of the industry, I don't think it makes sense to separate ETS into different buckets because, as we know, an ETS is a different vehicle than an ETS. So let's start there. That is important that investors should know when you're not. you're buying an ATF, it is a fund. It could be a leverage, your inverse one, but at the end of the day, it's still a fund.

A note is different because it's issued by a bank. And in addition, some notes may be even more ethoteric with things like volatility, trades in there, or commodities and the like. But with ETF, again, as long as investors, we do need to do our homework, whether we're a trader investor. At the end of the day, whether it's two-time or three-time performance, what's going to cause that performance up or down is what's in the basket. it. So we strongly encourage everyone to understand that, whether we're talking, again, about

a one beta product or a leverage and inverse product. More so, if you're going to be taxical with it, more so if you're going to look to trade it for a shorter-term opportunity. So I do think it makes sense for investors to be informed, and we want to continue to educate folks on that. But trying to bifurcate and already confuse the matter, because as you guys know, and you've talked about on your show, there's now semi-transparent coming, non-transparent coming, for ETS, I think it would almost confuse investors more if we end up with even more categories than there are. Okay, guys, we're going to have to leave it. That very stimulating discussion hit on a lot of important points here. Now it's time to round out the conversation with some analysis

and perspective to help you better understand ETFs with our Markets 102 portion of the podcast. Today we'll be covering the complex world of inverse and leverage products. And as always, My producer, Kirsten Chang, joins me now. Bob, you talked today on the show about how Credit Suisse is closing down some of its leveraged exchange-traded notes. How do leveraged and inverse exchange-traded products work and how do they contribute to overall market volatility? I'm thinking specifically back, of course, to February 2018 when we had that inverse VIX

blow up that tanked the markets. Leverage and inverse exchange-traded funds are very complicated vehicles and, you know, and rather difficult to explain. They're really professional investors. They're designed to deliver a greater return than the returns from holding a long or short position in a regular ETF. So for example, two times the S&P 500.

If the S&P 500 is up 1%, and you own two times the S&P 500 ETF, you make 2%. But you only make 2% on that day. These are reset on a daily basis, and that's part of the problem that investment professionals, and indeed people who cover these markets, journalists like myself, have with them. They were created for a very specific reason to offer longer or shorter exposure to certain benchmarks like the S&P 500 or the NASDAQ 100 than you would normally get if you just held it and stayed long.

They usually mirror an index fund, that's typical, and the fund usually provides a higher level of investment exposure. So as I mentioned, if you have a two-time leverage S&P and the S&P's up 1%, you get 2%, but only, on that day. So the leveraged ETF maintains a $2 exposure to the index for every $1 of investor capital. That's a pretty neat trick. How do they do that? Well, they do it by largely relying on derivatives. So the fund's goal is to have any future appreciation of the investment with the borrowed capital essentially they're using exceeds the cost of the capital itself. It's that simple. So they respond to demand, Lee's leveraged ETFs, to the share creation, redemption by increasing or reducing their exposure to the underlying index. How do they do that? They use

derivatives. They use things like index futures and equity swaps, index options. This gets very, very complicated. The big disadvantage and the reason that I don't particularly recommend them, and investment professionals that I cover don't particularly recommend them, is that the portfolio is rebalanced on a daily basis. This comes with added costs, but it also comes with added attention that you need to pay to the fund itself. So experienced investors who are comfortable managing their portfolios, in the opinion of most investment professionals, really should control their exposure directly.

So for example, if you want to have twice the exposure to the S&P 500, then just double your exposure. Don't go out and buy an ETF that's leveraged in that direction. The point is, again, do your homeowner, on this and look what investment professionals will typically recommend. These kinds of leverage and inverse ETFs are typically recommended only for professional traders, people who are paying very close attention to their portfolios. The daily reset is a major problem because over the course of a week or a month, you're not going to get exactly two times the exposure to the S&P 500

you think you are getting. So yes, on one day, if the S&P is up 1%, congratulations, you now, are up 2%. But over the course of a week with the continued daily reset or a month or longer, it's highly unlikely that you are going to be seeing that two times exposure working, particularly in an up-down market. It gets much worse when you're seeing up-down markets. And that's typically what happens. Very rarely there's a stock market keep going in one direction for days or especially for weeks at a time. That's it for today. I'm Bob Bazani. Thank you for. for listening and make sure you tune in next week and in the meantime you can tweet us

your questions or topic ideas at ETF Edge CNBC.