ETF Edge - Morgan Stanley Entering the ETF Space – and Hot Takes from the World’s Largest ETF Conference 2/6/23

Episode Date: February 6, 2023

CNBC’s Bob Pisani spoke with Tony Rochte, Global Head of ETFs at Morgan Stanley, Dave Nadig, Financial Futurist at Vetta-Fi and Vance Barse, Founder of Your Dedicated Fiduciary. After a disastrous 2022 for both stocks and bonds, they dove into the hot topics being talked about at this year’s Exchange ETF conference – everything from fixed income and dividends to thematic tech, buffered products and the raging debates over global vs. domestic and active vs. passive. Plus, Morgan Stanley is finally getting in the ETF game, launching a suite of brand-new ETFs for the first time ever. Rochte dishes on what finally made them take the plunge into the sizzling ETF space. 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 on all things, exchange traded funds, you are 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, we're coming live from Miami Beach at the world's largest ETF conference, that's ETF Exchange. After a disastrous 2022 for both stocks and bonds, we'll dive into the hot topics being talked about at this year's conference. Everything from fixed income and dividends. ends to thematic tech ETFs, buffered products, and the raging debates over global versus domestic and active versus passive. Plus, Morgan Stanley is finally getting into the ETF game, launching a suite of brand new ETFs for the first time ever. We'll sit down with the man in charge of those new ETFs and ask him what made Morgan Stanley finally take the funds. All this from Miami Beach. Here's my conversation with Tony Rockty, Global Head of ETS at Morgan Stanley. Dave Nautic is the Financial Futurist at Vetify and Van Sparse is the founder of your dedicated fiduciary. Dave, 2022 was a disaster for stocks and bonds, and yet 2023 is seeing much of that reversed.

What are the hot topics here amongst the RIAs? Our viewers want to know where is the money going right now? What are RAs doing in terms of where they're putting new investments? I wouldn't be leaning too hard into this narrative that somehow like unprofitable growth is coming back and we're all going to pile in. Talking to the advisors here, there's still a lot of caution, a lot of focus on inflation, a lot of focus on doing better with your fixed income. I think a lot of interest in active strategies there. And in general, the active, passive debate seems to be a yes-and kind of improv at this point.

People are looking for the right tool for the right job and active as deeply in that mix again. Yeah, that makes a lot of sense. Vance, you're an independent financial advisor affiliated with people who are. What are you telling your clients about what to expect in 2023? And what do you expect the major trends in ETF investing to be? You're an advisor. You're a person involved in the thinking part of the business, an advisory part of the business, thought leader.

That's the word I was looking for. Thank you. What are you hearing? Clients are talking incessantly about one thing, inflation, inflation, inflation. And I don't buy the narrative that inflation is done and that the Fed is going to be able to jump to this manufactured 2% target overnight. So we're explaining to clients that while inflation has shown signs of coming down, that we would expect inflation to continue at an elevated level,

and we're playing that out thematically in portfolios. It's tax season, so a lot of clients are asking questions and poking the facts on tax. That's coming up. And interestingly, we've seen a newfound interest in alternative investments, which Dave almost always happens after the sell-off. Yeah, well, isn't that something to happen? But I want to move on.

I want to come back to the tax season and get your thoughts on this. But one of the things that's very important, we've got another sign of the continuing strength of the ETFs. Morgan Stanley announced last week that they were finally going into the EETF business. This is the last big player there. Joining us now, Tony Rockney, he's the global head of ETS from Morgan Stanley. What made you finally take the plunge? You know, in case you don't know, Tony Rockney, this guy's a veteran in the business.

More than 20 years, Morgan Stanley brought him in to shepherd their entry into the ETH business. They're lucky to have you, but what what's the thinking from Morgan Stanley? Why now? Yeah, thank you, Bob. The logic was very simple. We launched last week for index Calvert ETS and two actively managed ETS from Calvert. But we looked at our clients, institutional investors, the advisors we serve, self-directed retail investors, and it couldn't have been clearer.

They want the ETF wrapper. Alongside mutual funds, the customization engine we have with parametric, and also, we managed over 200 billion in alternatives, Bob. But it was clear that investors wanted choice. So it's not as if mutual funds are going away. They're not. But investors want to have ETFs alongside mutual funds, SMAs, and alternatives. And that was the logic.

Yeah. So you entered with six ETFs, as you mentioned. I see a broad equity ETF. There's a short-term investment-grade bond ETF. And then there's four others. I consider it ESG-like, essentially. Why did you chose a bit of an emphasis on the ESG part of that? Is there a demand there?

You would be doing this if there wasn't a sense that there's some demand. Yeah, there's certainly demand on ESG, and specifically Calvert, is we're building an ETF platform, Bob, with multiple brands, across jurisdictions, across asset classes. But specific to ESG, all six of the new ETFs we launched are actually focused on ESG. And interestingly, last year was a tough year, no question about it. in the ESG space, three quarters of the year saw net outflows. Calvert was one of the few fund families, Bob, that saw net inflows in their mutual fund line.

So investors voted. They like Calvert for ESG. And to Dave's point about active management, one of the ETFs, the Calvert ultra short bond, symbol CVSB, 5.5% yield, price competitively at 24 basis points, fully transparent active ETF, which Dave, you know is a significant trend in the marketplace. Yeah, we've seen a lot of move towards that fully transparent structure, a lot of conversions in the last year. But, I mean, more funds launched under an active umbrella than a passive one in the ETS base last year. That sort of says volumes.

I want to come back to active, but I want to first get to some of the hot products, hot topics that Dave was referencing and go a little bit deeper. First, I want you to comment on buffer products. Now, these offer participation in stocks or bonds, and they also provide some level of downside protection. This was arguably one of the big products of 2022. They have products, innovator products, were all huge last year. Equity Power Buffer, P-N-O-V. You want to look up that one there. Raking in cash in the second half of the year.

They were great in the down to sideways market, but investors give up significant upside in the markets when it's trending up, right? Yeah. So we're going to see this again. Or just what he was talking about earlier. Vance, like, oh, you're pouring money into the top of the market and do buffered products, and this may not be the year for it. Well, you know, the thing about the buffer is they really do what they say they do

right on the tin. And so if you're looking at the market and you're uncomfortable and you think, gosh, there could be 15, 20 percent down still to go here. You're not willing to be invested there. A Buffford product is going to solve that problem for you. To your point, you're going to give up upside. There's no free lunch. That's what you're doing is you're selling upside potential to get some downside certainty. I don't think those products are going anywhere. I think they feel a very important behavioral niche for a certain kind of investor. And Vince Buffford products and remind everybody, buy, own equity. usually S&P 500, but they also buy call options there.

So you're giving up some of the potential upside because you're collecting a premium there. Be Jack Bogle with me here saying, is that a reason why you need to buy that now? You have to have a direction opinion on the market to do that, right? Jack Bogle looking down and saying, you know, it's not going to make a difference in the long run. You know, you're going to be a meme version.

Just don't sell. Just don't sell. Keep going, right? Most of the families that we serve have a long-term horizon, and they're not necessarily worried about short-term volatility. We will look at different objectives for different portions of an estate and take certain accounts to structure them idiosyncratic to what that particular pool of assets' objective is. Do we have a short-term liquidity need?

Do we need to save for a house? Do we need to save to pay an estate tax, for example? So the appetite for those types of products for our clients would be driven by us because most clients don't come to us with that particular idea. Yeah. Yeah. And you have to do this too. You're running an ETF family now.

You have to decide what's hot and what's not. I guess the question is, I know you haven't done anything yet like this, but how do you make the decisions about what's going to, what we need for our clients right now? I mean, we have plenty of ETF families. They sort of chase whatever the hot product is. Yeah. Hot ETFs or cybersecurity or whatever. How does Morgan Stanley think about this whole thing?

So we think about things, and Dave mentioned active advancements in tax efficiency. That's why the ETF wrapper will complement these other strategies. But again, when you talk about trends, Bob, certainly thematic has been in focus over the last two to three years. We launch CDEI, the Calvert Diversity, Equity and Inclusion ETF. It's focused on large-cap companies, broad-based, and really Calvert applies the Calvert principles to their methodology. looking at companies in the way in which they manage diversity, equity, and inclusion. That's a trend. You know it.

You work with your clients who are looking for this ESG type of exposure. It's competitively priced at 14 basis points. It's the lowest cost in the thematic DENI space by almost 30%. In addition, DENI is such a part of Morgan Stanley's core values. At the end of every year, we're going to contribute two basis points from our own coppers, from our own management fees to charities focused on diversity, equity, and inclusion. So we believe in this, Bob. It's very important.

And look, Calvert differentiates themselves in the ESG space. But thematic is definitely a trend. Good. I want to come back to the minute, but I want to hit on international now, because for the first time in decades, we're seeing some outperformance here. Outperforming the U.S. for the first time in years, led by Europe. International Region flows posted record inflows in January. The question is, again, I go back to Jack Bogle.

If you have a broad, diversified portfolio, you always were in the international. Well, except what we saw, like when we looked at the VETify data from behavior of advisors, what we saw over the last two years was a real re-domestication, right? Years and years of getting people to get over home bias and start investing internationally, get a slug of emerging markets in there. That kind of reversed during the pandemic. People got really conservative. They brought assets home.

They didn't want to be investing emerging. They didn't want to have to worry about what was going on in Japan. That's changed. Advisors are now putting those portfolios sort of back into a more normal light, and they can do it in an environment where they also have that ballast of a viable fixed income sleeve too. And that makes a huge difference. Yeah. I have to say that it's fun to watch international finally come back a little bit.

But you have to say on a mac, put on the macro hat here, If we're having even a modest global recession, emerging markets, for example, doesn't seem like a necessarily great investment. I'm trying to not be a person that's just doing a mean reversion here, but just on a macro observational level, it's kind of hard to make that. And yet, the market is making that then. That's exactly what's happening. That's right. And the reason that we are fired up in particular about emerging markets is because with the anticipation that the Fed will eventually cut rates, and that interest rates organically will come down as inflation comes down, the dollar would

lose strength relative to cross currencies in international, specifically emerging market currencies, which would theoretically be a windfall to emerging market equities. And I think that's really what has been driving the risk appetite for that particular sector. Yeah. You want to put on your global macro hat? Make any comments? It seems kind of counterintuitive to me. I keep saying this, but on a macro level, even if you want to put on your global macro-level, even

Even a modest global recession is going to hurt, even modestly higher rates is going to hurt emerging market for example. No question. It's not. My theory is, it makes sense and yet it's wrong. It's not the best theory. All the best theory makes sense. There's my whole career, actually. Just summarized that. Go ahead.

Look, the team that we have is focused on building the ETF vehicle, Bob, and we're going to provide choice. So we launched CV-I-E, the Calvert International ETF. that'll provide exposures for allocators and investors to the international space. The other thing, we're building a global platform. So today we're here talking about the U.S. listed, Calvert being the first family. We have aggressive plans to launch multiple brands beyond just Calvert, Morgan Stanley, the likes of Eaton vance, and others. And we're spending time in London to build a local European ETF business,

non-US traded, of course. But we're very focused on the global environment. No question about it. You're very good at staying focused on the Morgan Stanley story. I'm very impressed with how he does that. I'm trying to get him off to be the, like, you know, broad macro guy. You're very on point all the time on Morgan Stanley.

One topic, very close to my heart. Dividend appreciation. I love it because it seems so boring, but it's the way to wealth creation. No one cared about dividends in an up market. Nobody. But last year, there were big inflows. into stalwart like Vanguard's dividend appreciation,

VIG, the pro shares dividend to risk the Cratz, the noble, which invest in companies with a history of steadily increasing dividends. Guys, are we gonna see that again? Yeah, this is a beautiful thing to me, because reinvested dividends are the way to wealth, and it's a big part of the S&P's total return. But here's the thing, I think actually the story in dividends

hasn't been about clipping that coupon and reinvesting it. It's been a way to play defense with your equity position, right? Long-term dividend depreciators are almost by definition high quality, high cash flow good companies that have been around for a while. That's the definition of a defensive portfolio. I know you're a fan of some of those products that like really focus on free cash flow. There's been this move towards actual fundamental quality and investing. That's why those funds I think have really picked up the flows.

The dividend stream honestly matters a lot less when you can go get four or five percent out of the bond market. For a long time, that was the only story in dividends. Now I think it's as much as anything about quality. Yeah, but you're still, yeah, and you could still reinvest the returns on the bond market in the same way. Are you in the same camp he is on the? Very much so. So even if inflation comes down, the potential for it to remain elevated is such that we want to over-allocate to holdings that are comprised of companies that have a history of being brick-and-water companies, having pricing control.

Being stuff out, yeah. Absolutely. And clients certainly resonate with that because they understand. understand that inflation is hurting everybody at the register and they get the connection between what's happening in everyday life and what's happening in their portfolio. I'm finally fixed income here. There may be a little life left in the old 6040 stock bond portfolio. Remember, we killed it last year. Guess why? This year, both are doing better after disastrous 2022 bond. ETS had 20 billion of inflows in January. Will investors be content

to scooping up 4% to 5%, 6% with relatively minimal? risk like you just said. Yes, absolutely. They're going to be very content. That's it. We're back here from some other time. Now that you just killed by all story. No, I think this is a case where the interesting stuff is happening is an outside that core bond exposure.

In the junk bond exposure, we've seen a huge shift from things like J&K and HG towards things like senior loan products. So even though we've had a bit of a route. J&K being high yield. High yield, but in a different way. As opposed to just buying junk bonds, you're in the senior loan market. your loan market. Right. That's been a very interesting way for folks looking for that outsized yield, yield that's actually

printing above inflation right now. So there's a lot of moving parts in the bond market. And like we said, active is back in force in that part, especially as we get into the shorter end of the curve. A lot of short-term active bond product. Any more? Yeah, you know, clients are really interested in T-bills, interestingly, enough, because they can finally get a yield, which didn't exist.

And I think so much of the market right now is something. still looking at investing through the lens of quantitative easing. We were in that ZERP, Tina, QE-driven environment. And that paradigm changed when inflation reared its ugly head in the latter part of 2021. And we're now seeing that play out. And the QT isn't going anywhere, right? So we can talk about when we may or be done

with the interest rate hiking cycle. The sort of stealth tightening is going to keep happening. Absolutely. People forget that there's a mathematical impact on interest rates when with the Fed running QT in the background. without question. Good. I would have flip this around here.

There's sectors that were formally hot that I think have sort of muted enthusiasm these days. I want to get the experts' panel's opinion on this. Starting with ESG, environmental, social, and governance, ETFs. The space has become very heavily politicized. There's still debate on how to weight the factors, intellectual issues we've all been having, and performance has, frankly, been disappointing.

So I think the big issue here, and what I want to ask the three of you is, Is there a successful path forward for the ESG space? I think we got to throw that to Tony first. Yes. Well, as I said earlier, Bob. We'll hear about Morgan Stanley. I would say this.

Last year is a lot of headwinds for ESG. In the last three quarters of the year, there's no question about it. But we're very focused through Calvert, which is part of the Morgan Stanley family, Bob. Really? Required to say that. Well, let me make a note about that. We do that. We actively manage the exposure.

and create the Calvert principles and apply that to our screens. And many of the other ETSs, over 200 US listed ETS focused on ESG, many of them farm them out to index providers. They do a good job, but I would tell you, back to the opening comment around active management, that's what we're applying to the ESG space. And we think it's a differentiated. But back to the question, is there a way forward?

You know, I had a discussion this morning with Jennifer Grantzio, the head of engine number one, who tried to reframe this question. this whole story after, you know, it's become so politicized. In one sense, you could stand there and say, well, who's in favor of more polluting of the planet? You know, give me the votes on that. Who's in favor of less diversity? Well, less women on the boardroom.

I don't think there's any votes for that. And yet, it's become politicized. So my question is, how do you move this story forward? Well, because when you talk about ESG investing, it's about more than that. What it really is about is stewardship, right? ESG investing is about owning companies and then being involved in what those companies are doing. That is, I think, a trend that we are seeing really on the upswing, this focus on who runs companies. So even non-ESG funds that may not have the label on it, you're going to start hearing more and more about passing votes back to shareholders, both Vanguard and BlackRock are talking about doing that.

We're doing it in various ways. That's where the ESG discussion is moving. I think the era of everybody launching new ESG products and now we've got 3,000 of them, and now we've got 3,000 of them, and now we're have to pick between those. I think that that's calm down a little bit. That's probably healthy. Now we can have the real conversation. I'm going to move on here. Kathy Woods and the ARC funds. Now she gave the keynote interview at last year's ETF conference. And despite a terrible performance, her legions of fans have not deserted her. In fact, the outflows from the flagship fund really were very minimal in 2022, startlingly minimal. The fund is actually up 37% this year.

She's stuck to her guns. She believes that technology of her choice will continue to be the big disruptor. The fans have not deserted her, and yet people who brought in at the top there in 2021, 2020, early 2021, ewes. It's a volatile strategy. I mean, she's the first one to tell you,

her team is the first one to tell you, when you're investing in these highly innovative, generally not super profitable growth companies, you're going to have wild swing. The time horizon for those kinds of strategies is not a trade. It's a lifetime. And I think that's the key thing to remember. Those are not tactical funds.

Those are long-term funds. If you're using them, it's probably a small portion of your portfolio, but it's definitely not a portion you should be day-traded. I think it's very disruptive when you look at what she's been able to accomplish, but it goes back to active management. As much as many RAs, many institutional clients want the passive exposure, they also, in some cases, want thematic active exposure. I think it's as much about great skill.

Clearly, she's demonstrated, but the rapper itself. Right. But, advance, Kathy's right in her assertion, at least I believe she's right, that disruptive technology like she's investing in is going to change the world. We all agree on that. The question is, what's the price we're willing to pay for it?

And obviously, a lot of people are not willing to pay the price right now for that. Everyone might agree. Teledoc is going to change, you know, investment. in the, you know, talk to your doctor at home space, but how much you're willing to pay for that future stream of earnings is the issue. And that's what got killed when interest rates went up. So it's a, she's right intellectually, but she's rolling on the price, potentially. And isn't that the right way to look at this?

And you have to be really long term, like Dave says? Yeah, I agree with Dave. I think that Kathy is a religion. She has quite a following, right? I mean, she's truly innovative and is a well-known thought leader in the the industry, a lot of clients are fearful that because we're not back in that QE-driven, zero-interest rate-driven world, that high-velocity growth tech stocks, for example, might not fare as well in the current environment as they did for the decade plus when the Fed

was implementing the so-called Fed put. Yeah, yeah. Let's broaden that out. Thematic tech in general. Now this is a topic that is very dear to my heart because I spend a lot of time back five or six years ago, covering cybersecurity, covering gaming, covering robotics, or 3D printing, social media, cloud computing. We had all the ETAF providers on at that time.

They all had their moments in the sun, and they all faded. This year, they're back. Wrong again. But despite the surge in the thematic ETF performance, to start the year, investors have not yet thrown significant sums of money. I watch the flows, not the dollars, not the price. And I don't see huge inflows yet. No, and I think Vance's point about, you know, in an era of easy money,

it's really easy to invest in a lot of things that aren't going to pan out. Now that you have to actually pay to borrow money, those companies are going to be more constrained. Now, the good news is you probably end up with better capital market outcomes. Some of those companies shouldn't be raising money and should go bankrupt. Some of them should be rewarded for being actually profitable. That's what we want to happen. The challenge is packaging that up in a thematic ETF. can be a real issue. So I think this is one of those things where smart investors are looking at those kinds of funds very carefully.

There'll be some flows into them, but I don't think this is going to be everybody pile on. But again, Vance, the question is what's the right price? There was a study out of the University of London. I think it's coming out this week, but where they looked at new ETF issuances, and they found that the thematic tech stuff, pot ETS or, you know, cybersecurity, has dramatically underperformed the market because they tend to go, they think, to float them at the top. Yeah. So the demand is high for cybersecurity stocks five years ago, and so you're buying cybersecurity stocks at the top of the market,

and of course they'll tend to underperform. This makes a lot of sense. Again, Jack Bogle, you know, wagging me down on your, Bob, you're not paying attention, mean reversion. They're buying at the top, and it makes some kind of sense. And yet people love these topics, because it's a way of picking the market. It's a market pick, essentially.

So how do we cover this responsibly and tell people these are products that are out there, But at the same time, tell them what the evidence is. You know, that you've got to be careful with this. You're buying at the top of new products sometimes. Yeah, for us, data drives all investment decisions, right? Having opinions about where markets will go is one thing, but how to play out the satisfaction of a particular sector.

When we look at beta and alpha and having a core holding, and largely the type of account as well, because people forget that there are ultimately two buckets of money. There's the bucket that is qualified for retirement, IRAs, 401Ks, and so forth, and then non-qualified or so-called brokerage or taxable money. And many investors are demanding additional value, particularly on the heels of last year. People forget that the 60-40 portfolio, Bob, was down 15% in 2008. Newsflash, this just in, it was down 17% last year.

So the pain was discernible, and it's coming up in conversations. And as clients are looking for different ways to find value in their portfolios, we'll implement thematic strategies, but it really has to ultimately have an appropriate home pursuant to that client's long-term objectives. Most thematic, Bob, and you've seen it over the last, certainly I've seen it over the last 20 years, the first mover advantage, that typically grabs market share. But over time, right, as new entrants enter the game, it gets tougher and tougher to raise assets. I just think as a journalist, as much as I cover these things and point them out, I think journalistic is a responsibility to tell people what happens when you buy things at the top.

And also, look, thematic products are made to be married to headlines, right? Big cybersecurity break by the cybersecurity ETF. We know that investors are going to think that way. What we can do is educate them about what those products are really doing and that they're not a short-term trade. One last thing on the not-so-hot product, the Bitcoin ETF, right? Okay, forget about it, right? Yet the futures, the Bitcoin futures, ETF, it just keeps chugging along. ProShares was right. Folks, it doesn't matter. We have a product and it just keeps chugging along. Markets up, markets down. It just keeps chugging along there.

And crypto is certainly well off its lows. I don't think that narrative is gone. I certainly there's much less conversation at this conference this year about crypto. I hear nothing. Virtually nothing. I think there's a lot of people waiting for the GBT lawsuit against the SEC. I don't think that they're going to win that. So I don't think we're seeing a Bitcoin ETF, I won't say, in my lifetime, but, you know, certainly in the next year. Morgan Stanley Bitcoin ETF fund is not. I am focused on a lot of other topics, Bob. I will defer to Vance and Dave on the top of time.

Okay. I will roll right to date. It's always. Gentlemen, thank you very much. It's been a stimulating discussion, as always. Three of the best in the business, I promised to you, and I gave it to you. That does it for this week's ETF Edge. My thanks to Dave and Tony and Vance.

We'll be here through Wednesday. That's right, yes. The shot is not going to change. At the Exchange EPP conference, I'll be talking to several of the big thought leaders here. Look for my interview with Laura Morrison at Direction. It's CNBC Pro. That's going to be right after the close today.

Everybody, thank you for joining us. Have a healthy, happy and safe trading movement.