ETF Edge - Reassessing “thematic” ETFs 9/12/24

Episode Date: September 12, 2024

“Thematic” tech funds were big winners on the back of MAG 7 and Nvidia. But with recent market volatility, are they still the vehicle to stay in for the rest of the year?  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'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, tech and thematic ETS. We're leading the markets earlier this year, but they pulled back. Should you stick with them? And here is my conversation with Dave Mottes, CEO of Roundhill ETFs, and Dave Nautic ETF expert and independent financial futures. Dave, you launched the actively managed magnificent 7 ETF a little over a year ago. Big hit. Thanks to NVIDIA is still outperforming. It's up 33% this year.

But it was up more in July, and inflows have stalled out here. So what's going on? Is the public losing interest in putting money into big cap tech? I think that really what we're seeing is a reaction. to the market reassessing the stellar performance of the Magnificent Seven Stocks and what that may mean for the future. We know these names have had exceptional performance in 2023 into 2024, really driven on the back of excitement about AI and strong earnings.

And this most recent earnings season made it clear that companies are still going to need to be investing significant amount of CAPEX into AI before there's a large benefit. But at the end of the day, these names are still performing well. Certainly we saw a wobble in July and August. And if you look over the last month, performance has generally been in line with the market. So it has become a bit more two-way from inflows and outflows into the fund.

But again, if we look over the last month, we have continued to see inflows in the Magneton 7th. Yeah. The other big story, big ETF thematic story, is AI ETF. You've had chat out, CHAT is the symbol. You launched that a little over a year ago. And, you know, in theory, this has got all the right names.

It's got Invidia. It's got Microsoft, Alphabet, meta, Adobe. But really, it's just performing in line with tech and hasn't done much for months on end. I think it's up 11%. Here you see the holdings, all the right names in here. But this is a problem for thematic tech in general. How do you find companies beyond the obvious ones that are going to truly benefit from AI? This broadening out story is having a little bit of a tough time right now. Yeah, the chat ETF focuses really at looking at companies in two ways, identifying a keyword search of companies in their financial documents saying that they're involved with terms related to generative AI.

And then we use fundamental analysis to really rank and score them, really to ensure that a company is not just saying they're doing generic AI and saying they're selling AI chips and not doing it. Look at Navidia versus Intel. If you were to look at just using the word count for Intel, they didn't be higher than the video because they're trying to make a case that they're involved, but we know they're not in that company's facing some real struggle. So that's how we do it. What's interesting though to your point, though, is thematic tech in general has had a bit of a problem.

And the problem has been the negative seven is you've actually been performed better by just being overweight for seven names, not trimming back NVIDIA. But in the case of chat, we actually. you have have exposure to names outside of Chisdeme, it's obvious. You know, there are companies like Dell and the portfolio and others and ServiceNow and Cailports who are using AI and integrating AI. But right now, all the focus has really been on the chip theme and particularly that one thing that we talk about all the time.

Yeah, Dave, Roundhill. Dave's the king of thematic ETFs here. I mean, look at the list of video game. of ETFs, cannabis ETFs, Metaverse, luxury goods, GLP1, sports betting, right. We go on and on. But you and I have talked about this. Does it make sense to chase themes like this as an investor? Are there good thematic tech ideas or the stupid thematic tech idea?

What's the big picture? Every thematic idea is going to have its moments in the sun and it's moments where you might want to be shorted. And I think that's the important thing to think about here. Whether we're talking about the Mag 7, which I think has its own unique use cases, or something like a GLP1 or a chat, the case that you're making is you're trying to capture headline movement, really. If you're a trader, there's nothing wrong with that. If you're basing your 30-year retirement plan on owning a single thematic ETF, you probably need your head

examined. So this is a question of having the right tools for the right job. There are a lot of folks out there who do trade more actively than just a, you know, once every congressional election, they rebalance their portfolio. For the folks like that, having the ability to go long, or short, these very obvious big headline themes is very valuable. So it's reasonable to have some skepticism. I don't think anybody's going to say put all your money in the mags and never think about it again. But then again, might you want to be over or underweight versus your core exposure? Absolutely. Why? Here's the problem. The thematic tech, we all get hot and bothered over pot ETFs or cybersecurity

ETFs or anything else like that. And somebody creates an ETF and it's the top of the excitement, they're buying high. And then the excitement kind of wanes. We saw this with all of these though, didn't we? Except the counter to that is that we've had thematic ETFs, frankly, for about 25 years. We haven't talked about, for instance, solar in a while,

but tan has had an absolute tear lately. That was a thematic ETF. So it went back, fell out of favor, kind of back in, Right, exactly. You stay around long enough. But that's the point. These tools have real value.

Are all of them going to be going up at the same time? Of course not. Just like any sector allocation, energy might be down and tech might be up, or vice versa. This is basically the new way of thinking about sectors. The traditional way doesn't make nearly as much sense as focusing on headline movers for new things. I guess the other problem I have, Dave, while I'm complaining about thematics, is they're expensive. I mean, you know, O-ZEM, your other one, your weight loss is 0.59%.

Your sports betting is 0.3, I think, 0.29%. You know, these aren't, these aren't cheap, Dave. That's another issue that has to go into it. So go ahead, defend your pricing structure for me. No, happy to do so. I think if you can pair the Matic equity ETF from Roundhill or many other issuers, they're going to be more expensive than ultra-low-cost

core portfolio building blocks. And I think the other Dave made a good point a few moments ago is that it really depends on your objective. So if I'm looking to build a long-term portfolio and really set it and forget it, not trade, not think about it, there's probably tons of low-cost UTS and you can do so at really extremely low basis. But for investors we're looking to either do more, have the potential to outperform, not a guarantee that any schematic is, you know, it may be worth paying up for either credible active management or a means to identify a particular outcome in that space. And so when I think about it from that perspective, many thematic ETF are actually maybe less expensive than traditional active management and mutual

fund form. So it really depends on kind of how you're thinking about it from that point in. Yeah, it's definitely less expensive than traditional asset management, which would charge you 2% for this a long time ago. Fair enough. But it's still 0.6% and 0.3. But that's the name of the game. If you're going to do something narrow that requires, frankly, more monitoring. It takes more energy to focus on constantly reevaluating who isn't, who isn't an AI company. I mean, I can't keep track, can you? So it takes more work.

People get compensated for it. It's also the case that as much as I love Randall and Dave and the funds that they've got, it's pretty unlikely any of these is going to be a $50 billion behemoth anytime soon. They're narrow plays. and therefore to cover the basic cost of running them, you should expect to pay more. Somebody's running a $50 billion S&P fund, you should expect to pay a lot less.

Yeah. Another, I want to move on here. Another thematic ETF, you had some success with, that started with a splash this year, was your GLP1 weight loss ETF. There's 20 companies here, but, you know, 40% of it is Novo Nordisk and Lilly.

Lily's 20, and Nova Nordisk is 20. I remember I had you on Dave, when it debuted in May, it's up, I don't know, 10% since then, but here's the breakdown here. How much upside is still left in this weight loss business? No Mnorsk is up 300% in three years. I think Lilly's up 500% in four years. This is a classic ETF thematic concept here, but what more is left here? Is there other things that have come out?

It's going to be new stars. Tell us why we should be watching. this. Yeah. So it's really interesting. When you think about OZM in the GL1, GLP1 and weight loss space in general, is we're really at the early days. And yeah, you're absolutely right.

The companies that are actually selling drugs in market, Lilly, Novo, have seen their share prices grow astronomically. But also because their revenue that they're generating and protected to generate from this really new line of drugs is astronomical. I view them as the nevidian. of the weight company. They're the kings. They're so far ahead of other companies that they deserve such a high weight in a thematic weight loss portfolio. However, the way we identify the names of portfolio are companies that are either selling drugs in market like lily and novo or getting

weight to their various stages. So if you move up successfully from a phase one to a phase two to a phase three, you're going to gain more weight in the portfolio. And we'll be beginning to be beginning to really see, again, the early stages of this, where there's companies like Viking therapeutics, Zealand turns pharmaceutical, who are doing even more innovative things. Right now, the primary means of getting weight loss drugs are injectables. And some people may be turned off on this. It may be uncomfortable. Now we're seeing companies make a lot of progress on oral therapeutics.

That's actually a hard scientific challenge just because of the way those drugs are absorbing your system when it comes to weight of it. the gLP ones, but people are working on it and it's exciting that OZM actually has been structured in a way to actually outperform, you know, broader healthcare because of that concentration in the names have done well. So of course we can't guarantee what the future looks like, but I do really think it's early gains in the company, even if their returns have been stellar to date. But here again, I'm giving you a chance to justify your, your fee structure here. OZM, what was OZM's 0.6?

percent I think you've got to stay this is actively managed right so you have to decide if you think there's somebody who's coming up that's got some new innovation here that you're gonna give them a higher weight right I mean you actually have somebody doing this right yeah that's absolutely right so the the fund is managed by the round Hill Investment Committee so it's not a sudden and forget it we didn't just run a screen and these are the names and we hope that the GL1 T LP1 space stays the same it's actively managed right we're using a rule based

help guide that. And that's why, you know, we believe it deserves a higher fee that you can buy with a traditional health care sector. To date, we think, you know, performance has been there. That in the grand scheme of things is incredibly short period of time. And so time will tell. But really the idea here is to give the precision exposure that somebody wants, whether that's for three months, three years or 30 years. Right. Okay. So basically, we work very hard. We have a lot of professionals. So stop bugging me about our fees. Where you please?

But here's how much more innovative can you get, though? I mean, this stuff is unbelievable. All of us know people are using it. Oh, absolutely. Lower weight reports, lower blood sugar level reports. It's going to have big economic attacks. Potentially lower heart attacks. It's going to revolutionize the health care.

Oh, absolutely. And I think that's legit. And as Dave was saying, the important thing here is not, is the number going to go up? When you think about thematics, that's not actually the question. And the question is, does this ticker represent the theme well, whether that's up or down? And I would say the way Round Hills approach this definitely fits that mark. Having an active manager overlay on it makes a lot of sense because this is fast-moving technology. I agree with it.

In this case, Active Manager makes a lot of sense. Goldman Sachs research numbers. The obesity treatment market could expand 16 times its current size. It could hit $100 billion. That was the number we've been thrown around for months now by 2030. and that means a lot of companies are scrambling to get into this business. I want to move on a little bit. Dave, you've got leverage products out there for the Mag7 ETFs.

Now we're going to get into, I'm going to beat him up about leverage products. Two times long you have, okay, come on, I beat you up about your fees. Now I'm going to beat you up about the leverage. Two times long, you have a daily inverse, right? Okay, does that's true, yeah. So we have a two times long mag act and then a daily inverse. Okay. Thank you. Right. Not to be annoying, but does the world really need all of these leverage products, Dave? I mean, is there really, is there a demand for this? Look, look, we've talked a lot about leverage and inverse ETF before I, before Roundhill, I worked at a leverage and inverse ETF specialist as the head of products. So the way we, I need, you need to really firmly believe investors and particularly traders need to think about these products is do you have the ability to make a buy, sell, and hold decision daily? If you don't, if you don't,

stay away, look for something else. But when we're thinking about the ecosystem, and this is important that the as ETFs have grown, we saw the growth in Mags itself, which is even that was innovation to be able to provide that much precision in the ETF. For the trading community, we were getting demands of having a leverage version. And again, I see the point that some would say who needs them, but if you look at the marketplace, it's grown significantly. They were once a really It remains a very small portion of the broader ETF market. But there is a case to be made for traders who are looking for to maximize their upside in shorter period of time, willing to take that risk. These tools can be better for them and perhaps even better for them if they're trying to do that with margin or options in their own broker's account.

So time and a place for these ETS. I hear your point that they really need to be used properly. I completely agree with that. But we thought from with Magnetton 7 as sort of a subsector of the broader equity market that we think continue to have legs, it made sense to have a solution for someone to amplify upside or provide that edge on the downside. So the, here's your chance to riff on this. And we have talked about this for years and years and years. He is right. It is shocking how much of the volume these things attract from the leverage guys who want to. play this. It's shocking how much they charge. It's shocking how much money they make. I always

said pro shares is the company you want to be involved in because they have the monopoly on a lot of this. With all that said, I have said this for years. Leveraged and inverse products are 2% of the volume and 98% of the problems for the ETAF business. I have fought for years. It should be a separate product category. I don't know how you feel about it. But riff on this. You're the expert here. Do we have the world need all of these leverage products? We talk about this. The whole run-up to the ETF rule about whether or not it should be a separate bucket for complex products, whether that's leverage, whether that's derivatives use. The ship has sailed.

This is where we are. We have now effectively the mutual fund market in 1995 where there's 4,000 products of which, about 800 of which are what we would consider cheap core beta for building long-term boring portfolios. Almost the rest of it, thousands of funds are effectively trading vehicles. Whether they're marketed that way or not, that's how they get used when you look at how long the hold cycle is for most of these funds. Whether they're leveraged or not, like a lot of these thematics get used that same way.

The average holding period on thematics is weeks, not years, right? So people use these as ways of expressing short-term opinions. The ETF market has just evolved. It started out institutional. It moved into wealth and long-term asset allocation. And now it's become largely a retail and trading vehicle dominated space. That's just the way it works. What it means for investors is you gotta be careful.

You gotta know what you're buying. and why you're buying. And we have to remind viewers that these products reset on a daily basis and that the public cannot get their head around the daily reset. Yeah, if it says, I mean, there are a few folks trying to launch versions that don't do this, but if it says leverage or if it looks like it's got inverse qualities to it, chances are you need to watch that position every single day. Dave, I just want to move on here.

You had this big hit with the Magnificent 7 ETF. I know that you were going to be launching a similar concentrated bet on China stocks of the Brownhill Lucky 8 that bring us up to date and what if anything ever happened with that yeah that funds been filed for and hopefully we have more to talk about seeing when we identify appropriate time to launch that fund i think really what's interesting there is to Dave's point a moment ago the the utf industry particularly post the etf rule continues to have opportunities to innovate and mags really was innovative innovative and how it's structured right to provide that position just to the seven security

And we wanted to apply that to another market. It's really a lot of questions marks about the Chinese equity market and whether it's the best time to get in or the worst time. But we've been doing a lot of work on identifying the right name for that, structuring inappropriately. So it's going to be robust in a variety of markets. And I think it could be really interesting because there's actually a lot of similarities to the Magnetons 7th Stock in the U.S. to some of these names like JD, Alibaba, Fence that would have you in China that are mega national companies

don't have the state on enterprise issues, things of that nature, and that really almost are their own sub-economy, their own economy, outside this domestic China. So more come there, and I think I'm excited about seeing that product come to market. So here you go, essentially a concentrated bet on China. Right, exactly.

And someday China is going to be a good investment. If you're a super bull on it, that would be a great way to play it. But also, if you're a super bear on it, wouldn't it be great to be able to short it cleanly? Yeah, yeah, absolutely. 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. Dave, nodding, ETF expert and independent financial futurist joins us now. Dave, good to see you again.

I wanted to just follow up with a couple of things about the ETF business. It's been an amazing year. Yeah. And we have seen some absolutely stunning inflows this year. I'm wondering if you can comment on that. Record inflows in August. Even in bonds we've seen, it looks like we might be headed for a one trillion dollar year. Yeah, I suspect at the end of the year will be at about a thousand new launches and about

a trillion dollars in new flows. That would make it the biggest year for ETFs in both metrics. We may not hit 1,000 new products, but on a run rate basis, we're trending at about 1,000 a year. That is amazing. Now, so we have what, $10 million? $10 trillion in assets. Roughly $10 trillion in assets, roughly $4,000 individual tickets. Yeah.

So we seem to be on a massive product development binge. Yes. It's a combo of people coming to market with product that was already existing somewhere that's new in an ETF format. and just folks coming up with crazy new ideas every five minutes. Yeah, and what's amazing too is, you know, the ETF business, you and I grew up with is not the EDF business today. We grew up with cheap index-based ETFs. Yeah.

Low-priced ETFs. And now we are seeing the birth of more active management. We're seeing more even leverage and inverse ETF. We're seeing more, specialty products, thematic products. To me, what happens is they all charge more money. Right. So I think you noted in your blog post recently,

40% of industry revenue now comes from products that are not cheap beta. Yeah, so Tidal publishes a great weekly rundown of all the funds in the marketplace and how much they make and who's collecting all the revenue. And the run rate is about 45% of the revenue come from what we would consider non-traditional ETFs, meaning they're either actively managed,

they're smart beta, they're leverage, They're leverage, their derivatives base, their zero data expiration. They're not the cheap beta that you and I are used to. I think we've really had a fairly steady growth in the ETF industry from its institutional base, which was in the 90s when it was really only used by large, large firms, through the advisor and wealth markets, now finally down to that retail and trading-oriented market. I think it's important to point out that when we say retail, though, So we don't just mean like YOLO traders who are flipping GameStop and, you know, doing lots of leverage every day.

It also means, you know, retirees that are out there buying their own buffered products to sort of mitigate their downside. Or maybe doing a little bit of thematic investing to round out the edges of their core beta. That's retail too. It's not just traders. And yet, give me a chance to bitch a little bit. Most of these new products, you know, like these options overlay products and buffer products, They seem really complex. And it's hard to explain to people.

Is this good news or bad news or just the natural evolution of the market? I think it's the natural evolution of the market. Unfortunately, meaning like there's no putting this genie back in the bottle. The genie only goes back in the bottle when people don't want to buy these products and therefore they close, right? So we're not going to regulatorily change the structure. There's no impetus to do that right now. So these products will exist. The patterns of returns that some of them offer are, in fact, really,

interesting. I want to highlight one specific one if you don't mind, which is we just had Dave Maaz on. They run the zero data expiration funds. There are a couple of them now. One XDTE is focused on the S&P. If there's a QDTE focused on the NASDAQ100. And the idea there is that they're basically putting the buyer, the investor, the one who buys that ticker in the role of the lender to the degenerates that want to trade this stuff continuously all day every day. You're the seller of zero data expiration options. in those products to that sort of degenerate gambling corner of the market that's just yoloing with as much leverage. Turns out if you do that, you can extract a pretty good little extra

juice on your S&P 500. Because they're the dumb money? Because they're the dumb money. So like not the people buying it, the people you're selling it to are the guys who at 10 o'clock this morning are saying, I'm going all in on Nvidia through the clothes, right? Which is not how most investors should be investing, but obviously it's a valid way to speculate. Just like going to a black tech table is a valid way to gamble, right? I mean, it's a time-honored tradition. So some of these more complex products are in fact putting investors in a less risky position

or in a position to be the one that everybody usually complains about. Everybody always complains, oh, Wall Street's rigged, right? The big guys are always going after the low-information investor. You can do that in an ETF. You can take advantage of those low-information investors if you really want to. But again, to your point, it's going to be

be complicated and it's going to be expensive. Let's talk about private equity. Everybody wants to know how to get into private equity and part of the problem of course is we should yeah we should have more companies come public more and not hide in the private markets but let's that leave that aside. There have been the ETF industry is really eager to figure out how to get private equity into ETFs. There's some serious problems with doing that but we've seen some companies recently make some attempts. Is this a good idea or a bad idea? It's a terrible idea. It's a toxic idea. It's one that I'll probably end my career fighting against. You can start now. What? You can start now. You can start ending your career right now. Go ahead. So look, the only

product we've actually seen. Just give us 30 seconds. Why is this a bad idea? Because fundamentally, you cannot solve the liquidity barrier between public and private markets. You can maneuver around it but at the end of the day if you can't find the buyer for the thing that you're sticking in your fund it should not be an ETM. And you can't solve the problem particularly with ETES because of the redemption and creation mechanism they have to be able to come in and out and they're if you can't with private equity. You can't close it right that's the issue so like the best example of this is the product we just saw filed by State Street which

I seriously doubt will be approved in which they partner with a single firm Apollo absolute monster in the private credit business And the idea is they would take this whole fund, the 80% of it that's quote unquote liquid, and they would buy individual issues that are private from Apollo and put them in the fund. Apollo would then tell the fund every day what they're worth and agree to buy them back at that price. Now, that sounds like you're solving some of the problem until you posit an edge case like, oh, I don't know, the credit markets lock up and Apollo goes bankrupt. We've seen it before.

Firms go under. So you can't, it seems inconscionable to me that you would build. the fund, sell it to the average retail investor through the ETF wrapper, knowing that you have a single counterparty risk which effectively tanks your entire product. That's just an inconscionable risk. Yeah, I agree. This thing, the state street you're talking about seems to completely separate, but the mismatch between private and public funding and particularly the way the ETF mechanism works.

The real problem. I don't know how you'd solve that problem. Well, you solve a way things like what safety you're doing, but you find, you create a buyer's pool. You come up with other ways of marking it. But we all know that the mark on of private security is always going to be BS. It's always going to be BS. All right, Dave, it's good talking to you, as always.

Pleasure. Dave, of course, Dave, of course, Dave Notic. Independent Financial Futures. That does it for this week's ETF Edge, the podcast. Thanks for listening. Join us again next week. Remember, you can see all the shows, etfedge.cnbc.com. How does InvestcoQQQQQR rethink possibility?

By rethinking access to innovation and the NASDAQ 100. Let's Rethink Possibility, Invesco Distributors, Inc.