ETF Edge - Record Highs, Searching for Yield & IPO Market

Episode Date: August 24, 2020

CNBC’s Bob Pisani spoke with Kathleen Smith, chairman and co-founder of Renaissance Capital; John Davi, chief investment officer and founder of Astoria Portfolio Advisors; and Christian Magoon, CEO and founder of Amplify ETFs. They discussed what 2020 has in store for recent and upcoming initial public offerings, the risks and rewards of bond alternatives as investors hunt for yield, and the rise of the momentum trade. In the markets 102 section, Bob discusses investing in IPO's through 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 on all things exchange traded funds, well, you're in the right place. Every week we bring you interviews and analysis and you break down what it all means for investors. I'm your host, Bob Pisani, and today on the show we'll tackle the big ETF issues of the day. With the market hitting more record highs, we'll talk about what's driving the action, including momentum and quality ETFs. Where to search for yield and the current state of the IPO market. Here's my conversation with John Davy, founder and CIO of Astoria Portfolio Advisors, Christian Magoon, the founder and CEO of Amplify Exchange traded funds,

and Kathleen Smith, the co-founder of Renaissance Capital. Welcome, everybody, old friends, all of you. John, let me start with you. You've spoken often of your love for quality. You can actually buy this ETF, QUAL right now. It's at a new high today. These are companies that have stable earnings growth generally, low debt to equity, ratios overall? Why does the market like these type of stocks right now? I believe that quality

over time is one of these factors that's persistent, pervasive, robust. You know, we've talked about this ETF quite a bit on your show, ETF Edge, and I think that it's names that everyone knows and can understand. But what we're doing really, Bob, is we are shifting our portfolios, we are trimming quality. We still like it, but I think that where we are in the economic cycle, you know, the Fed anchoring interest rates at 0%, the Fed doing quantitative easing. I think equities and stocks, broadly speaking, have a green light. So we are shifting our portfolio owning more sickly-oriented stocks and sectors. Small-caps, mid-caps, they tend to grow a little bit faster than the overall market,

and sectors like energy, industrial, materials. So that's a new twist from us at Astoria advisors, and I think that that's, you know, what investors should be doing as well. I think the key point here is, and Bruce, I don't know if you want to comment at all, but on this group here, Apple and Facebook shows up on quality. And again, you're looking at companies, low debt to equity ratio, generally good earnings for it. But you also have some very strong consumer names, not associated with big growth necessarily, but stable, Coca-Cola and Johnson and Johnson, for example.

So it seems like the right kind of mix. You don't want to throw all your money into tech mega-cap. It seems a little bit too much momentum oriented, but quality kind of strikes the right kind of tone for this market, doesn't it? Yes, I do think so. But what I would point out, Bob, is that since March 24, you know, QAL has underperform the S&P 500 ETF by about 200 basis points. So, you know, there is a change in market leadership, and that I think is important. But, yes, I agree with you. You want to have, you know, broad, you know, diversified basking.

You just don't want to own, you know, large-cap kind of tech stocks. So, you know, that's the message from us is to kind of tilt away own more cyclically oriented portfolios. Yes, Qual is reaching all-time highs, but so is the S&P 500. But since March 24th, the cyclically oriented sectors, small caps, you know, they've really outperformed dramatically compared to the S&P 500. And that, as you look forward the next 12th to 18 months, I think that's what you want to be doing to your portfolio as we continue to rebound from an economic perspective.

Yeah. Sorry, Christian, I meant to tell us to you there. I know if you have any thoughts on this. I know you watch the market as well. And I can't help but think, just to repeat the question, I can't help but think that quality is a good way to look at the market right now, even over momentum, because here you're getting stocks that have generally improving earnings, but also low debt to equity ratios,

what people would consider some kind of modest value tilt as well. That's right, Bob. I think, you know, after the COVID crisis, people really want resilience and the companies they own. And Qual really provides that when, you know, it looks at companies that have stable earnings, high return on equity, low debt to equity, all characteristics to kind of batten down the hatches, if you will, against kind of this unusual economy and this resilience in these companies in the form of these characteristics.

We think not only make a good, you know, investment here in the times of COVID, but should last for quite a long time. And, you know, the performance of Qual has been pretty nice, you know, since not only year to date, but, you know, going back several years. So an interesting ETF, 32% in IT, Facebook, and Google, though. So it might be getting a little ahead of itself in terms of some of its technology and communication exposure. Yeah. I want to move on to the IPO market because it's been fascinating to watch this year. Kathleen, this is your bailiwick.

you run the Renaissance Capital IPO, one of the most successful ETFs of the year. You're up 45%. You're approaching $100 million in market cap. That's nice to see. So not only your price is going up, but you're getting money going into the fund. Flows are positive. 45% versus 5% for the S&P is pretty good. Tell me why you buy a basket of about 60 IPOs that have gone public in roughly the last two years.

Why have the most recent IPO done so much better than the rest of the market? What's the outperformance due to? What are investors looking at? Sure. The IPO market and companies that go public tend to be new economy companies, and they're doing disruptive things. So we're kind of in the sweet spot of what the market's been looking for now. We've had many digital work from home kinds of.

companies like Zoom Video is the top holding in the ETF, and I'm on Zoom now. It is just been a very strong stock. Another company such as Slack does enterprise messaging. So these businesses are benefiting from this kind of environment where businesses are moving to a more automated and virtual way of working. Also, we've seen a lot of digital platforms, Rocket Mortgage, for example, they're self-service. So they're able to do customer acquisition at low prices because they're using technology, lemonade, renters insurance, self-service. And then finally, we are, it is a low-leveraged kinds of companies that we've been talking about.

IPOs tend to be growth companies. And growth companies are really much more valuable in a low interest rate environment, basically because the present value of future growth is higher when you're, discount rate is so low. So we're in the sweet spot right now of what investors seem to be interested in. And the future looks pretty bright. Now, we've got some rather notable names talking about going public and have filed confidentially. We have DoorDash. We have Airbnb. We have Palantir. I think it's interesting, Kathleen, like seven or eight months ago, there was a lot of talk about direct listings. Maybe DoorDash would do a direct listing. Maybe Airbnb would do a

direct listing. Or we don't need to raise money. That seems to have gone away to talk about direct listing. Now they're talking about classic IPOs. But give us a quick preview about the rest of the year. What do you see happening? Sure. I think to see what the rest of the year is, is to take one look at what's happened so far this year after the market basically shut down in March.

And right now, year to date, we're ahead of last year after that shutdown. And in fact, the summer months, including this August, is going to finish up with more capital raised, I think that any August on the record books. So we're seeing an amazing turnaround, an amazing amount of issuance in the regular IPO market. We're also seeing SPACs come out, which are sort of getting, enabling companies that don't have easy to study metrics get to be acquired through SPACs. So some of the froth, I think, is coming out through the SPAC market. That's a great point. I want to follow up on that point you're bringing up about SPACs.

And John and Christian, feel free to jump in. But let me just follow up on that question, Kathleen. You know things are getting hot when we have a SPAC ETF announced. Defiance announced they've got a SPAC ETF that's coming out, which obviously is going to consist of recent SPACs, special purpose acquisition companies. And I'm wondering if you could comment on that because that's taken me a little bit by surprise. It started gaining some steam last year. but now it's really big.

What's going on with everyone trying to do a SPAC right now? Is it a way to end run the IPO market? Kathleen, just give us 30 seconds on what the SPAC explosion is all about? What's really the story there? Sure. The most important thing to know is our products include operating companies and SPACs are not operating companies until about two years after they then make an acquisition,

but they're public blind pools. And the way we see it, we've studied these once they make their acquisitions, and the returns are much worse than the returns in the regular IPO market. So investors have to be pretty cautious about how when they hold them and whether they'll stay in through the acquisitions that are made at the end. But they're very popular because there are a lot of companies that cannot go public and simply they don't have the kind of metrics that IPO investors want. And so they're able to go public by being bought by a spec.

And so some of the froth, I think, that could have been in the IPO market, I think the IPO market still is a certain amount of discipline. If any, right now you can say the market just have discipline. And then some of the more speculative vehicles, such as Virgin Galactica, companies that don't make money but are like these big ideas, are getting funded through the SPAC market. So is it fair to say that in a hot market, and we have a hot IPO market, SPACs are kind of a way to end run some of the public scrutiny that might be brought down on them

that are not completely ready to IPO. Is that fair? Am I know. I think that explains it very well. And I think it's really buyer beware with this vehicle. But they have to work. And our studies show they don't yet work. So perhaps that will change.

But we have studied the ones that have made acquisitions. and the returns have been poor on average, with the exception of some very hot names that tend to then attract investors to the space. Yeah, Kristen and John, any thoughts on the IPO market? I mean, you have to admit, I mean, the IPO, which is a basket of about 60 stocks, up almost 50% this year. That is really rather spectacular. Perhaps they're lucky enough to be in biotech that's doing well. And, of course, as Kathleen says, a lot of it ending up as work from home. but it's still a pretty spectacular outperformance overall.

I would just say that I think the IPO market this year has really captured this theme of the digitization of commerce. And when you look at many of these top performers, Lemonade, Rocket, Zoom video, Cloud Fair, that's the digitization kind of movement, especially in this COVID economy. And in addition, as you said, there's been some nice, you know, biotech health care that has been, you know, unique to the COVID environment. So kudos to this IPO ETF. It's really delivered on its promise this year. You know, I'm a big believer as a quant investor that if you're going to take on the risk of owning an asset, you should be compensated for that risk.

So if you look at the IPO, ETO from Kathleen's firm, you know, it has produced better risk-adjusted returns than, let's say, the Rust of 2000 in there. So, I mean, Kathleen may have a difference of opinion about what's the right benchmark, But the volatility of the IPO market, you know, if I match that versus the small cap index, the IWMETF, I mean, it has outperformed that index on a risk-adjusted basis. So I do think that there's a place for, you know, thematic secular growth stocks, IPO stocks in a portfolio. And what Kathleen said is spot on, like, you know, in a low-intestrade environment, companies that have higher growth prospects, you know, will produce more cash flows as the Fed anchors. interest rates at 0%. A couple of reasons for the benefit of this kind of portfolio is that we put these constituents are the largest most liquid ones. So when you worry about a low float,

we have very high tradable float, which minimizes that those first day pops and things like that, the valuations become sensible, more better and the larger companies that go public. And also these are companies that are not yet in big, indices. They're either not in them or they're underrepresented. When Facebook went public, for example, it took two years for Facebook to be in the S&P products. So it's a way to own. There's some diversification that comes out of this portfolio. And Kathleen, maybe this is a good time just to clarify what's in this, because I get this question all the time. And my shorthand answer is it's roughly 60 companies that have gone public in the last two years. But can you clarify that? Do you cap the number? And do you

do you set a cutoff date after two years you drop them? Just clarify what's in the, and point out also there's an international IPO ETF as well, I would say. Sure. The way it works is it has to be, it can't be more than two years from its IPO. So any company there qualifies. But also, if you take the market caps of all the companies that have gone public over that period, the top 80% get in. So we are trying to capture the essence of the IPO market without having the turnover and the stocks that are not, that are small and not part of that market cap. And then it will include on a fast entry basis, very big ones. So rocket companies, for example, came in between rebalances, their quarterly rebalances,

so we could include the really large ones. The interesting thing about our international product, which has not been out as long as the U.S., is China and the fact that China, and the fact that the Chinese companies are going to pretty soon not be able to come public here unless they follow our U.S. regulations on accounting disclosure. And so what's happening is we're getting Chinese companies rushing to come out here ahead of this window closing, like Lufax, one of the very large peer-to-peer lenders, is going to come public here. But Alibaba's Ant Financial, which is going to be the largest IPO ever, is not going to come public here. It's going to come public in Hong Kong. And so our international IPO ETF, which includes stocks outside of the U.S., is going to be one of

the early products that can hold ant financial. And, well, it's not that well known here. It is going to be a very big name and an important name to hold in portfolios. So the international product will give exposure to that. And you can buy this in U.S. So you have a, it's a vehicle that's efficient for a U.S. dollar investor. When will Ant Financial go in the international? Do we have a timetable for when it might go public yet? We think in the next month. In the next month.

Next month. And when would it go into the international IPO ETF? Well, given its size, it will go in before a rebalance. So as early as after five days of trading, we're going to include that in the ETF, the international ETF, because it's so big. Within five days of it going public? Yes. Is that right?

Within five days, you could put it in. Yes, after day five. That's a very important point. Thank you, Kathleen. That's very good information. I just want to move on. A final little point I want to get to. I get this question all the time from investors in the ETFs

about the yield problem that we've got out there. A lot of bond ETS are now throwing off yields of 1 to 2% range. I don't know if we can put this up, I see there's some yields of some big ETFs that are out there. The big one, AGG, the aggregate bond, 1.2%, the LQD investment-grade corporate, is only throwing off about 2%. The munis are throwing off 2%. High yield about 6%.

So I guess the question is, what do you do about all of this? And, Kristen, I'm going to turn to you. You've got your Amplify High Income ETF, Y, Y, Y, which I find very interesting, It tracks an index of U.S. listed closed-end funds. Now, this has a much higher yield, but it's a slightly different product because you're dealing with closed-end funds. Very briefly, could you tell us what's in this and why you think this is an alternative for people looking for yield? Sure. So closed-end funds are kind of the lesser-known type of fund in the U.S.

There's mutual funds, there's exchange-traded funds, and there's closed-end funds. Closed-end funds actually started, though, before all three of those categories. The odd thing about closed-end funds is that they often trade below their net asset value, meaning you can buy them at a discount to what the actual securities are valued. So Y, Y, Y, Y, Racks an index of discounted closed-end funds. These closed-end funds are stock and bond closed-end funds, managed by some of the biggest names of the industry, Black Rock, like Mason and Nouveed, and they're all designed to produce high-curled. income. So YWYY's index seeks to own 30 that have kind of the highest blend of

discount to NAV as well as distribution rate. So currently YWIY owns 30 closed end funds that trade at a 13% discount to NAV and what that does is produce high current income. The current SEC yield on YWIWI is 8.85 percent. You know, how can we do that? Essentially we're buying you know a dollars worth of assets for 87 cents. That's that closed end fund discount that we're taking advantage of. And then those funds themselves are all income oriented. So this is a more volatile income investment from an NAV standpoint. The tradeoff is you should get quite a bit more high current income over time. So this, we think, is an alternative to some of the traditional

bond ETFs. It's an ETF of closed end funds trading at a discount. I think it's fairly unique and potentially, you know, if you're thinking about an income investment, it's probably one side of an income barbell. You may have more low volatility, conservative income investments on one side, on the other side, a higher yielding, more volatile side of the barbell, which YWI, Y, why would fit in. Okay, John, this sounds like a great deal. 9%. Who doesn't want 9% yield versus 5% or 6% for a high yield fund. But then again, you're, you're in closed end funds. Is there, is there something we need to be mindful of here, John?

Yeah. I think you need to be mindful that the discount to net asset value may never close. There's no guarantee that these things will reach their net after value. They are expensive. And I think that investors should really look at total return as opposed to just pure yield. So going back to what I mentioned before about IPOs, if you're going to take on the risk of owning a financial asset, that you should be compensated for taking that risk, right? Same thing like, you know, in life, right? If you're going to start a business, you should be compensated for starting a business. And I just don't think that happens with close-in funds.

I see a volatility, a standard deviation of about 17%, which is the same standard deviation as the S&P 500 EPA. And then if we talk about the total return over the last three years, you know, the S&P 500, you know, has produced a total return of 50%. You know, whereas Y, Y, Y, Y, Y, has, has total return to about 2%. I think there's other ways to generate yield

if people are just going to be purely focused on yield, and they've got, you know, if they're running a pension fund and trying to match, you know, liabilities and assets. But, you know, LQD, I think, is attractive from a yield perspective. I think PFF is attractive

from a yield perspective. Even HYD, the high-yield mutiny ETF, I think is pretty attractive. All those have much lower than deviations, higher total returns. So on a yield per unit risk basis, I think that you're better off in those areas compared to close end funds.

I think the key is just to be mindful that these things may never reach their net asset value. Again, all sorts of alternatives out there. This is a question, probably one of the top three questions. What do we do? How can I get better yield? So I thought we'd bring up some alternative investments. We've gone a little long, but we had a lot.

We covered a lot today. 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, and today we'll talk a little bit more about investing in IPOs through ETFs. Here's my producer, Kirsten Chang. Bob, it's been a big summer for IPOs, despite tough business conditions during the pandemic. Today, we heard from Kathleen Smith, who runs the Renaissance Capital IPO ETF. For investors looking to get in on the action, though, and own some of these newly public companies, what should they keep in mind about the different vehicles out there?

You know, this is another good example, Carson, of the amazing power of exchange traded funds. Up until a few years ago, if you wanted to invest broadly in the ETF market, you'd have a very difficult time doing it. You'd have to buy a single-handle, a basket of them and hope that it sort of performs in line with what the overall IPO market was doing, which was itself hard to measure. But thanks to ETFs, now we have several IPO ETFs out there. The one that I follow the most is the Renaissance Capital IPO ETF. The symbol is IPO.

And what you get here is a basket of roughly 60 IPOs that have gone public in the last two years. Now, they adjust this for market float and capitalization roughly. So they avoid getting really small ETFs in them. For example, there's a lot of biotech ETFs that might float just $50 to $100 million, something around there. And they're usually excluded so that you get the larger ones. And when you keep a relatively small number like 60 in there, you still get a good size, but you don't get dragged down by a lot of tiny ETFs out there. So you want to look for an ETF here, and there aren't many of them, but you want to look for one that's fairly broad but excludes the tiniest ones. so you get an accurate gauge on what's actually going on in the overall market.

And then, of course, we've been hearing a ton about SPACs this year. Seems like everywhere you turn there's a new SPAC on the way. Goldman Sachs says the SPAC business is surging 145% from the same time last year. Now we have Defiance launching the first ever SPAC IPO ETF, ticker SPAK. Do you expect that to be a game changer? I'll have to say, Kirsten, the SPAC renaissance, as you might call it, is really a surprise to me. You know you are capturing the zeitgeist when all of a sudden somebody announces a ETF around your idea. So there is a SPAC that's coming out from Defiance, the symbols SPAC, and these are thematic ETFs.

So we had pot ETFs, so we had attempts of Bitcoin ETFs. We have social media ETFs. Now we have a SPAC ETF. This tells you you've really hit the Zyathex. the overall sudden feeling that there's something in the air. But the question is why. We looked at SPACs in the past, and I've talked very extensively with Kathleen Smith, the Renaissance Capital IPO ETF. Now, SPACs are not operating companies, so they are not in the Renaissance Capital IPO ETF at all, because they're not operating companies. But Kathleen's looked very extensively

at the history of SPACs. These are special purpose acquisition companies. And overall, after they have targeted a company to buy, and that's what SPACs do, usually they have up to two years to buy a company, they announce they have a certain pot of money and they're going to research it for two years. You then go buy a company. She's, her opinion is that generally, after these companies have announced a target acquisition, they tend to underperform. So they're not necessarily great investments long term. And yet they're undergoing a bit of a renaissance. I mean, there are just tons of them out there. this year. And the question is why? Kathleen feels, and I tend to agree with her, that in a very

strong market, and we have a hot IPO market right now, SPACs are one way to end run some of the scrutiny they would normally face if they were just a normal company attempting to go public. In other words, in a hot market, it may be easier just to use a SPAC methodology to go public instead of a formal IPO process where you'd face the whole scrutiny of the public markets. Remember, in a SPAC, you're essentially announcing, okay, I have X amount of dollars. Pick a number, $100 million, a billion dollars, and in two years I'm going to buy a company. You get to sit on that for two years. It's not a bad deal, and you can opt out if you want when the announcement is made to what company to buy.

So the important thing is you've got a company out there that has got a while to announce what they want to do. And when they do announce it, well, you could opt out, but it doesn't necessarily face a lot of scrutiny. The deal is already done when it's announced. So the important thing is I think, and Kathleen feels that is a factor in why SPACs are doing so well. It's also a good deal for hedge funds, by the way. It wouldn't be nice for you to announce that you bought into this SPAC by this WAC by this one. well-known person and you're a hedge fund and you do nothing for two years and you're still charging a fee to sit there. Imagine you're a hedge fund. You're charging 2% and 20% of the return

and you're buying into a company for two years that doesn't do anything. Usually the par value is $10 and you get to park money for two years. That's not a bad deal if you're a hedge fund. So there's certainly a reason why amongst hedge funds, hedge funds at least, SPACs are rather popular. That's it for today. I'm Bob Bizani. Thank you 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.