ETF Edge - SEC Votes on Climate Change. Plus, How is an ESG Fund Actually Built? 3/4/24

Episode Date: March 4, 2024

SEC votes on new rules requiring disclosure of material risks related to climate change. Plus, ESG funds face criticism for their holdings - but here’s how they are actually built.  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 InvescoQQQQ, supporting the innovators changing the world. 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're 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, Bhazzani. This week, SEC Chair Gary Gensler will hold a vote on one of his most controversial proposals requiring corporate America to disclose. those material risks posed by climate change.

Here's my conversation with Arnie Noak. TWS head of systemic investment solutions for the Americas who also run several ESG-oriented funds, as well as Dave Naught a financial futurist. Arne, let's just explain to people what's going on. Number one, how's the vote going to go? And simply explain, what would this proposal if it goes to require corporate America to do?

Yeah, so fundamentally what we're talking about is rules that stipulate, what corporations here in the US have to publish in terms of their emissions data. Specialists go a little bit more deeply. There's scope one emissions, scope two emissions, scope three emissions. So basically saying where along the value chain of you as a corporation do these emissions apply. And in terms of how the vote is going to go, I'm going to myself abstain in trying to make a trying to make a recommendation or a prediction.

But it's an important vote. Isn't it fair to say, though, that Mr. Genser would not hold a vote that he's going to lose? That makes, it sort of makes sense that something's going to happen. Dave, you're shaking your head over there. Well, first of all, the SEC's done a really good job at losing lately, so I wouldn't put any bets out there at all. But also, I think that this is something that really does need to be resolved. It's been two years we've been sitting on the set of proposals. They largely line up with European standards that are already in place.

They're largely redundant with California standards, which are already being litigated. So it sort of fits into this ecosystem of greenhouse gas disclosure, which frankly is a good thing if we standardize it a little bit. That's really the positive thing that could come out of it. But I actually think there's a reasonable chance this doesn't get a thumbs up vote and go through a litigation process. I think there's a reasonable chance. You think it's not going to pass? It's three to two, right? The Democrats do Republicans.

I don't think this is purely a partisan thing. If you read through the enormous number of comments that this got, 1,000 legitimate comments for. 15,000. A thousand of which were deemed by Ropes and Gray to be legitimate, like, unique, new ideas. There's really good points in there made by the industry about some of the regulatory burden. I think those are going to carry a bunch of weight. I cannot believe that Genser would hold a vote that he's going to lose. But it's interesting.

Let's get into this a little bit more. I want to know, you know, the purpose here is to talk about climate change and ESG here. So there's many climate change and ESG ETFs are out. We covered this extensively several years ago. Arnie, you run several of them out here. That's why we have him here, folks. He runs some of these. So where does the ETF community come down on this?

Are they generally in favor of this proposal and why? Yeah, so first of all, for our listeners and watches, generally speaking, ESG is a pretty broad topic. You know, we talk about environmental, social, and governance-related aspects. We run those funds. Yes, SNP for example. SNPE, for example, is one of them. However, it's important to note that those ESG funds don't only focus on climate. We do have some strategies that specifically focus on climate, for example, USAA.

It's called Climate Action, MSCI. And here it is. We're just putting up a chart here. Thank you. And here I would say the principle applies the more data that is available and the better the data is, the better it is for our investment strategies. Why? Because the closer the data is to the actual reality, the closer.

so we can, or the better we can adapt our investment strategies to the reality. Yeah, that makes sense, right? Some of this ESG stuff, we've always complained about. You and I have talked about this. It's a little fuzzy some of the data. It's hard to get quantitative as opposed to qualitative measurements. Yeah, and a lot of what we're talking about here is specifically what Arnett called the scope three emissions, which is your whole supply chain, right?

If you're buying widgets, what's the impact of the widget that you bought? That's a particularly thought. You can imagine, if in a big, complex company, chasing every part in your entire order, organization is a big deal. There is already a data infrastructure setup to provide that. You have to pay for it now. You pay sustainability, you pay MSCI. They give you good estimates on what those scope three emissions are. This would actually make those publicly disclosed and put the burden back on the companies. So I think there's real reason for this data to be out there and standardized. I think anybody on the by side, anybody who's an investment manager, obviously would like better and

cheaper data. And this is going to make for better and cheaper data. Let me back up a little and ask you Dave, what happened to ESG? I mean, remember a few years ago, don't you remember folks? We did these stories, environmental, social governance, ETFs. They were all the rage. But that enthusiasm has gone away. There's been outflows from most ESG funds. Several have shuddered.

There's been investor uncertainty over just how to define and measure ESG. There have been high fees. And there's been political controversy. So, Dave, is ESG still relevant? And if it is, how is it going to redefine itself? This is a classic case of the old Gartner hype cycle curve, right? So in 2017, we were at the peak of hype on ESG, lots of new products launching, was in the press all of the time. Now we're on that sort of curve of disillusionment where everybody's like, oh, this is never going to be worth anything.

That's not true. What's really true is globally, there's still an enormous amount of money chasing ESG. If you look at the US ESG ETFs, most of them have one large single shareholder who owns 20,000. 20, 30% of all the shares of that ETF, because they're bespoke for institutions that have specific mandates about either decarbonizing their portfolio or whatever those mandates may be. Arnie, is that true for your funds? Do you have a single large shareholder or something? It's true for some funds, yes.

So, for example, USAA, our key climate strategy, we have a fairly sizable investor concentration. But S&PE, which is sort of a broad S&P 500 ESG tracker, has a very diversified climate range, sorry, the investor base. So I would agree with Dave that there are a number of ETS out there that have a high level of investment. So your point, I think you and I probably feel the same way. I feel a lot about this the way, like electric vehicles. So electric vehicles are going on a downturn now, which says, oh, we have range anxiety. But you're an idiot if you don't understand that that's where the world is going.

Right. It's not like we're all of a sudden going to stop making electronic vehicles, period. Of course not. We're just at the bottom end of that disillusionment cycle. We're in the same place with ESG. Yes, some of the assets have flown out. That was obviously all hot money that wasn't particularly. committed to those ideas, the performance has actually been there.

That's the surprising. Well, I want to talk about what's in the underlying stocks in it because that's why the performance has been so good. But I guess the point here is that you see these companies doing really well in this particular space. So how do you redefine the politics around it have gotten ridiculous? Awesome. So here I'm sitting there thinking to myself, well, gee, let's think about it fundamentally.

Who is not in favor of a cleaner environment? I vote against the cleaner environment. So clean energy, the world is moving in that direction, number one. Number two, who's not in favor of more diversity in the boardroom? Who wants less women and minorities on the boardroom? I don't, I want to see anybody vote on that. So generally, the world is moving in that direction, it gets wrapped up in a lot of politics. So how do you redefine or reinvent itself so that it becomes relevant again?

I think there's a bit of unbundling that has to happen. To Arna's point, right, he's talking about USCA, which is a climate action fund. It's very specifically going after one of the legs of the stool. I think you're going to continue to see the environmental part, the E and the social part, get pulled out into their own funds. And governance, I think, is one that's just universally getting better across the board. Doesn't that make sense that this whole EST that we kind of glue these parts together? That's what kind of makes me feel awkward about it. Do they necessarily all go together?

No, they absolutely don't. where the idea came from, but I think it's caused problems, don't you? He's staring at me like... Problems is always subjective, but yes, it certainly requires sometimes more explanation than it might need to. But I still maintain that having something like a S&P ESG tracker that focuses only on sort of the top names within each industry group can be an interesting way of investing, yes. Yeah, but you and I agree.

We awkwardly bolted these things together here, and they don't necessarily... There can both be an investment problem there because it's not necessarily the case that your social justice fund is going to be your clean energy fund and they may actually contradict each other. I think those are just real. I want to get back to the proposal, Gensler's proposals. The final proposal has not yet been released, but it's going to require disclosure on direct emissions from owned or controlled sources. This is called the scope one, as well as indirect, and here they are folks, as well as indirect emissions, such as from generation of energy. Now, it's less clear as well as, The rule would require disclosure of greenhouse emissions from their supply chains, as Dave was referencing, and the users of their product. This is called scope three. This has been vehemently opposed by many. Now, Reuters has reported that the scope three requirement is going to be dropped. That is not official from the SEC. We don't know that yet.

But I guess the question is, how much does corporate America support this? I mean, again, sir, I mentioned they got 15,000 comments. The most ever received. America does not support this. Let's be clear. I don't think there are very many boardrooms where people are saying what we need is, more expense to disclose more about our operations. They're not asking for that.

But most of them are saying they are. Walmart submitted a letter saying they understood why and that they were already reporting most of the information they asked for. For the companies that are in the S&P 500, virtually all of them already report all of this data or they have very good estimates on the street. So from their perspective, it's like fine, whatever, they don't particularly care. Here, look, this is Walmart's comment letter.

We wholeheartedly support the commission's objective of facilitating the disclosure of consistent, comparable, reliable information on climate change and other environmental social and governance topics. Walmart has been reporting climate-related information for 15 years and on certain other ESG issues for longer. And they noted that a large part of their emissions are scope three, in fact. So this is why I'm wondering how much real, how much opposition. I can understand why the scope three is eliciting problems. This is another case, Bob, where we've got the U.S. effectively being the secondary regulator. The reason Walmart has done all of that is not necessarily out of

the goodness of their own hearts. It's because they want to be considered a target investment for a Nordic sovereign fund that demanded they have scope three data. So these large companies have already had to do most of this work. So it's easy for them to say yes. The overall tone of those comment letters was negative on scope three. If they cut all the scope three requirements out and only require scope one and scope two, then I'm with you and I think that they probably do get a thumbs up vote and it's not even that big. So assuming that we eliminate, Reuters reported they're going to drop the scope three. Let's assume that actually happens, and they leave in scope one and two and even soften it a little bit. It'll pass then, right? Three to two? And it will also have

very little impact on anybody, because like I said, most publicly traded corporations, I went and looked down to the bottom of the midcap zone. Everyone I looked at, I could pull up a screen that had all that data already there. Well, I see a lot of activist groups eager for a fight on this. It seems like somebody is going to sue the SEC on the grounds that they're overreaching, for example. So we've talked about. the Administrative Procedure Act in the past. And folks, you don't know this, the APA outlines the rulemaking procedures that federal agencies need to follow.

And there's a very famous clause in here called the arbitrary and capricious standard under the APA, which requires that the actions of any federal agency had to be based on some connection between the facts found and the regulations that's created. They can't just make up stuff. So the question is how successful would a lawsuit be? In this case, corporations are going to probably argue that the... the SEC failed to establish there was a problem that needed some kind of regulatory action. Or they're going to say they didn't do a proper cost-benefit analysis.

They have to do that and explain how much impact it's going to have on corporations and the cost. Or they didn't account for all the public views that are out there. There's all sorts of lawsuits potentially. And we're living in an era where people are suing the SEC in winning. People are suing the EPA in winning. There is a concerted effort to dismantle the administrative state any way you can. So I think almost goes without saying whatever happens and gets past, somebody's going to sue on the APA to try to undo it because what's really going on is trying to erode the foundations of the SEC's rulemaking authority. Yeah.

That's on the start. Right. So there's a broader ideological assault that's going on here independent of the climate change proposal. It almost doesn't matter what rules the SEC comes out with next. If they're in any way a burden on corporate America, they're probably going to get sued for it. Yeah. And yet the world is moving in this. direction. They are moving towards more disclosure because actually it does have a material

impact. I mean, I always say if I'm investing in bonds in Miami Beach, I sure as hell want to know something about climate change. And how does the Miami Beach, are they building a sea wall? I'd like to know that. If they're doing that, that's a disclosure on climate change. So this is an obvious one, but that's sort of the way I feel about it. I mean, think about insurance companies. If it's material. And then you get hung up on what's material. Right. But think about what's going on the insurance market right now, not just in Florida, but in California as well. You're seeing homeowners insurance getting pulled further and further back, fewer and fewer issuers. These are precisely the kinds of risks that we get disclosed more broadly across

industries. And Bob, I think you made a very important point on financial materiality, because we're sometimes talking about ESG and it sounds and feels and is perceived as if we're talking about ideology or political topics. No, we're talking about risk factors. that can financially and materially impact a company's profitability. So therefore, I think this conversation is super relevant. Yeah. So these rules are going to have an impact on corporate America, as you said here. So just think about it.

Increased costs overall for reporting. Increased litigation risk from both the SEC potentially suing them and from activist investors suing them. For example, can you see an activist investor saying, you know, based on your disclosure, XYZ company, you're not doing enough to address climate risk. So here's just three obvious things here where it can impact corporate America. So you can see why they're pushing back. There's going to be a gigantic mini industry around here. Climate changed disclosure committees, just like there is for cybersecurity.

Now, cybersecurity has now spawned a gigantic little industry of advanced. advisors within corporate America, advising them on how to proceed? We absolutely already have that in the climate space. I mean, there's a very large business in climate consulting for corporations already. Again, because most publicly traded companies already have to do most of this work anyway, just to be viable targets for investment from big institutions. I want to talk about what's in the funds, because you and I used to have this argument all the time about why these funds look this way, because they mimic large cap and large cap growth funds

a lot here. So the biggest holding in the climate action ETF that you run. Here they are folks. Invidia, Amazon, Microsoft, Alphabet, Apple, and Meta. This is what we call the Bank of This is 7 by the way, but here it is. And it's really the same with the SEP 500 ESG ETF. This is USCA. This is the climate action, but if you look at the other one, the S&PE, you know, it's essentially the same thing. How do these stocks, people ask me this all the time, how is it that these big cap tech names suddenly make it in an ESG fund?

Is there nothing else that's out there? Can you explain the criteria for? Yeah, absolutely with pleasure. It's relatively straightforward because both S&PE as well as USCA aim to invest in those stocks that are the best within their respective industry groups. So the idea isn't to be super concentrated and only select a handful of stocks that do the best from an ESC, from a climate principle, but still have a portfolio that largely resembles the economic makeup of the US economy, largely resembles the weights of each industry group within the benchmark index.

And so, you know, there's sometimes a misperception that ESG funds cannot invest in energy companies. That's absolutely wrong. Energy is a vital component of our economy, naturally. Every light that glows needs to be powered. And so the ESG funds that resonate the most in our experience are the ones that acknowledge economic realities of production of necessity and at the same time invest in those companies that do relatively well compared to the rest of their peers.

So the point here is going to try to answer the simple question. Why are tech and communication services? Because these are reflective of the industries, right? So if 27% of the SPP is technology stocks, 20% percent of the SMP is technology stocks, 20,000, 37% of an ESG fund is going to be in technology? Is that, am I? That's roughly correct, yes. So the reason that you see, I'm just trying to answer, lead you here and answer the question, why are we just seeing so many tech stocks? Well, that's the way it is. There are energy stocks

that are in the ESG ETFs, right? Conoco shows up all the time in these. They're just further down because their market cap is smaller. Is that the answer as simple as that? It really is. And even if you go to a fund that doesn't have those kinds of guardrails, which I think are actually very smart for most investors to stay broadly invested in the global economy. Even if you didn't want to do that and you go to a pure sort of leaders type strategy of which those products exist, those funds end up tending to be even more heavily invested in tech because, frankly, tech is one of the cleaner industries in the world. It's certainly cleaner than most major heavy industry. It's cleaner the most energy and extraction

industries. So yeah, if you solely look at climate as your window, you'll probably not end up owning a lot of energy companies, not owning a lot of miners, not owning a lot of steel companies. And so you end up with something that looks like services, healthcare, and technology, which is a very strong bet to take. So you should be doing that with very wide open eyes. And it's ESG, right? So there's three components here. Are they weighted equally ES&G when you break these down? How do you, how do those three components could have come in here? Yeah, for the standard ESG funds, you can, it's a little bit difficult to say it's fully equally weighted, but they're equally important in a standard ESG fund on something like USCA.

So you run a screen for, like, let's just put governance, diversity in the boardroom. Is that a factor that's considered when you screen it? Is there's a score assigned? I mean, what, it's, it's quantitative, right? It's purely quantitative where, let's say, under the environmental category, there's a number of factors, under the social category, a number of factors, and governance a number of factors as well, then they get aggregated into one broad ESG score. Okay.

So how do we push this ESG story forward? It's like electric fields. Right now, it's in a hole, right? Nobody wants to talk about it. Nobody wants to talk about this right now. So it seems like, I said this before, most people are in favor of clean energy. Most people are in favor of diversity in the boardroom. How do you re- how do you repurpose this idea?

I think what we'll see is that this will become a, a quiet story that a lot of people buy. What I mean by that is if you talk to financial advisors, almost every advisor I know has an ESG strategy for clients who come in and want that. The question is, are they being responsive or are they being proactive and recommending an ESG strategy out of the gate?

I would say back in the hype cycle, when it was the hot news in 27, 2018, there were a lot of advisors who'd made the pivot towards actually learning a lot about ESG and starting to build their practices around that. Those folks pulled back, they probably aren't coming back. The demand from individuals, however, never really waned. What went away was the hot money of people thinking this was going to be a momentum kind of play. It's not a momentum play. This is a long-term

way of approaching your allocation. ESG funds did have their moment. Remember 2018, 2019? Yeah, it was all the time. Yeah. Or even pot ETFs or crypto. I mean, this is the beauty of the ETF business. It picks up whenever it was hot. And that was that was hot now. Anything else, Arnie? The only thought I want to share is actually the topic of climate emissions actually has applications beyond pure ESG strategies. So, for example, two weeks ago we launched our first active ETF. It's a global natural resource ETF. It's not an ESG strategy. Yet the manager pays close attention to carbon emissions, makes predictions in terms of what that makes...

What's the symbol for that? N-R-E-S, natural resources. Very interesting fund from my perspective. Not a ESG fund, yet the topic of carbon emissions. super important. Okay. Thank you for getting that in. Appreciate that. This has been interesting discussion, folks, because this is going to be a hot topic this week. We're ahead of it. And of course, that's the purpose of us being here. Now it's time to round out the conversation with some analysis and perspective to help you better understand ETS. This is the Markets

102 portion of the podcast. Financial Futurist. My old friend Dave Nautics continues to join us in the conversation. We had a great discussion with Arnie Noak about ESG and where it's heading. I just want to pivot here and talk about flows so far this year. We seem to have strong flows in the month of February. Sometimes these are not that interesting, yet we had, what do we have? Fifty-eight billion? Fifty-eight billion, right? That's a good month, right? I mean, we've had bigger months, but, like, that's a healthy $700 million run rate for the year. And break this down for us. I know everybody wants to say it must be Bitcoin, but it. Bitcoin is about 12% of it, which for one new little asset class is a lot. That's fine. You know, obviously major flows into that

complex. But 75% stocks, a lot of it just going into straight up boring, S&P 500, a little bit of growth, SPG. Despite S&P 500 growth, cut a bit of a bid. We have seen this continued story of money fleeing SPY,

the State Street product, and flooding into VOO and IDP. This is because it's 10 basis point or 9 versus 3? It's the expense ratio, but it's also the construction. So, you know, SPY isn't a traditional 40 Act fund. It's It's a unit trust, and that means it can't invest dividends since they come in.

Companies have been paying a lot of dividends, and the market's been going up a lot. It makes it very hard for SPY to keep up with their own index. Right. You know, that's something you don't think about, but you can't reinvest the dividend if you own SPY. No, they have to distribute them. So there's that window before they get them out of the book. Yeah, that's a problem. That they can't reinvest them. They also don't short sell out of them or lend out of it because they can't.

So that combo sort of puts a little bit of a performance drag on it. It's not enough that most retail investors are going to notice. It's a basis point here. there, but institutions, it's a slam-dunk. And how about fixed income? Everybody keeps wondering when all these people sitting in their money market funds at 4% or their short-term treasuries at 4% are going to pull money out, but they seem very happy sitting there.

Well, what we don't know is, you know, we can't really tie people selling their money market mutual funds in their swab account and then buying IBB to get ex-SP exposure. Some of that is, of course, happening. Sorry. Now somebody's got to edit it. I'm sorry. No worries. Go ahead. I crossed my legs. What was I saying?

You were talking about flows overall. We were talking about where we're going to go from here on fixed income. Oh, fixed income. So we can't really tell whether people are selling their money market mutual fund and buying SPI or IVV. But what we can see is what they're doing inside the ETFs and money's not coming out. Right? People are putting more money into fixed income. last, I think in February, it was 75% stocks, 12% Bitcoin, and everything else went to bonds.

So people are still buying, people are still sort of looking at that 10 year and trying to play the curve there. There's a lot of people. Is it simply, it's as simple as an explanation of people feel comfortable getting four or five percent. It feels right to them, even though inflation is still high. This seems to be good enough for a lot of people. Yeah, getting actual real returns out of the bond market is a bit of a new experience for people. I think people are excited about it. You know, let's talk about Bitcoin. We had a successful debut. I think that the inflows seem good, not overwhelming.

Yeah. A lot of it is coming out of gray scale and into the nine other ones that came out. And yet, by any success, it seems to be helping Bitcoin. Sure, absolutely. It's moved up since then. I mean, it's a, it's a, there's no elasticity in that market, right? There's only so much can be manufactured. We're coming up to the end. We're actually in April, we're doing the happening, which means the rewards that miners get from Bitcoin will be cut in half from, I think it's four and change Bitcoin per block now, down to two and change Bitcoin per block. So their revenue line just drops right off a cliff. But that also means it's a scarce asset that people want to put money into. It's a pretty straightforward piece of math.

You've got to get somebody to sell you the Bitcoin for it to end up in Ibid or BitB or any of these funds. So I'm not going to see her make a price call, but all the mechanics. factors point towards any buying drives the price higher quickly. That makes sense. And just in anything else that's moving here, this industry is maturing, as you and I have noted, $8 trillion in assets under management. So Bitcoin is a big hope this year for the industry that wants to bring in more assets. Remember, this is a business, folks, it's Wall Street.

The other thing that they're pinning their hopes on is active ETFs. And I see a little bit of precedent. the digitation here with this active definition where all of in the old school way to me active means alpha generating stock picking right the old school active there's not much of that not much of it yeah and now they're trying to say that uh options overlay programs where you're owning the s and p but you're selling options is somehow an active strategy well so this is part of this is a definitional thing the SEC has rules about what you can call active and what you can call indexed it's very difficult not impossible but

but very difficult to create a fast-moving derivatives-based product that is technically indexed. Can be done indexed. Indexed. So that is a tough definition to meet because it means that which options you're buying on a Thursday has to be completely algorithmic. Right. In the real world, if you're... Rules-based?

Rules-based, right? There can't be a person deciding that they're not going to buy June. They're going to buy August. In the real world, it's actually kind of a bad idea to be an indiscriminate, buyer or seller of derivatives. It's because things move to- You can buy it in an awful moment. Yeah, and you can buy into liquidity problems. You can be the chump that everybody is selling into. Knowing that it's there. Which is why if you look at things like JEPP Morgan's Equity Premium Income product, which does a lot of options overlay,

that almost needs to be active on top of the fact they are doing stock picking. But even in something like the innovator-defined contribution products, you know, just these straight-up S&P exposure with the bumpers on the bowling lanes, those products are technically active because somebody still has to manage that hedge. And it's very hard to do that without. I get it. But you get my point, too. I completely get your point.

And there's not a lot of that shoot from the hip, high conviction, active management, high active share. There are some, Kathy Wood, we talk about all the time. He's the famous one. And there's a handful of competitors to that. But it's pretty thin. And we know what the math looks like. It's very hard for those folks to actually generate risk-adjusted alpha over any meaningful

period of time. I want to bring up a comment, David Einhorn made, David Heimor, the famous hedge fund manager. This happened about a month ago. He made a comment that the markets were broken. And he said the reason he can't generate the kind of performance that he used to. He seemed a little bit baffled by this. And he wanted to blame or implied that index investing or passive investing was part of the problem. I find this rather amazing because you have a man who's made a lot of money,

trading stocks who now says, I'm not making enough money. Therefore, something's wrong. Can't be me. It's got to be something else, right? And he's blaming index funds. This is a game we've played a long time. But what do you have to say something? I think you're going to be surprised. I think he's basically right. I wouldn't use the term broken, but the nature of price discovery based on fundamentals has shifted in our lifetimes, Bob. It just has. It used to be, and this is sort of the point he was making, it used to be if you were a value manager, you could go find a stock that was trading at a PE of 10 and know that it was really should be trading at a PE of 15. And that was an arbable gap. If you were right, you could

count on getting rewarded for that and getting your exit at the PE of 15. The problem is now, it's not uncommon, particularly in the mid and small cap space where there are no analysts left covering these things. You and I both know that. That number of people has gone way down. It's now possible for a company that's sitting there at a P.E. of 10 to fundamentally change its business in a positive way and for the market to simply not notice for years. And then suddenly a story comes out. And this has happened why? Because there's not enough analysts? There's not enough analysts. There's not enough people covering these stocks on a day-to-day basis, really doing that old hard work. Now, I'm not suggesting that this means that somehow those old active managers

were doing it correctly. I think we could argue about whether this is better price discovery or worst price discovery, but I think it's absolutely true that the VIG, the amount of profit you can actually make being an active manager. Is this because the market is not more efficient? Maybe the world's discovered Warren Buffett and how to do quality investing by owning ETFs. I mean, there is definitely some of that, but there is also, and you know, Mike Green at Simplify points this out pretty much every day. There are, in fact, mechanical effects to the amount of money chasing passive products right now, particularly the indiscriminate buying and selling of target date funds and retirement plans. When you know you've got a buyer coming in every

Friday on payroll that's going to buy no matter what the market did, that has an impact on price discovery. It just does. So what is the implication here? The implication is that the price discovery mechanism is a little more fragile than people think it is. Now, on the one hand, it means there's probably fantastic opportunities out there for active managers. It just implies the market's not efficient. If there was some implication somehow that active stock pickers could make a bigger impact than they actually are, wouldn't it, why would this draw people in? Because somebody has to be the buyer on the other side, right? So if you buy that 10 PE stock knowing it should be 15, somebody else has to believe it's 15 and want to buy it there. There are fewer people buying that

individual stock. Then why aren't, it seemed, you seem to be playing the market is not efficient anymore, though. You seem, why doesn't, why would it not happen that somebody would step in knowing that that eventually should happen? As a percentage of the market, the active manager is now smaller. No, so the dollars may be bigger, and I think people get confused by that, but if you just think about it in terms of individual market participants setting prices, they're actually fewer of them as a percentage of the market versus the price setting that happens based on flows. So what's the answer to this? What should happen? The answer, well, I'm not sure there is an answer.

It implies that there is fragility and pricing that we might not expect. And look, we can look at stocks from the last two weeks. Look at what happened with SMCI. Look at what happened with Nvidia. Yes, they've reported great quarters, and so you can reset some expectations. But what really happened was they became news stories, and speculators showed up to buy them as momentum plays. This has happened before, though. Was there anything shocking here?

Well, what's shocking is we went from a company that people really didn't know about to an SP inclusion in 18 months. That's what's shocking. The SMCI inclusion path is one of the wildest things I've ever seen in my career. So that's the thing. We're going to see these sort of convex movements and stocks, and it can happen in the other direction. But we also have a shocking new paradigm called AI that was as important as the internet was. The internet created some crazy things as well. Is it justifiable to see something like a SMI? You sort of have to believe that there's an endless appetite for the purchasing of the hardware behind these things. I think that's a tough argument to make.

I think that, yes, these companies are in the right place at the right time, but when the speculative bubble wears off those names, the same thing happens there that happened with weed stocks and ESG and SmartBade. There's a reckoning on all this. All right, we've gone a little longer, folks, because I got Dave here and always an interesting discussion with Dave. But I'm going to have to stop that. That does it for this week's EPF Edge. podcast. Thanks for listening. Join us again next week or at ebfedge.cnbc.com. InvescoQQQ believes new innovations create new opportunities. Become an agent of innovation. InvescoQQQQ

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