ETF Edge - Single-Stock Bull & Bear ETFs – Why Now? 8/15/22

Episode Date: August 15, 2022

CNBC’s Bob Pisani spoke with Dave Mazza, Managing Director and Head of Product at Direxion, Will Rhind, CEO of GraniteShares and Reggie Browne, Principal at GTS. They discussed the new wave of single-stock bull and bear ETFs that launched just last week. They talked about why now, why Tesla and Apple appear to be getting the most attention and broke down how exactly these leveraged and inverse ETFs work for the average investor. What are the mechanisms behind them and are they setting the stage for many more complex products to launch down the road? In the Markets ‘102’ portion of the podcast, Bob continues the conversation with Reggie Browne from GTS. Hosted by Simplecast, an AdsWizz company. See https://pcm.adswizz.com for information about our collection and use of personal data for advertising.

The ETF Edge podcast is sponsored by InvescoQQQ, 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 are in the right place. Every week, we're bringing you interviews, market analysis. And we're breaking down what it means for investors. I'm your host, Bob Pisani. We saw a wave of single-stock bull and bear ETF's launch last week. Today on the show, we'll discuss why now? Why Tesla? and Apple appear to be getting the most attention in how exactly these leverage and inverse ETFs work for the average investor. What are the mechanisms behind them and are they setting the stage for more complex products to launch

down the road? Here's my conversation with Dave Mata, Managing Director and Head of Product in Direction. Will Ryan's CEO of Granitechairs and Reggie Brown principal at GTS. Dave, I'm going to start with you. You launched these four single stock ETFs last week. You had

two for Apple, two for Tesla, two for this Tesla daily bull ETF of yours, this gets investors one and a half times Tesla's daily return. It's doing well. It's got some volume. How would you describe the trading action overall? And tell us who you're targeting this product to, considering, of course, it resets every day. Yeah, that's correct. We've been encouraged by the early success, particularly of TSL as the ETF industry continues to innovate and shows the resiliency of the actual vehicle itself. These are tools similar to other leverage in inverse ETS that are really intended to be used as a tactical trading vehicle. And so by that I mean specifically someone who has the ability and interest to monitor their positions on a daily basis to make that buy, sell, or hold decision daily. Because these funds do have leverage embedded in them, particularly in the case of our bull fund on Tesla and Apple, 1.5 times the daily exposure.

and then the inverse of that in the case of the bare funds that we're discussing today. So these funds tend to have, they're going to have a higher risk profile because they have an individual security, and they're really intended to be used by traders. But again, we have shown that the leverage and inverse ETFs on indices have been useful tools for traders, and these actually are a further step in that direction for folks who are interested in the convenience of an ETF and the benefits that the ETF structure can bring to allow them to amplify expose. You know, well, I just want to turn to you. You launched several new products. You've launched an Apple ETF last week. You launched Coinbase Tesla. We've seen these leverage in inverse ETFs.

They've been around for a long time, but they've been around for index products like the triple queues. And I'm just curious, all of a sudden, single-stock ETFs have appeared. You know, why now? What's, what happened? What magic was in the air for them to be able to launch now in such a big way. There was a regulatory rule change in the last couple of years that have allowed for this to happen. And it's really just a natural evolution in terms of the market, because as you said,

we've had leverage products on broad indices, such as the Q's, S&P, et cetera. We've had leveraged DTFs on commodities, which have been very popular, single underlying commodities as well. And so now single stocks are the next sort of generation in that category, so allowing people to take either leveraged or short positions on popular companies. Yeah.

You know, Reggie, SEC Chair Gary Gensler, who I've talked to many times, has expressed concern about leverage and inverse ETFs and these other, what he calls them, complex products, which is a sort of an overarching category he's defined. He had a speech in May. He said these funds can present unique and potentially significant risks to investors across market sectors. Obviously, these products are complex. It is difficult for investors to get their head around the concept of the daily reset. But how much protection do you think investors need from these products? Well, I think that's a good question. As Will said, and these ETFs are now trading tools, not investment tools,

and understanding how best to utilize them is paramount. And from the perspective of leverage and inverse ETFs, they've been around for a number of years, I believe the community now understands them well. And the risk to the marketplace is really just retail investors understand how best to use them. There are some proposals on the table to limit the exposure to the retail community of complex ETS. I think that's a giant mistake to limit access to the financial market systems. And contrary to what's great about the U.S. system. So with the innovation that is occurring in the leverage ETFs, particularly in single stocks,

By the way, this is not a new idea. It was first proposed in 2009 when there were low-price corporate equities like Citigroup that were trading into teams, and certain institutional investors could not hold low-price securities. And so it serves a purpose. I think that this type of ETF has the ability to have a thousand different corporate equities inside them and bring innovation to the marketplace. And this is a good thing.

I think investor education and some protections is warranted, but not limiting the access to the marketplace. Well, let me just pick up on what Reggie was saying, Will or Dave, either one of you, do we need to put these products in some separate classification? This has been talked about before because these are essentially day trading tools, right? Even you guys would admit that, right? So should we change, for example, the sales practice? this is a broker-dealer. Should leverage and inverse products be in some separate category?

Will, Dave? Dave? Well, they should, I mean, they're under the rules currently. I mean, they're publicly traded ETFs. And so if a publicly traded ETFs are the same in terms of you've been able to buy them. Now, what's happened is over the course of time, as Reggie said, I mean, these products have been around for a long time. You know, brokers, which are the access point at the end of the day, between the investor and the ETF, have implemented their own rule. rules in order to make sure that these are suitable for the customer base. So typically, if you go buy one of these products or try and buy one of these products for your broker, there is a flag some sort of suitability measure that you have to meet before

being able to buy them. And that's perfectly logical. Dave, do you want to weigh in on this? Yeah, I would agree with that to Will's point there, is that there's rules that have been put in place by broker dealers to make it clear that these tools are intended to be used as trading vehicles. You need to have generally an aggressive trading profile and things of that nature. But as opposed to limiting access, I believe and we believe that we need to promote education and the utility of how these products can be used. Again, these are not long-term investment

vehicles. The ETF wrapper also has many, many products that are extremely low costs that can be used to meet those needs. But also, there may be a need, particularly in heightened times of volatility, for those who are interested in those who understand the inherent risk, to express viewpoints and to amplify their exposure on a daily and daily basis and on a short term basis. Who wanna make that view, again, if you're bullish on Tesla over the long run, this is not the product for you,

you should buy the single stock or use other tools to do so. But if you're bullish on Tesla on a short term basis, this product, TSLL, for example, can be beneficial. I wanna just get back to why now. And Reggie, feel free to weigh in, but I can't help but notice. I watch ETF flows. I could not help but notice the volumes in leverage and inverse ETFs,

particularly around high beta stuff like the triple Qs, went through the roof during COVID. And actually, it's remained fairly high. If you look at the ETF trading list, Reggie, you're the master at this every day amongst the highest volume is those leverage and inverse triple Qs that are out there, even on a dollar volume basis, not just a share volume basis. And I can't help but think that the ETF community is sitting around noticing this saying, Oh, there is a demand for leverage and inverse.

And the younger community has grown up around using options. They're a little more sophisticated. And we're in the ETF business. Our business is providing product to people. There seems to be a lot of interest in playing leverage products, judged by what we're doing. So am I crazy? The answer to the question is why now is because this is where people have been going recently. Yeah, and I think it's, again, comes down to, you know, leverage is not a new concept.

It's been around for a long time. But leverage within an ETF makes it accessible in your brokerage account. You know, if you have other forms of leverage, typically that can be clunky to implement expensive in terms of, you know, the financing rate that you can obtain. And this is definitely something that you have a lot of investors looking for a higher rate of return over a shorter period. And this is what these products, you know, seek to provide. Reggie, am I directionally right on this?

I mean, I'm still trying to answer this question, why now? I mean, there was an explosion of interest in leverage in inverse ETFs around, for example, the triple Q's recently. You've seen that. I mean, isn't it reasonable to assume that the ETF community is responding to that to that interest? Well, I think there's a couple things here. One, during COVID, work from home, work from any place.

We had more engagement by new retail investors into the marketplace. And as they understood more what the products were available for them to express their views, solve explosion in trading from a day trading perspective. Right or wrong, the benchmark is serves a certain part of the community. And I believe that there are some investors that like to have amplify returns and where they can make four or five or 10 percent returns a day in their strategy. So there's a segment of marketplace that demands these products, that want to use these products, and Will and Dave are just filling a need.

As far as the number of products that comes to the marketplace in the future, competition and through innovation, the prices will come down as far as expense ratio in these products and a number of products on the marketplace with a number of different asset managers launching products. Why now? One, because the regulatory rule set has flattened playing field for new interests to come in the marketplace with some speed and efficiency. The Commission has an understanding of how to approve these products.

On one hand, they're saying you're approved. On another hand, they're saying, please don't trade. So I think the commission just needs to have more comfort into these products and how best they're fitted into the marketplace and how best to use them from a retail perspective. But institutionally, there's institutions who want to use these products. There's big demand for them. And then you look at the high price stocks like Tesla, for example. There's a lot of day trading in these corporate equities. and having it into an ETF to price leverage is just meeting indeed.

So that's why now I'm like it. Yeah. Dave and Will, I'm very curious about the amount of leverage in your product. So, you know, Will, you have your Apple-long ETF, AAPB, is 1.75 times long. You have a Tesla-long ETF, T.SL is the symbol. That's 1.25 long. Dave, your Tesla-Bull ETF is 1.5 times long. How did you choose these degrees of leverage? I mean, do you negotiate with the SEC on this, or do you pick it out of a hat?

I mean, I'm just curious. Is it just a strange series of numbers here? I wouldn't necessarily say it's a negotiation, but we start with two. So the maximum is two times now, so you can't launch something that's more than two times leverage. Then during the registration process, there are a set of rules, particularly it's around a new derivative rule that has a value at risk measure. and it's derived from the benchmark, a reference benchmark that you choose. And so in our case, we're obviously choosing a different benchmark than what Dave's firm is choosing for Tesla, and therefore we have a different leverage factor.

So, Dave, is that the case as well? I mean, when you say what's at risk here, explain that concept. Because why didn't you just have two times? And why not why one at a quarter or one at three? It just kind of makes me, it befuddles me a little bit. Yeah, I appreciate where you're coming from from that point of view when you have the same security underlying and different leverage points from different firms. But to Will's point, yes, it's a balance between the regulatory environment where there's specific rules around what's called a measure of var or value at risk, which is essentially, you know, really, really, again, a measure of risk. in some ways very complicated, but in other ways, straightforward for those very interested in learning.

And in that particular case, when you map it back to particular benchmark, the 1.5 that we have in the case of Tesla and Apple are the levels that we're comfortable as our firm to comply with those rules and offer a product prudently to the marketplace. So again, these are more sophisticated in how they're created, but at the end of the day, the wrapper is still the ETF structure, and we're complying with all the same rules that any ETF would have on it. Yeah. Reggie, several viewers have asked me to ask you this question. I don't know if I'm putting you on the spot, but it's an interesting question. Walk us through how the daily reset actually works. Some viewers actually befuddled by how that works. So we have this daily Tesla

bowl, one and a half times shares ETF, the TSLL. It gives you one and a half times Tesla on a daily basis. What actually happens at the end of the day during the reset? What gets bought and sold? The viewers, several viewers have asked me to sort of, can you explain what happens in the reset? Well, to keep it as simple as possible, there's a swap that is utilized to give the leverage effect in all ETFs. And then some counterparties, some ETFs have five different swap counterparties to reduce the risk to individual investors if there's some sort of corporate risk to the swap counterparty. Remember, when some of the banks had an issue, their credit wasn't good, and the swaps they were issuing became at risk. So there's swap counterparty risk here. And so the leverage

ETFs, they are backed by swap, and the strike price or the cutoff period is the ending of the leverage and the ETS are still trading after the cutoff period where the swap is struck and reset. And then this ETF has a gamma effect or another derivative effect of how they're trading. So it's important to understand, one, read a prospectus, to understand when is the cutoff time, when does the leverage stop. And then, you know, and this is not necessarily meant to be a long-term holding. And so there's a reset. you're getting the daily exposure return of the underlying asset, and at the end of the day,

it resets, and then it starts again the next day. So it's meant to be held for one day, and if you hold it over a period of days, you're getting the reset effect, and you're getting another derivative called gamma over, where it's resetting inside of it, you're not getting a full return. So it's important to understand, one, when is it reset, What are the periods, not covered? And then the next day, what happens? So it was important to understand these important factors.

Now, Will Ryan can accurately describe how he built his products, and when does the cutoff period begin, and what happens after that? Well, thank you for that, Reg. I knew you do the answer. I'm sorry, folks. I know that was a little wonky, but people were asking. So here's the question. Swop counterparty risk.

I mean, Gensler's worried about this. I'm trying to figure out, is this some weird fantasy of his, or is there something? Is there some way that somehow a swap counterparty risk could translate into some effect on the underlying stock or even some systemic risk in some way? I'm trying to get out. What's the worry here? Well, if you're talking about counterparty risk, which is obviously a valid concern where you're talking about a swap, which is a bilateral contract between two parties, that the risk is

whoever the counterparty is, typically as an investment bank, if they're not. they go bankrupt, then that will affect the value of the ETF. Now obviously we saw this during the financial crisis with Lehman Brothers, and there were a few exchange traded notes that were issued by Lehman Brothers that were cancelled or redeemed as a result of that, so people lost money. So that is a concern. But again, go back to the points that I think it would be mentioned by Dave and Reggie, that these are designed really to be held for short periods of time.

So if you're holding for a short period of time, typically counterparty risk. is not going to be one of the highest levels of concern here, because you can trade in and out of it. Yeah. Reggie, I'm just curious about what you think about the type of single-stock ETFs or the names that have been issued recently. So we have these same Tesla ones we've been talking about that people are interested.

But I wonder how much demand there is for some of these other single-stock ETFs out there. I mean, we have them for Pfizer. We have them for Nike now. Does anyone really need Pfizer, single-stock leverage and inverse ETF? We have them for payball and Nvidia, maybe there is for Nvidia. I can't help but think, I want your opinion, will interest in these things coalesce around the high beta names, which kind of makes sense to me, or are we going to have hundreds

or thousands of low-volume single-stock ETFs out there? Well, fortunately, the markets are efficient. There'll be winners and losers, and issuers will not leave a product to marketplace, is not getting with reception by gaining assets. So, do you need to have a levered ETF on Pfizer? Probably not. Will you need it on Apple or Google? When I say need, will they be desired to have it?

Probably. So these products are meant for daily returns, for daily exposure. And so generally, stocks that have high conviction, high beta, high volatility is where you'll probably see the most assessed in a levered or input. universe single stock structure into marketplace. And I'm a little load to call it an ETF because we're starting to get into innovation that is broadening the ETF industry. And this is the good things, bringing more investors into the marketplace.

But having a clear view on investment tools versus trading tools as we go further into innovation, it's probably the best practice that we can put in. I say we, the ETF industry. Some sponsors have been talked about this for a couple of years. And as we see more innovation like this, I think it's probably the best case. Yeah. Dave, what's next? Can you give us some insight?

What other single stock ETFs are coming? What are you working on here? Everybody thinks there's more of this. Yeah, again, we're encouraged by the early success and early interest, particularly from a trading volume point of view in our initial launches, especially around Tesla. And as I've noted before, we have filings for other securities, particularly some of the mega cap names that you're going to see. Again, we're talking about names in the case of Tesla, almost a trillion dollar market

cap. In the case of Apple, approaching $3 trillion in market cap, the largest security in the world, the fourth largest security in the world. So I do expect to see further innovation here, further filings and launches in the space. We're really at this time focused on, again, those larger names that have depth of depth of volume and liquidity around them, so that we are in the best position to both create ETFs and manage them, in this case, as daily trading tools. Well, as I knew, he wouldn't tell me any names, of course not.

But so the logical names are, you know, semiconductors, even the high beta oil names. I mean, every day, if oil's moving, I could tell you a half a dozen oil names that are moving twice, you know, if oil's up one, they're up two. or down. I mean, I could do this. In fact, let me do this. I'm going to leave. You take my job. I'm just kidding. Help us out. Where is this going? Yeah, that's true. Look, I mean, a part of it is, obviously, as Reggie said, we've got to bring products to the market that number one customers won, and then number two that are commercially viable. So the answer or the question we always get asked is can you do it on GameStop or can you do it on AMC? And the question so far, the answer has been

it's been too volatile. So we can't provide, you know, a consistent level of leverage over time. So there's actually a level where it's too volatile for it, for you to, and under what circumstances, would that be a problem? It goes back to the rules that we are under in terms of the regulatory rules and how we can launch products. So why we have the different, what we call leverage factors, so they'll, you know, 1.5 times or 1.75 times. And so there are stocks that are just too volatile that wouldn't be able to compute with that rule. And so we wouldn't be able to offer those because it's consistent leverage and it can go back to the reset, the rebalance. You're reinvesting those profits every day at the rebalance at the end of each day.

And so sometimes there are stocks out there. There are any instrument commodities the same that's just too volatile. Yeah, yeah. That's a great answer. Thank you. I appreciate that. And I didn't think about the fact that it would be too volatile. Now, folks, I want to thank you.

We've got a fascinating discussion. I know we got a little wonky with Reggie there, but that's why we have Reggie because, you know, he's the actual. expert in this stuff here. Now it's time to round out the conversation with some analysis and perspective to help you better understand ETFs. This is the Market 102 portion of the podcast, and I'm joined with my old friend who's remote with us, Reginald Brown, principal at GTS. And those of you don't know GTS, they are one of the largest market makers in the world. Reggie, how large are you? How many markets in countries do you make markets in? Well, we're global from New York. We make markets on a New York stock chains for 1,200 listings on in New York, where we do the opening closings.

You see us through C&BC right behind in the blue jackets. That's GTS. We also cover the ETF spectrum globally trading U.S. ETS and where they're listed. And then from their perspective of rates and crypto, GTS is there. So we have a significant footprint in the marketplace. and we tend to be the broker's broker, not a household name, and we make the markets work. Yeah, so we talked today about these single stock leverage and inverse ETFs, which have descended on the marketplace. And, you know, we had Will on and Dave Mata on.

And the standard line here is, well, these are for professional investors. But you watch the flows in these very carefully being with GTS. Can you can you tell? Tell us who is using the product? Is it professional investors that are out there that are arbitraging, you know, a Tesla long ETF against Tesla futures or Tesla stock? Or is it retail investors who are watching Elon Musk tweet and saying, let's go long or short Tesla? Who's using these products right now? Yeah, I mean, it's definitely the retail community.

This day trading is taking best. directionally, based on what they're seeing in the news and what they think the online asset class will trade. There's definitely a hedge fund community that has a portfolio that they're watching and they're using the amplified returns of Tesla and others in order to deliver results for their shareholders. That's a big part. And then there's a large market making community that's keeping the ETS in line to its

underlying assets, whether it's to swap. that the ETFs are built upon for levered ETSs, or also there's futures, there's single-stock features out there, and there's also Broadbase other types of products that correlate well to the levered ETSs. So it's a holistic community out there that's driving the flow, but primarily the success of these ETS is we've built on underlying asset classes that have high volatility, that moves around quite a bit, high-price securities like Tesla, like Apple, and others, and that there's a lot of significant interest for what they're moving every day as far as price movements. This product is so interesting because it seems to me, you know, the average investor can't get

their head around the daily reset. And I think the average investors is probably either going to lose money or not get the return they want over time. But the professional investor intrigues me here, and this goes to the efficiency of the market. So, for example, a professional investor might see an opportunity. He might see some inefficiency in the market. He might find some way to own this leveraged, say, Tesla ETF, and also own a Tesla future or the underlying stock,

and somehow, by some arbitrage mechanism, essentially make money on a consistent basis? Or is that a silly idea? I mean, the markets are not perfectly efficient, right? No, they're not efficient from the standpoint of where's the best and cheapest liquidity. So in a levered ETF that's been out for 12 years, that's used by a lot of users, it's high a lot of daily volume. The price of acquisition or the price of using is pretty low because the bidet spread is pretty tight. When you're looking at newer ETS where you don't have a lot of average daily volume, the bidet spread will be at the arbitrar zone, and then you'll have to pay a little bit of premium

to capture that inherently because that's where the marketplace has set where you can buy itself. But from the perspective to your question, it really comes down to the user. The user wants the cheapest exposure, and then if their institution, they may not want to put up a hundred percent collateral or a fully paid account. So they may use a future where they get some leverage and not put up the collateral in order to get wholly exposed into the instrument. So it really comes down to cheaper to deliver and then the setup of the end user. Yeah, that makes some sense. I know this is getting wonky folks, those of you are listening, but there is a way, I think,

that these products can fit in with a toolbox of a truly professional investor who knows how to use them. So I'm saying there is definitely a use case here. What concerns me is the crowd that gets up in the morning and say, oh, Elon's tweeting, let's go shorter long Tesla. And then, you know, over several days, it diverges dramatically. That's what I'm concerned about. Let me just move on and talk about the mutual fund flows in general. You watch these very carefully. And what amazes me is sitting and watching this business for so many years is how consistent the inflows actually are. Even this year through six months, with the market down almost 20% at one point, we still saw overall inflows even into equity ETFs.

And it was remarkable to me. And of course, as you know, most of this is still plain vanilla indexed ETFs where the money keeps going in. But I wonder what you think accounts for that. I mean, it seems to be in a year when the markets are down, when the markets grew up, nobody cares about the fees that much. But when the markets are down, fees matter. And we still saw money coming out of mutual funds and into ETFs. I don't know if that fee structure still matters,

but how do you account for the consistent inflows? Well, I was at a recent event where one of the Best of Bank CEOs, I won't name him. was talking about this $2.2 trillion in household net worth in this particular period of time. There's a lot of money sitting on the sidelines. It has to be deployed. And I think smart investors have recognized that great companies are trading at historically a discount to their forward-looking earnings. And there's a lot of controversy around already in recession or not in a recession. I think people are expressing their views. So the inflows into equity,

Mutual Funds and ETFs are representative that, you know, people along America, they believe that fundamentally the economy is strong. It is. Look at the jobs report. And, you know, the flows are consistently strong into, you know, across asset classes. Yeah, rates are higher. They're probably a little bit higher in order to bring down inflation if we still have it. You know, it's still a growing problem.

But it's temporary. And I think a lot of folks understand that. based on the jobs report, based on housing, and based on the fundamentals of the economy. If you look at the ETF flows, the thematic ETFs, you know, they're all the rage. I mean, they're capturing 130 billion of assets, you know, into these products. And if you look at just overall how people are thinking about it, yep, there's the ESG crowd. Yes, there's the oil crowd that wants to expose your product. to what's happening in oil, but you've got to go someplace to order to capture it, and the flows

are coming to the marketplace. Yeah, when you say thematic, do you mean like thematic tech, like, you know, cybersecurity, ETS, for example? Yeah, all the themes, whether it is, you know, all related health care, you know, blue sky stuff, you know, it's just, you know, there's so many different products in the marketplace where investors can jump into. And then now they're going to the themes, this new momentum. They're gobbling up cheap beta, basically cheap beta mutual funds and ETFs and are going

to the themes. And because there are so many different investors going into the thematic ETF spectrum, whether it's ESG, whether it's health care, or whether it's clean energy like electric vehicles, and they're going into, you know, sector bets here, you know, I think that's driving the interest, it's driving the flows, it's driving returns. And all this stuff is positive because you have. now a larger retail community that's engaged around best ideas and where the money's being made. Yeah, good point.

All right, Reggie, I'm going to leave it there. I always appreciate your insight. Folks, Reggie Brown is a principal at GTS and one of the great legends of the ETF business. Everybody, thank you for joining us on the ETFA podcast. InvesQQQQQ believes new innovations create new opportunities. Become an agent of innovation. Investco QQ, Invesco Distributors, Inc.