ETF Edge - S&P's Tesla Snub & The ESG Explosion

Episode Date: September 10, 2020

CNBC's Bob Pisani spoke with Tom Lydon, CEO of ETF Trends, Andrew Mcormond, Managing Director at ETF Trading Solutions at Wallachbeth Capital, and Eric Ries, Founder and CEO of the Long Term Stock Exchange. They discussed the S&P's snub of Tesla and a new exchange that focuses on ESG-type investors. In the 'Markets 102' portion of the podcast we'll continue discussing the ripple effects of the S&P's snub of Tesla and the impact on 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 in all things exchanged traded funds, well, you're in the right place. Every week we're bringing you interviews and market analysis and breaking down what it all means for investors. I'm your host, Bob Pisani. And today on the show, we'll hit on the creation of a spate of new stock exchanges, including the newly launched long-term stock exchange.

We'll talk to the founder and CEO of that exchange about why the world needs more exchanges and about the red-hot engine of growth for ETFs. That's ESG, Environmental, Social, and Governance. Here's my conversation with Tom Lighten, CEO of ETF Trends, Andrew McCormand, managing director of ETF Trading Solutions at Wallach Beth Capital, and Eric Reese. He's the founder and CEO of the long-term stock exchange.

Tom, we often say the S&P strives to contain the largest companies in the United States. How is it that they excluded Tesla at $360 billion? And I think that's the 10th largest company in the United States. What exactly were they thinking in excluding this? Yeah, you're right, Bob. I mean, the key point here is the S&P 500 is not the 500 biggest companies. It's actually an actively managed index, and they made the decision, even though it met some of their criteria, not to include it. So what's interesting here, Bob, is when you look back 100 years ago, the Dow Jones Industrials was the benchmark.

63 years ago when you and I were babies, it was the S&P 500. I think the S&P right now is playing defense. And many investors and advisors and institutions are looking for indexes like the NASDAQ 100 that are a little bit more modern in nature that will take into account, especially in this new economy, companies that are more forward thinking. But they didn't want to take the gamble on Tesla, and that would have been a big move for them. And they're under scrutiny for that.

Go ahead, Andrew. I think that it's okay. I mean, you're exactly right. I think investors will go to other indices. However, you know, I'm not always the biggest believer in that history always repeats itself. And we're in a new time with the meteoric rise of some of these companies. I'll point out that Facebook took over six months to get included. And I would argue that Facebook had more of people thinking about what it meant for our, you know, for everyday life than a Tesla, even though Tesla's actually obviously done quite well.

But to have a little bit of human intervention, I'm actually in the camp that that's still okay. Does that mean that slows them down? Does it mean that people say, you know, they're not up to the times? You know, as it pertains to investing, I've seen a lot of rules-based only investment strategies not do too well in this kind of environment. So to take a pause and say, we're going to look at this and just think it over, it doesn't mean that Tesla's never going to make it. I think they're just taking a pause. We have companies like Zoom, DocuSign, Moderna, which are getting a lot of attention these days, they're getting a lot of growth.

They're probably continue to grow over time. They're not in the S&P 500 either. They are in the NASDAQ 100. So, again, we just have to be more sensitive to it. Do investors want more certainty with a rules-based system like the Russell 1000? I mean, this will go into Russell to Russell 1,000, obviously. But this is a reminder, I think, to everyone. The S&P is not rules-based.

It's essentially a committee. There are some general rules, but they have a lot of discretion. And obviously, here, they didn't consider size as a critical factor for inclusion right now. Do you think investors are more comfortable, Tom or Andrew, with rules-based systems now that are more easy to discern what exactly the rules are? It's very easy to say a rules-based system is working now. and now it's not working now under the current rules, right, which is going to have as popular times and not.

I just am a little old school in the thinking that S&P has a brand and a trust, if you will, right? And you'll see that in that why the institutions and endowments and, let's say, pension plans, you know, that have promises to their long-term employees, their benchmark ends in being S&P because they kind of trust the process. It's not the state that rules don't work. And there are rules with the S&P. I just think there's some old school thinking in that and a brand that they've kind of built with that name doing kind of a hybrid rules, but we have the right to change, you know, not just value those rules in. Yeah. The important point here is that we often say the S&P 500 is the 500 biggest companies, and it's not. And while they strive to represent the large cap part of the stock market, it's not quite accurate to say that they're the biggest 500 companies that are out there.

And this is a good reminder of that. I think a better question, guys, is why did they decide not to include it? And I think probably, perhaps, the volatility was an issue there. I think also what are they exactly? So if you put a $300 billion company in, that changes the market dynamics. What else are you going to necessarily leave out? Do they need another category? Is it an auto stock?

Is it a tech stock? How about some kind of new category maybe to be created in the future, alternative of transportation. I don't know, Andrew or Tom. Maybe that's what they need. Obviously, they're looking for some reason to include it, but they didn't make it right now. Why didn't it? Yeah, my guess is volatility. You made up a great point, Bob. I know all that makes a lot of sense. Let's look at a different stock, just for example. Let's say Moderna comes out, has the vaccine, right? That will be a really big company, really fast if it's not already. And then three months later, God forbid, all right, this one didn't work, scrap it, AstraZeneca. And then what is,

the SP out, like, oh, sorry, we put that in there. We've got to yank it out now. I mean, yeah, rules-based would do that, for sure. But maybe that's not a guess, just a guess, is that they think about the volatility and the rather meteoric rise of these names. But Tom, I'd be, I'd love to hear what you know. Yeah. Yeah, so we know the FAP 500, 28% is represented by Fang and Microsoft.

I think investors have enjoyed the run-up that we've seen in those stocks and what that's meant to the F&P 500 index. going forward investors, especially index investors, hope that they'll also have a piece of those future fang stocks. When we see instances like Tesla, which is such a big company not included, that concerns me. We're not going to settle this here. I think the answer is they're going to include it eventually, and I'll bet you they'll create some kind of new sub-index category.

I mean, literally alternative transportation or something like that and figure out a way to get it in there. I want to move on here because another fascinating second. topic that we've got here today, which is there's new stock exchanges coming, folks. Three of them, three of them in the month of September. That's a fairly rare event. The question is, do we really need them? But the one we're talking about today is a very different one here. Three new exchanges, as I mentioned, but the long-term stock exchange started trading yesterday, and their pledge to support companies who share a long-term

interest in sustainability, inclusion in diversity, and treating employees fairly. Sound familiar? Those are ESG concepts. The CEO Eric Reese is joining us to discuss this exploding interest. You know, Eric, we do welcome to ETF Edge. We talk about ESD all the time. When I read about the long-term stock exchange a couple months ago, I said, darn, this is an ESG exchange. Is that a fair characterization of what you're looking for?

What are you trying to do with the long-term stock exchange? Well, there's no question that ESG is the hottest category in the markets. I mean, what is it, $20 billion? have flowed into ESG funds this year. And yes, we think that ESG, we think of it as kind of as a subset of focusing long-term. So when you're focusing on outcomes like resiliency and having a stakeholder approach,

that's really increasingly what shareholders in society demand. And what we want to do is focus companies on that long-term horizon so that things like sustainability, good governance, treating employees fairly, operating in a 20th century way in the communities that where companies operate, that that becomes a natural side effect or consequence of that philosophy of long-term thinking. And what amazes me is you really sort of walk the walk. I was looking at your board the other day,

80% women on it all eminently qualified, the top people in the field. I guess the question is, is this the right time to do it? This seems like a hard sell. I mean, everyone buys into, we see the oceans of money going to ESG. People are buying into the, concept, but can you build an exchange around it? Now, initially, we had a conversation a couple days ago, you explained to me, you're going to go after private companies that are seeking to go public initially to list on the exchange, but you're also, in the future, interested in current companies that are listing on the NYSE or the NASDAQ, for example. Could you, do you believe you could successfully get, I don't pick a company, a Proctor and Gamble, I'm just picking one out,

to change based on the idea that you have a higher listing standard, would come? companies be receptive to that argument? Has ESG advanced that far that you think you could succeed in doing that? This will be the acid test of all these pledges and commitments. I think it's one thing to sign a letter. It's one thing to put lofty rhetoric in a press release or a financial statement. But the question is, what have companies really committed to? So if you look at it from the investors' point of view, a lot of ESG investing is about finding the least bad company in each category and investing in that. Nothing wrong with that. But how are we going to get? net new ESG qualifying companies. How do we influence the mindshare of the next generation of managers

so that they view this as a source of competitive advantage? Now, part of that is on investors to support the companies that are taking these bold stands to make sure, you know, the evidence is very clear that having long-term investors on your cap table is a source of strategic advantage and leads to outperformance of any company stock. So if investors and managers are partnered together to produce these outcomes, I think that is the path forward for our society. And listen, that's what stock exchanges at least used to be all about bringing investors and companies together for mutual benefits. If I can jump in for a second. So there are fewer and fewer companies that are moving from private to public these days. We know that. And when they do go public, there's a lot of

pressure on. And there are a lot of business decisions to be made. Can you make a case for having this thematic platform, but also offering similar or even better economics, technology, listing benefits that a company in going public that would be ESG-oriented would want to choose your exchange. I really appreciate that question because I don't get to talk about this very often. I'm a technologist by background. That's my training. And LTSE is first and foremost a software company. So this is not just a legal innovation, a technical, legal listing standards innovation, although

those elements are very important. It is also a software platform. And we do think that there are opportunities for technology to, improve the engagement and relationship between companies and their long-term investors. We're a big believer that companies need to have transparency into who their long-term investors are. And we think that long-term investors ought to get privileged capital raising opportunities from companies whenever possible. So, you know, I don't know that in the early days of this, we'll ever get to a point where long-term investors, you know, buy stock at a lower price than speculators. I think that,

you know, that's a dream one day that we could start to differentiate between the tourists who are just passing through and the citizens of the Republic who intend to stay. But I think there are a lot of ways to create true mutual win-win beneficial partnerships between genuinely long-term investors and the managers that want to engage with them. I'm going to tell you under the hood of the ETF industry, since we're looking at, you know, the bat, your point is true. I mean, a lot of the push is like, wow, Robin Hood, everyone younger wants to be involved in this. But I could tell you, I was on the phone with one of the largest ETF strategists this morning, Horizon Investment, make it part of their core strategies, right?

And they view it as a factor. And a factor to them is a subset of securities that investors value higher. And they're already at Gen 2. So they're not simply putting the ideas into their portfolios. They're already doing risk mitigation into that. So what that tells you is if you're doing risk mitigation, that means you're holding on to this investment for a long time. When you get these big strategists who can raise a lot of money and stay long term

and have a great reputation like Horizon does, then you're going to have sustainability. and that is already happening. Not that the Robin Hood investors don't drive money, they certainly do, but I will tell you that it's already happening with the strategist community and ETS. 100%. How do you feel? How do you feel? Eric.

Is this next generation of companies? They don't, a lot of them, you know, they've been very focused on growth, on technology, on building a brand. They have not necessarily started to engage with these issues in the broad way that investors might assume, given their size and sophistication. So there's a genuine opportunity here to win over hearts. and minds and to change the governing philosophy of the next generation of companies, and that's the ballgame. What's interesting to me about ESG is, well, in theory, most people would subscribe to the idea behind it, and there is finally money that's definitely coming in.

We saw these numbers that we just put up earlier, yet we're seeing some pushback against this. The Labor Department, for example, just issued some commentary, essentially trying to remind fiduciaries that they should not be pushing what they call social agendas, that their job is to maximize profits for their investors, and including people who are voting as proxies on that. I know you pay attention to this, Eric. Do you view this as a sort of temporary pushback on certain parts of businesses like oil that are not necessarily being very well treated by ESG and something to overcome? Or do you think this is a serious objection that some people like

the Department of Labor have had? I mean, it's basically ridiculous. I mean, in the middle of a pandemic and all of the other crises that we're living through that have made it crystal clear that human capital investment is not a luxury but a necessity, the vulnerability of supply chains, the fragility of business models, like if there ever was a reminder that conditions change

and that what is material for a company one day suddenly is not or vice versa, we've really seen this. In this crisis in particular, that companies that act to keep employees suppliers and workplaces safe. They are the ones who are performing in ways that those stakeholders are going to remember for years to come. So to say that that's a social agenda or that's not material to business performance,

I mean, I don't know who said that, but that is pretty absurd. I mean, the employees want to stay at those companies. They don't want to leave, and that's what grows companies is happy employees. I have spent 10 years trying to reform companies in a variety of ways, you know, through my work on the lean startup.

And if you've never sat in an all-hands town hall meeting of a large company and watched the questions that employees asked to CEOs and seen that change even over the last 10 years, the pressure is not just from Wall Street anymore. Most companies that understand 20th century thinking that are going through digital transformation are in a war for talent. And the next generation of employees, let alone the next generation of investors, they're not going to tolerate this. So I think there might be some rearguard action, some pushback here and there. but this is a generational seismic change and the next generation want something different. And believe me, they are going to get it. Yeah, I would agree the trend is definitely in favor of ESG. How about the competition?

So I'm trying to think about this. I'm the New York Stock Exchange or I'm NASDAQ, for example. And I'm saying, okay, so there's this new exchange, a competitor, long-term stock exchange. What they want is sort of higher listing standards, more ESG focus. And I guess if I was the NYSC or NASDAQ, I would think, well, that's not. but there's nothing in the listing requirements of the NASDA or the NYSC that would prevent any company from having higher listing standards. I think that maybe their attitude might be, well, okay, but they can do that here with the NYAC and NASDA. Why do you need a separate

exchange with a completely different listing standards? We'd welcome higher standards if the companies want to want to. Eric, what do you say? Yeah, we imagine people said that kind of thing about financial compliance. Like, what do you don't need standards and rules? So just, you know, anyone can be compliant if they want to be, that should be good enough for the public. I mean, come on. When something's important, we standardize it, and we want to know that there's accountability to following those rules. So, you know, beware companies bearing gifts. When you read an S-1, when you read a prospectus, and companies are claiming to be a next-generation company, believe in transparency and diversity, inclusion, inequality, justice, all these buzzwords

are loaded up in these documents. I think the public needs to know who's for real and who's not. Now, to be clear, we don't view the legacy incumbents as competitors, and old school, old-fashioned companies need a place to list too. So more's got to be listed somewhere, I understand. That's not really for us. We encourage companies to dual list out of an abundance of caution, still access the liquidity of NICC if they want to. We're happy to be the secondary exchange. We don't need that extra subsidy of running the open and close auction every day. We want to hold companies to a higher standard and help them develop a governance framework that actually will allow our civilization and,

our capitalist system to survive and thrive into the next century. And final points here, I mean, there couldn't be a better time to bring this forward. We talk about ESG regularly, Bob, and it's not a fad. It's not going away. We can just see by the numbers. And then really, Eric, what you bring out in today, what everybody's going through individually with working from home, you know, their environmental and physical resources, social issues that are going on, it's a great opportunity to bring it forward.

So best luck. Oh, thank you for saying that. Really timely with the city group hired today as well. You know, we're very pro-gender equality in wildlife breath. We're very pleased with that news at a city group. Size and change. The ties are, what's the way? The ties are changing.

I'm blanking on my metaphors here. Well, Tom and Andrew, you summarize my feelings exactly. So no need to have me do it anymore. Now it's time to round out the conversation with some analysis and perspective to help you better understand ETFs. This is our Market's 102 portion of the podcast. Today we'll be diving into the ripple effects of the S&P 500's big snub of Tesla this week and the impact on exchange traded funds.

My producer, Kirsta Chang, joins me now. So, Bob, I guess I want to ask you about the politics of indexing. Looking at what happened this week, with Tesla being left out of the S&P 500, a lot of market watchers viewed that as a major upset, while others called it a brave decision because of Tesla's somewhat shakier fundamentals. If you look at what got added to the index instead, though, Etsy, Terradine, Catalan, their combined market cap isn't even a quarter of Tesla's more than $340 billion right now. But considering the S&P 500 is thought to consist of the 500 largest companies in the U.S.,

what are the implications of this for investors, particularly ETF investors with so many ETFs indexed against the S&P 500? I don't think there are many immediate implications for investors because of this, I call it a snub, Kirsten, but I do think it's important. I think there's a problem of perception here. So most people think the S&P 500 represents the 500 biggest companies in the United States. And that's not strictly true. As you could see here, they declined to include Tesla, which is the 10th largest company by market capitalization.

What S&P actually says is that the index is supposed to measure the performance of the large cap segment of the market. It's considered a proxy for the large cap equity market. And it doesn't claim to have all 500 of the largest companies. That's technically correct, but that's kind of not what the public perceives. So I think this is a bit of a problem. The debate here is whether or not people are more expecting of a rules-based system rather than one that is based on a committee. Now, there are some procedures they follow.

that we know about. For example, they want at least $8 billion in market cap. They want four quarters of profitability, things like that. But still, it's a committee that makes a decision. And they still have a lot of latitude. And it's not strictly rules-based, like the Russell 1000 is, for example. So there's a bit of a perception issue here. And I think this was a bit of a gamble for the S&P Index Committee that decided at least this time around to exclude Tesla. So the problem for them is if Tesla continues to appreciate, investors are going to look to other indexes like the NASDAQ-100, the triple Q's QQ, that's gotten a lot of new money. They have Tesla. They have other new economy companies that are in them. So what do you do here?

I think in terms of the question should be, why did they not put it in? And they don't say. And they're notoriously closed mouth about these kinds of things. But I think What their idea was here is, number one, they probably saw Tesla as extremely volatile. And I think they'd probably like to see it calm down a little bit. The other question is, do they have a proper representation of everything they want in the market? Because that's what they care about. Are there other issues that better represent the field? So what is Tesla?

It's an automotive company. And yet, if you talk to Elon Musk, he'd say it's a technology company. So the question is, where would it go? Obviously, you'd say it should be in the automotive, but that would be another $300 billion in automotive. And the S&P is very interested in having a balance in the economy about where things are. This is a big stock to stick in an automotive. So maybe there's an issue of a category. Maybe I think in the future, and I think that Tesla will go in in the future, maybe they need another category.

I don't know, alternative transportation or something, a sub-index that doesn't exist, a sub-category that doesn't exist already, that's some kind of hybrid of technology and auto that would make them comfortable to include that. Either way, this very much highlights what I call the politics of indexing. And here you have an index that isn't strictly rules-based and that surprised a lot of people. So this goes back to that whole point I always make about buying mutual funds, but particularly ETFs that are tied to indexes. You've got to know what that index is. And sometimes a lot of people were expecting the majority to have Tesla get put in the S&P very soon and didn't happen.

So sometimes things don't always work out. And again, not necessarily a rules-based index when you're dealing with the S&P 500. 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.