ETF Edge - SPY ETF Turns 30: First ETF in the U.S. 1/23/23

Episode Date: January 23, 2023

CNBC’s Bob Pisani spoke with Rory Tobin, Head of the Global SPDR ETF Business at State Street Global Advisors, and Todd Rosenbluth, Head of Research at VettaFi. They celebrated the 30th anniversary of the SPDR S&P 500 ETF Trust – the largest, most heavily traded ETF in the world. They discussed why indexing has challenged active management and why ETFs have been such a successful wrapper for indexing – to the point of actively challenging mutual funds as the investment vehicle of choice. Hosted by Simplecast, an AdsWizz company. See https://pcm.adswizz.com for information about our collection and use of personal data for advertising.

Welcome to ETF Edge, the podcast. If you're looking to learn the latest insights on all things, exchange, traded funds, you are in the right place. Every week we're bringing you interviews, market analysis, and breaking down what it all means for investors. I'm your host, Bob Pisani. Today on the show, we're celebrating the evolution of ETFs. As the nation's first ever, ETF turns 30,

that's the Spider-S-N-P-500 ETF. Ticker symbol is Spy, SPY. It's the largest and the most heavily traded ETF in the world. We'll guide deep into the history of this ETF, the revolution of indexing and assess whether ETFs are poised to take over mutual funds. Anytime soon. Here's my conversation with Rory Tobin. He's the head of Global Spider-ETF business at State Street Global Advisors,

along with Todd Rosenbluth. He's the head of research at VETI. Rory, this is, I call it the ETF that launched a thousand ships. It's still the flagship ETF for you and the ETF community. Why has Spy remained such a popular? investment vehicle. It's popular amongst the buy and whole crowd. It's a popular amongst active traders as well. I think Bob, thank you for having me. Nice to be here and nice to see you too, Todd. I think spy has become so popular just because of its liquidity. Spy really

has extraordinary liquidity in terms of how it trades on an interday basis. It trades on a penny wide spread, trades $39 billion. And we have days when you have five, six, seven billion dollars of inflows into spy in terms of creations. Some days you have five, six, six, six, $6, $7 billion of outflows in spy. But that liquidity gives real confidence to investors, large investors, small investors, that regardless of the market conditions, they can trade in and out of the S&P at any point in time. And it's particularly important for those who are trading options and futures that they really need to know that they can get that underlying basket liquidity and get really good

execution. So for that reason, it really is the granddaddy of the whole ETS. So that's the secret. I mean, the volume just amazes me. I mean, I estimate $32 billion in trades, $400, $80 million shares a day. You said $39, but it's the most liquid ETF in the world. And I wonder if you have done studies. What percentage of the volume is from the active trading community, which is more buy and hold?

Because they both seem to use it, and that seems to be the source of the success. Correct. I think you're right. We've not. It's pretty hard, as you know, getting specific data on holdings can be a challenge in the ETF industry. We've done a lot of work over the last number of years to actually understand who holds it. And particularly, their buying or selling behaviors and what drives that. The biggest community that trades by far is the broker-dealer community, the hedge fund community.

And that community investors, those large asset owners or asset managers that really want to be able to trade and make very significant asset allocation decisions quickly. But they also need to get that guaranteed execution. The buy and hold investors, some of the smaller investors, they might be more. willing to, they may be looking for maybe a different type of instrument. We have one of those two SPLG. But they may be less concerned about liquidity and more concerned about cost. And so hence, they might make a different decision based on that. But for the pure liquidity, for that tightness of bid outspread, when you look at the total cost of ownership, Spy really gives people a very strong value proposition. And that's why those large broker dealers, those large head funds do use it on a very

regular basis, and particularly that option and derivative community upon which spy is based. You know, Todd, you know this. Spy is still king of the hill, but it's got competitors out there. Vanguard's got a competitor. BlackRock's got a competitor. Even State Street

has an in-house competitor that's cheaper. The one thing that I've noticed, everyone's notice, is spy's been having outflows in the last few years. The competitors, including their own internal competitor, have had inflows. They're cheaper. Spies not. basis points, everything else. The competitors are three basis points. What's driving that

dynamic there? Is there a reason we need to keep that at nine basis points? Maybe I should ask him as well, but what's going on here? Well, Spy came out in his four institutions and is primarily used by institutions based on what we think about at VETify, but there are competitors that have offered products for three basis points. So you mentioned the I-Share's product, IVV, the Vanguard product, VLO, as well as SPLG, which is the other state tree product, the Spider portfolio, S&P 500, ETF. And if you're a longer-term investor, if you're holding on for even intermediate term, six, nine months, 12 months, or even for your overall retirement, then three basis points, really that savings makes a big difference. And so investors that are

holding on for the longer term for their retirement, they're shifting out from mutual funds CETFs, a cheaper product from an expense ratio standpoint, has been better. And that's opened up the doors for many more products. There's a lot of products out there now that Spy has come to market. Rory, does that worry you at all that the three other competitors, including your own internal competitor, has had inflows, spies had some outflows. You're still king of the hill. But I guess you don't feel the need to do anything here, right, at this point?

I mean, obviously it has something to do with the nine. basis point fee there. We look at it all the time, Bob, and you're absolutely right, and Todd has made good points there. You know, buy and hold an investor may make a different price decision depending on their holding period. When we look at SPLG, SPLG is more geared. It's a lower price point.

So the actual size of the share is one-tenth the size of spy. It's optimized more for a retail investor versus institutional investor. Spy is a larger chunk in terms of trading and trading out, the minimum creation, redemption size, etc. And the feedback we consistently get from the big users of spy, these are those asset owners, asset managers, broker-dealer community is, it's very clearly is don't mess with what works. And they tell us that for their holding periods, for their requirements, you're still dealing with a fund that's sub-10 basis points. And in today's world, if you look at where a lot of neutral funds trade, where a lot of other instruments trade, sub-10 basis points is a pretty strong value proposition. So for many of those users and traders of spy on a regular basis, their message to us is it works and it works very effectively.

And we need that liquidity, so don't mess with that. So we've stuck with that. We take survey findings on a regular basis, but we stuck with it. When we got some feedback about that buying whole investor base, we did launch SPLG a number of years ago. And that's really working well for us in the segment of the marketplace. Yeah, and that's the answer. They've got a competitor. It's their own competitor.

And people can go over there. nine basis points, by the way, those of you don't know how to calculate this, is $9 for every $10,000 invested. Still a pretty good deal here. Todd, you're the sort of ETF grandmaster here. How do we get to this point where the ETF business is now $7 trillion in the United States? The mutual fund business is, what, $22 or $23 trillion? And yet, this feeling seems to be in the ETF community come the next five, six, seven, eight years. The ETF business could end up to be bigger than the mutual fund business. Do you think that can happen, number one?

And number two, how did we get here? Why is it that the ETF business is seeing inflows every year and the mutual fund industry seeing outflows? So I do think we're going to get there. At what point, it's not exactly clear. Is it five years? Is it seven years? Is it 10?

But it's going to happen in both our lifetimes, hopefully when you're still here at CNBC. No notice now, Bob. But what's striving it is, are looking to get exposure to the marketplace. They don't want to pay a lot of money. We're seeing investors move towards index-based products. There's a lot of data that's out there from S&P Dow Jones Indices, Morning Star has it as well, that active management struggles against an S&P 500 index. So instead of trying to beat the market, why not just replicate the market

and do so for just three basis points? It's also more tax-efficient from an ETF structure. So if you are a buy-and-hold investor in a mutual fund, you not only love it, lost money in 2022, but you likely had to pay a capital gains tax as a result of it. If you own spy or any of its competitors that are three basis points, you didn't have to do that at all. You did relatively well versus the active fund, and you didn't have to pay any capital gains. And so that's what's going to drive ETF adoption. Yeah. So there seems to be two things that happen here.

Number one is the triumph of indexing, of passive investing, which the concept of which existed before that, Jack Bogle at Vanguard, launched his S&P, 500 fund in 1976. So the index and concept has been around before, but then you overlay the ETF wrapper on top of it. And as you mentioned, no minimum purchase, trades intraday, lower costs, more tax efficient. So you'll overlaying the index concept over the ETF wrapper, you get a kind of double whammy here. That's the way I explain this. You do. And then what's also going to cause mutual funds, money moving into ETFs, is actually the asset managers that are launching ETF versions of some of their products. So we had companies like Capital Group and Double Line and Matthews Asia launch products. Morgan Stanley is going to be launching their first

new ETF in a couple of weeks. And we're seeing conversions of existing mutual funds into ETFs, not of critical size, but that's going to continue to swing the pendulum in favor of ETFs. And that's a good thing for investors. They're going to pay a lot less. They're going to have capital gains efficiency as a result. And the ETF investors, and in general, the investor wins as a result of spy coming to market 30 years ago. Can you think of anyone out there? It's hard to think of an asset management firm that really hasn't launched an ETF. As you mentioned, Morgan Stanley's the last big one out there.

They're about to launch. We're waiting any day now for that to be announced. Right. So they're probably the largest one that comes to mind. Dodge & Cox offers a number of mutual funds that they don't have an ETF version of. And they have about five or seven different mutual funds but of critical mass. That would be a key milestone that's there. But a number of these firms have come to market,

and they're going to be down at the Exchange Conference down in Florida, educating investors about their products because they're new to the industry and the ETF business is just different than the mutual fund business. Rory, I want to just move on a little bit and talk about some other things that State Street offers. You've got a big suite of sector ETFs, S&P sector ETFs around the SEP 500.

The largest, and this is what, I think is very interesting. The largest one is one of the smallest by market cap. Energy has more money. The energy, Spider-Select ETF, which mimics the S&P 500 energy sector, has more money in it than technology does. This is the number one fund out there. And I guess if I think about it, it's not surprising, but it is surprising, considering that technology is magnitudes of order bigger, seven or eight times bigger in terms of market cap. And yet, number one is actually the energy select ETF for you. You're right, Bob.

I think there's two factors of place, similar to what the time has told earlier. You've got the market cap move and you've got the flows. So last year, from a, interesting enough, from a flow perspective, we ended up the year without flows of a billion in energy and actually inflows of a billion in technology. But the real move in terms of the underlying assets in the fund was the market move. And energy essentially rallied about 50% increase. Energy started off 2022 at about $27 billion and ended at about $41, $42 billion.

Technology started off about $52 billion and ended the year around 38. So you had a market move that basically took technology down and a market move that took energy up. Now, you might say why did energy have outflows in the end of last year? Well, we saw big inflows in energy in the first six months, after the Russia invasion of Ukraine. But then as the market started to move up, investors rightly start to take profits. So we saw outflows from the fund perspective

at the end of the year, while the underlying NAV was rising because of the market. You know, this is really, I guess, an indicator of market sentiment overall. I mean, obviously some people saw value in energy and piled into energy and other people didn't see as much value in technology

and there's not as much in assets under management or technology. Is it that simple? I think it is that simple. So if you own the, S&P 500 a couple of years ago, you had a 3% weighting to the energy sector. And then the first year happened in energy was the top performer. And you looked around and said, wait, why do I have no exposure to the best performing sector? I'm that well diversified. And so Energy Selects sector, Spider ETF, it's a good product. It holds Exxon and Chevron in sizable weightings, but it also

owns other companies that are benefiting throughout the energy pipeline. And that's going to be a beneficiary for investors that want to overweight their exposure to the energy sector now heading into 2024. So Rory, State Street has other products that are out there. One of the biggest is one of the big high-yield funds that you have, J&K out there, which is, I think, a notable one as well. What else? The gold shares, I have a long relationship with the spider gold shares. I was the first person to cover that when it opened in 2004.

That tracks gold. It's got gold in a thwart. and it tracks the futures, tracks very well there as well. Yeah, so there's gold. Gold has, I mean, gold last year ended up having some outflows, but gold continues to be a very strong product, particularly in times of risk off. Last year, we did see some outflows to the tail end of the year.

There was a little bit of risk on emerging. We saw some sell off there. But gold, for those who are really concerned about markets and market sentiment, we see inflows into gold. And to your earlier question, when we see outflows in spy, very often the natural hedge for those spy outflows is inflows into gold, our GLD fund.

So that's a risk off expressed in spy and risk off expressed by selling spy and risk on expressed by making maybe almost an asset allocation decision into the gold ETF. In relation to JNK, again, significant outflows for the first half of 2022, But then in Q4, we actually saw inflows into high yield,

or there's some element of risk gone coming back. And then final, just to build on what you're saying about sectors earlier on, it's absolutely right that you're talking about people making asset allocation decisions and it being that simple. In addition to what you talked about in terms of energy, if you look at what happened in 2021, which is very much a risk on year, we had about $20 billion of inflows, new money into this select sector funds. Last year, it was only $2 billion.

But you saw this real asset allocation. shift. We saw money flowing into healthcare and consumer staples and money flowing out of technology, out of consumer discretionary, and particularly out of financials. Yeah. I have to say, I have a fondness for the gold ETF because I saw the gold vaults in London, one of the few people to ever see it. And it's really something to see, I mean, a whole room full of gold. But I never quite got it. I did this whole thing in 2010 about this. And I couldn't find a correlation between gold and

inflation. They say it's inflation. I couldn't find it. I couldn't find a correlation. What I saw was a correlation between the economies and how the economies of India and China were doing. And these are the two biggest purchases of gold. Indians are very large purchasers of gold as a part of their household wealth. That seemed to be a correlation for me. But it's a real asset class. It's become an asset class. Commodities in general. But gold is actually an asset class that you can argue people have, unlike, say, maybe Bitcoin, which is not arguably an asset class or has not become an asset. Right.

So both many advisors and investors will use a slice of their portfolio for gold, but then gold itself, the physical gold that's used that's going to impact the price of it is widely used within emerging markets. But yeah, right, the GLD product, which is a strong product, and there's also a lower cost version, GLDM, similar to there's a lower cost version to SPY for more buy and hold investors. it didn't see the same level of demand that you would have thought in that high inflationary environment. We'll see if 20,23 is different.

Let me ask you a 30,000 foot question, Todd. Do you see any break on ETF growth? I mean, the whole argument, okay, we got inflows, but wait do you see a real down market? Boy, you know, people are going to pull money out. And yet we saw it $600 billion in overall inflows into ETFs last year, and the worst year in years for stocks and the worst year in decades for bonds still. I mean, what would actually, if anything, would stop it? If that doesn't stop it, I don't know what will.

Yeah, so we don't think it will. So we are expecting that there'll be a trillion dollars of net inflows in TETS in 2023, assuming that we have a more typical year in the equity in fixed income marketplace. We saw two years ago $900 billion of net inflows. You mentioned the roughly $600 billion in 2022. We think that there's still going to be adoption. You're right. So if you owned a mutual fund and you saw it.

how much you were paying in 2022 and saw how much money you lost, you now are likely taking a closer look at these lower cost ETF options, Spy, SPLG, and everybody else that's out there. So we think we're going to... The low cost indexing still wins,

even though the industry is pushing active management to come on in it's still the low cost. It's still that's there. So actively managed ETFs are gaining some share, but people still want to have low cost diversified index-based products. Rory, put on your strategy. just hat here, your themes for ETFs in general in 2023?

Well, one topic we haven't quite touched on you. We touched on a little bit with JNK, but I think you just recognize this as well. What really has emerged is the fixed income asset class in ETF space. So coming into the COVID 2020, there was a big question mark about the resiliency of fixed income ETFs and would they make it through the crisis? Not only do they make it through the crisis, but fixed income ETFs in their own right became that source of price discovery. and people use the fixed income ETF to basically reverse engineer where the underlying bond should be trading.

Last year, you saw $200 billion of new money flowed into fixed income ETFs. That was the third best year ever for fixed income ETFs, following on from 2020, which was the best every year. And of that $200 billion, a very significant portion, I think about $75 billion flowed into short-dated instruments, where people were looking for yields. And last year, we know the Fed put the income back into fixed income. people switch to buying fixed income ETFs, particularly ultra short-term fixed income ETFs, to get that yield. So we're seeing now significant adoption in passive fixed income in addition to passive equity space. And then you also have this new leg of growth we talked about, which is active, both active equity and active fixed income, which will take off. And as you said, many asset managers are stepping and putting your toe into that water.

But the wrapper there has become the wrapper of choice from many investors. All right. Rory, congratulations on the 30th anniversary. It's a big milestone for everybody. Of course, those of us who follow the ETF business a big day as well. Todd, thank you as always. That does it for this week's ETF Edge. My thanks to Rory and Todd.

Remember, you can see all of our shows on our website, etfedge.c.c.com. And you can hear it on our podcast as well. Etfedge.cbc.com. Everybody, have a healthy, happy, and safe trading week.