ETF Edge - Taking on the “tokenization” of assets 9/23/24

Episode Date: September 23, 2024

What could new experiments in asset “tokenization” portend for an ETF industry that’s riding high? Plus, assessing post-fed market strengths here… and abroad.     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 Invesco QQQ, proud provider of access to innovation for the last 25 years. 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 is breaking down. What it all means for investors, I am your host, Bob Pisani. Could blockchain and tokenization of financial assets soon disrupt the ETF structure?

It's a great discussion, a great question. Here is my conversation with Nick Churney, the head of innovation, at Janice Henderson investors, and Todd Sonies, the ETOF and technical strategist at Straticus Securities. Nick, tell us about this. Janice Henderson is the latest large asset manager to start experimenting with what's called securities tokenization. Tell us what this is, what are you doing with this fund, and how might this affect the ETF business? Yeah, thanks. Look, at its simplest level, tokenization is really just about taking any kind of asset from

the traditional financial world, in this case of fund, and making sure that it can be transacted on the blockchain. So I think a lot of people really think about, you know, Bitcoin or other cryptocurrencies, and that's one aspect of what can be done with blockchain technology. But from our perspective, one of the really interesting things that you can do is take a traditional fund, right, in this case, a treasury fund, and ensure that you can be done. ensure that it can be transacted on the blockchain. So you have all the traditional features of a fund, but, you know, where an ETF might be traded on a brokerage platform, now you're able to buy

and sell it on a blockchain-based platform. And that really opens up a huge number of things that aren't possible today with traditional funds or ETFs. Yeah. So I want to make sure viewers kind of get this idea because potentially this could be potentially revolutionary. So with tokenization, you're converting an asset. In this case, it's a Treasury Fund into a digital token that can be stored and transferred on a blockchain. And you're not even bothering to turn it at all into an ETF. Tell us about what's the advantages to doing this. What's the advantages for you and for the investor?

Yeah. I mean, those two things are really closely aligned in this case. I mean, for us, the advantage is just that we think there are potential benefits to the end investor. And there's a number of things. I think at its simplest level, the way to think about it is that, that traditional asset managers like us, what we do is we have investment insights, right?

We provide professional investment management services and we wanna get those services and those insights into the hands of clients. Well, most products, there's a lot of steps between those two things, right? There's a lot of people who stand kind of between us and our clients and all of those steps take time and money sort of operational complexity.

And blockchain has the promise, I think it's a promise a little bit still out in the future, but it has the potential, promise to really collapse all of those things pretty significantly. And what that means for the end investor is kind of instantaneous 24-7 trading, instantaneous settlement, total transparency over fund holding. So even beyond what ETFs provide, right, real-time transparency. And then one of the really interesting things, I think, is this idea of programmability. And what that means is that you can use a fund like this or any asset, really, that's on the blockchain, as part of an automobility. As part of an

automated transaction. So that might be, for example, something simple like a contract, right? So if you think about in the real estate market, for example, the possibility for things like title companies to kind of not really need to be there, and those transactions could happen entirely contractually on the blockchain, or in the case of sort of traditional funds like we're talking about, things like collateral management, right, or treasury management or instantaneous access to cash management, right? So there's a lot of these potential applications. And what we're trying to do is really be involved in the early days of this, right? It is still very early.

It's a very small market today. But if we're here today, we're hoping that we can kind of learn and grow with our clients and really be leaders as this future sort of develops over the next five, ten, maybe even 20 years. I want to bring in Todd to get his thoughts here. This is one of the things about blockchain that I find very exciting. I've been very public before. I'm not terribly excited about Bitcoin, which runs off of the blockchain. it's a cryptocurrency.

But here he's talking about, for example, in the future, settling real estate transactions on the blockchain. You could even do settlement, stock settlement on the blockchain. You can send money to your friend in England without having J.P. Morgan and everybody else get in between. And in this case, you can actually take a fund and create tokens around it and trade it on the blockchain. Is this any threat to the ETF industry?

I don't know about a threat. necessarily. I mean, it is very early on, as Nick just said. But I wonder if this is how you start to get more of those private assets up and running in a better, more efficient market than what we're trying with ETS right now, where you're jamming ill-liquid assets into a liquid wrapper. So there's that side of it. I like the opportunistic attitude of saying real estate, private equity, whatever it is. The cynical part of me is though 24-7 trading makes me nervous. It should. So that's the one part where I'd want to be a little bit careful. depending on who is using this.

Maybe it's not going to be the older demographic because they probably don't understand it, but there's going to be some folks who get tripped up trading 24-7 or 3 in the morning. Yeah, I don't think we need 24-7 trading myself. That's a feature I can do without. But let's keep talking about this, Nick. I know BlackRock, I know Fidelity International,

I think Franklin Templeton, they're already running tokenized treasury or money market funds on public blockchains. You're looking to join them. Tell me about the cost, what kind of cost do you eliminate when you go to decentralized blockchain? It sounds like you're going to cut out a lot of staff here. There's a lot of people that support the ETF business, staff people, and you think essentially this will help reduce the staffing, which will help you sort of compete on the cost basis better, right?

It sounds like that. Yeah, I mean, over the long term, what you should be able to do is create increased deficiency. I mean, here's a simple example. It wasn't that long ago. all of us on this call, remember in our careers, where there was a very profitable industry around printing 600-page-long prospectuses and delivering them overnight for bankers in New York, right? That whole industry doesn't exist anymore, right? It just makes no sense to be carrying around reams and boxes full of physical paper. There's a lot of analogies that exist today in finance,

and I think I would agree with the comment that was made that it's not necessarily a threat to the ETF industry. I think it's more of a natural evolution. of how we try to get the way in which we deliver investment services to clients to be more efficient and less costly. And we've just seen a rapid decline over the last 30 or 40 years in the cost of delivering and accessing asset management services. And this is just that next step. So it's very early today, but it's rapid, rapid growth.

Right. In the last year, the amount of assets has gone up by four times. Why isn't it a threat to the ETF business? You're announcing a fund here that you're not converting it to an ETF, right? You're going right to a tokenized blockchain structure. To the extent that in the past you might have taken that fund and turned it into an ETF, and now you're not, why isn't it a threat? It seems to me like it is.

Maybe not this year, but five years, ten years certainly down the road, it seems that way to me. Yeah, no, it depends upon the problem. perspective, right? So as an asset manager, we don't view it as a threat in the same way that we don't view our ETF business as a threat to our mutual fund business. We view it as an evolution. At the core of what we deliver isn't so much product wrappers as its investment advice. And we want to deliver that in the wrappers that our clients want to have access to. So I think from the perspective of an asset manager, it's not really a threat. It's an opportunity. And we want to be early in that opportunity. I think there are certainly people in the ecosystem

for whom it's potentially threatening. But you see those players getting involved. So for example, the DTCCC, which is arguably the most significant financial infrastructure in the world, made an acquisition to think about how they can bring their business on chain, right? So a lot of those types of players who, you know, I think the average consumer doesn't really pay much attention to, custody, clearing, those types of really important services, I think what's going to happen is they really need to think about how they're going to deliver tokenized solutions because otherwise they will be disrupted. But for us, what it means is faster, more efficient.

less expensive delivery of our services to clients. But yeah, 20 years from now, it may mean that ETFs are less important, just in the same way that mutual funds today are less important than they were 20 years ago compared to the ETF wrapper. I don't think it's going to be 20 years. First of, those you don't know, DTCC does all the settlements. They're central of the structure, the organization

that handles settlements in the United States. Nick, of course, is a fund manager, and he has to be agnostic on the platforms that he provides this, so mutual funds, ETS, tokens, so to him it doesn't matter. But the ETF business is a threat to the mutual fund industry, clearly. I mean, this sounds like forget a threat to ETFs. What about a threat to mutual funds more broadly?

Yeah. Especially the retirement system too. I mean, can you get that on chain and change the whole structure of that? Right. There's $40 trillion now in retirement assets across the U.S., so that's a lot of money too for this structure and take a MAC. Yeah, yeah. I think you would agree, though, this is very early on.

But in the long term, this can replace an ETF structure in certain circumstances, right? I wouldn't, I mean, as an ETF person, a love of ETFs, I don't want to see it happen too quickly, but you have to adapt or we know how things go. Yeah. I want to move on a little bit. And Nick, jump in here. I wanted to ask Todd about where we're going in the ETF business right now. The S&P 500 at an historic high.

We have had huge inflows this year into ETFs. We might have a $1 trillion year inflow, biggest ever. We have 10 trillion in assets under management. I want to get your thoughts on this rally. We've had a great move up in all of these cyclical sectors. Consumer discretionaries at a new high. Industrial stocks are a new high. Material stocks at a new high.

Interest rate sensitive sectors like reits and utilities are near new highs. This is not the kind of stuff that is at a new high. if investors think the economy is going into a serious downturn. That's why I'm still relatively bullish. Nobody's going to be buying this stuff if they think there's an imminent downturn. You think you have to be? I love the idea of going back the last few years and remembering anything that was not tech has been in a bear market since late 2021, early 2022, right?

And that's a lot of these cyclical sectors that are finally moving. You haven't seen many inflows to these sector ETFs, which I really am a fan of, because that tells me positioning is not too aggressive. And until I start to see staples outperform and credit spreads, widening, right? Real simple stuff, it does not mean, as you just said, it doesn't mean the market is worried about any economic undertones yet. And we saw staples do a little better early on, but now they're being overtaken. So consumer staples have been lagging recently. Healthcare's been lagging.

Energy's lagging, but tech's also lagging a little bit. And nobody seems overly worried. It's not lagging much. Yeah. But nobody seems ever... It's a little bit of a correction in semiconductor. going on, but it's not dramatic. Yeah, the key part being it's a change in leadership that financials are leading, real

estate's leading. Tech is now leaving that leadership frontier. I'm okay if tech takes a backseat in terms of leading, as long as it doesn't start to go down. That's the big difference, right? It can rise with the rest of the market and not be a leader. That's totally fine. It's when that influential weight declines as the rest of the market goes up, they may get some sort of problem going down into 2025.

Nick, you've been in this business a long time. Give us, and your head of ETS and Janice, give us your thoughts on what you think is going on here. Do you agree with our point here? The market seems to be interested in cyclicals. That seems to be supportive of at least a soft landing in the economy. But your thoughts on what we're doing this year. Well, I mean, the part of this that is amazing to me. I mean, obviously we just had a pretty significant rate cut for the first time and a long time.

And it's interesting to me to see that when we're hitting all-time highs, there's a conversation about what does that mean for ETF adoption. When the markets sell off, we have similar commentary about what does that mean for ETF adoption. When rates are declining, when rates are being, you know, rising, it seems that no matter what the kind of macroeconomic drivers are, there's always an explanation for why that's going to feed ETF growth. And the reason is because it seems to. We seem to just be in a situation where kind of regardless of market conditions, we just continue to see this exodus from traditional fund assets into the ETF. And that to me is, you know, really we've kind of hit the tipping point in the last couple of years where it's almost just regardless of what's going on.

And there was a comment made earlier about the generational aspects of that. And I think that's true, right? We just are at a place where younger investors overwhelmingly prefer ETFs. You know, maybe in another 10 years they're going to overwhelmingly prefer, you know, blockchain delivery. But today it certainly is ETFs. He's got a point. You know, win or lose. It's sort of like win or lose.

You still get inflows into ETFs. A week year, you'll get inflows into certain other sectors, but there are still overall inflows. It's broad-based because of what fixed income is doing, because of what synthetic income is doing, leverage, right? All these, as our friend Eric Belt-Tunas calls them, hot-sauce, ETFs, right? That's contributing. Equity has been strong, but so is everything else. On top of that, international's not getting much love this year, but there's a small group of international ETFs at new highs. Mr. Modi, the Prime Minister of India, was in New York recently, meeting with tech executives.

So the India ETF is at a new high there. That's several different ways. INDA is the biggest one, I believe, that's out there. That market's at a new high. I see Singapore is at a new high, South Africa, Thailand, sort of a disparate group. And the Vanguard Emerging Market ETF, surprisingly, at a new high. So India has been a beneficial. of the blow up in China.

32 years, a 0% return, immense volatility. Investors have finally decided, I've had enough, which maybe that means it's the bottom for Chinese equities. But India has now taken that huge weight disparity and evened it out with China in the emerging markets, ETFs. And it's a new growth play. It's simply put a growth play.

There's plenty of tech there. There's plenty of consumer discretionary to get involved, the cyclical type of environment that investors are attracted to while China figures out whatever is underlying. And there's all sorts of debate about whether India really can replace China. Given how advanced China's infrastructure is, India is still relatively primitive, and yet the market doesn't seem to have any problems, throwing money in it.

I think that's also a derivative of reshoring, right? Manufacturing moving out of China, and they're going to India where companies can now build that up, and the idea being that that market can benefit from it. Yeah. There's an avalanche of cash going into fixed income as well. Fixed income is getting inflows. As the cutting cycle progresses, you might think, why so much, going into fixed income with the cutting cycle. Well, money markets fund, the futures market says money market's going to have a 3% handle. Now, I know some of you are getting 5% right now, but next year it seems they're anticipating 3%, yet the money is very sticky.

The $6 trillion, of which $2.5 trillion is in retail money market accounts, is the most fascinating psychological experiment in this industry right now, because that 5% is going to evaporate real fast if the pace of cuts continues. And so I think a lot of that retail money is going to go to fixed income ETFs because there's over 700 fixed income ETFs now. You can get any sort of yield, duration, credit risk you want. As opposed to say the cutting cycle in 2019, they're only about 300. And go back, there's less and less ETFs.

So investors can get the product they want with very high precision. And so I think they're going to be a huge beneficiary. And you also have to remember, the ag has been in a bare market for four years. So a lot of investors tax loss harvested out of mutual funds and it's all going to fixed income ETFs. The ag being the general bond from the largest bond. It's actually an index. Yeah, the benchmark that bond investors use. Yeah, but the aggregate.

Just want to be careful about the jargon. The viewers don't know all the jargon about that. Nick, give us your thoughts on inflows into fixed income. He's right. It is a fascinating psychological experiment, $6 trillion in money market funds. I can tell you for sure, the viewers are delighted with 5% yield on money market. If it stayed anywhere near, a lot of them would stay there forever and be perfectly happy because they can smell they're getting. And I think it's fair to say an inflation-adjusted positive return on that.

And yet it seems like that's not going to last. Like I said, they're expecting within a year to be in the 3% range. Your thoughts on this? I mean, I think this is a really, really interesting test case over the next couple years, like you said, for investor psychology. You know, $6 trillion in money market funds is an enormous number. or people kind of fled there because of the rate situation. But I think there's kind of a consensus that as rates come down, they'll just leave as quickly.

And I'm not sure that that's true. People got really used to 0% yields. And so while they're not going to get 5% or 6% for very long, 3% I think is still going to sound pretty good to people. You know, it's interesting. We have benefited, I think, from the desire for investors to reduce duration over the last couple years. We have the largest CLO product in the market. It's $12 billion in a AAA CLO product. And a lot of that money is from professional investors who are looking for yield in

excessive money markets. And in the last week, two weeks, three weeks, as people knew rate cuts were coming and then they came, we've continued to see very strong inflows into that product. And it was just about duration. I don't know that that would be the case. Now, it's yielding better than money markets, right? So people are definitely looking for extra yield. But I'm not sure that investors broadly and particularly retail investors are going to make a duration call as much as they want to ensure that they have adequate yields. And I think for a lot of people, 3% is going to feel pretty good for a while. So I definitely agree that the professional investor is going to start moving more and more into fixed income. And like every other cycle, when they go from money markets back to fixed income, they're probably going to pick an ETF over a mutual fund.

But I have a feeling that the money sitting in money market funds, particularly retail, is, likely to be stickier than people really expect. Yeah, I completely agree. I could just tell you the email I get, even conversing with my mother who's 95 years old, they just love it. And they don't, they feel it's a very good ballast to the stock market. They don't want the added risk. They're very comfortable.

I've heard people have 10%, 20%, 30% and money market funds seems pretty high to me. But they don't, the volatility for particularly the older demographic, that's the ones that tend to write to me, to say, I'm very comfortable here at this particular level. I think you're right, Nick. I think it's much more stickier than people. So in a sense, everybody's waiting for, you know, are we going to get one trillion or that $6 trillion going to the stock market? They may be wrong on this. I think you need a big bare market before it goes into stocks. Yeah. Right. Like in 2007, 2000. That's what happened then. I'm not sure about it right now. Yeah, I think so too.

Now it's time to round out the conversation with some analysis and perspective to help you better understand ETFs. This is the Markets 102 portion of the podcast. Todd's own, ETF and Technical Strategist Securities, Continues with us now. Todd, you and I both attended the Future Proof Conference in California last week. Forty-200 people, at least. There might have been more. Half of them, RIAs, registered investment advisors. I probably talked to 100, 120 of them. What I saw was certainly no recession in ETFs, that's for sure. These young RIA seemed very intent in using ETFs in their portfolios.

So the users of ETFs were there, as you just said, in mass. And then the providers of ETS. I went around and counted roughly 70 or so, either A issuers, index providers, custodians. They were everywhere at this conference. And some of them got creative with their boots, giving out whatever sort of goods. But back to your point, there's absolutely no recession

in the ETF industry. We'll see where the overall economy goes, but things are still booming based on this conference and the flows too. Yeah, and it makes sense for them. For most of these people, these RIAs are charging 80 to 100 basis points. And you can't run anything else other than an ETF on a platform on that kind of numbers. Even if you're buying an S&P 500 fund, just the cost of running, you know, an RIA, you know, that's a pretty tight spread. 80 to 100 basis points all in is a lot. It's not a lot. It's not much if you're actually managing the business for them. Yeah. So the ETFs are going to be dirt cheap. And so it's up to

the RRA to manage their relationships, right? You need to be educational and also explain why perhaps you're using an ETF. Low cost, transparency, access to any market, liquidity, tax efficiency is always an important one. And so, yes, while they may. have tough margins, RAs and advisors always always comes down to the type of person you are. What happened, what was interesting to me was there were less questions on asset allocation, like should I put money in SEP 500 or sectors or where should I go, and more about just how to grow assets under management and how to survive. A lot of these guys, you know, people always talk about a billion dollar RIAs, but my heavens, most of the people,

More than 50% had 10 million to 100 million in assets under management. That is very small number. And when you're dealing with, say, pick a number, 100 million, and you've got a million dollars in revenues a year, that's not a lot. You can have four or five people with you, and your basic game is just surviving. How do you manage the office?

How do you pay the taxes? How do you grow your assets? I think the interesting point you made was that everyone kind of has the same asset allocation at this point. The barriers to smart research are so low now, as it compared to 30 years ago when you had to pay an abnormal sum of money to get institutional research. You can sign up for anyone off of Twitter or X, substack, whatever it might be. And we all know the keys there, unless the market were to meaningfully, meaningfully change for whatever reason. And so I agree. The RAs out there need to understand marketing and content as opposed to the asset allocation part of this.

That's where a lot of this future-proof content came in handy. They also were, what I tried to pin them down, they seemed reasonably optimistic, and I mean, for good reason. I mean, the SPU was at a new high last week. Even the small-cap Russell 2000 is 2% from a new high. Earnings seem to be going up, and there was a lot of talk about the Fed put. The Fed is easing. That's an insurance policy against recession.

A lot of people seem to feel. It doesn't guarantee we're not going to get one, and inflation is going down. So they seem not terribly worried. They seem more interested in just managing their business to grow. What do I have to do to grow it? The marketing and the content. And I think you'll probably get one-off questions like should I be worried about five to ten stocks at 30 to 40% of my SMP 500.

That's a question that can now be answered very easily with an ETF solution. Yes, you can buy a buffered ETF or some sort of defined and structured outcome fund. So they have all these solutions now at their hand and they just need to get them their name out there. Where are we in this cycle right now? You know, there's an old phrase, bull markets are born on despair. They grow on skepticism.

They bloom on optimism, and they don't die until you get to an euphoric stage. I don't know where you think we are. It seems to me like we're somewhere between skepticism and optimism, and that's a long way from, you know, the bull market being over. I don't get a sense of euphoria.

Every once in a while you'll get a group that runs too hot and they correct. But I don't know. still don't get the sense as anything like 2021 a few years ago. And that was a completely different interest rate environment. Flows were extreme, especially for, say, thematic and sector corners. And right now it's just technology. Yeah, I am, I've been doing this for 34 years.

And honestly, I am hard pressed to find. And I see issues, I'm hard pressed to be overtly negative or bearist. Data just isn't there, particularly not the earnings, which to me is the most important thing. After that, it's short-term momentum, and I don't see that. I see cyclicals strong. They're not going to buy cyclicals if they think the economy is going to hell. I mean, that just doesn't make any sense. So the market may be wrong, but it's certainly not pessimistic right now.

Consumer staples are the easiest chart to look at and say, are they outperforming? If not, then we're okay. If they are in a meaningful way, then I'd get more worried, those are the stocks that suffered the most in this cycle. Until they see some sort of sign of relative life, I just don't see it yet either. And the Fed certainly is sort of an insurance policy against the recessionistas at this point.

So like I said, I keep looking for reasons. Seasonality, we were all ready to say September's going to be horrible, and so far September's up 1%. So that's been wrong. That's okay. And then there's an election coming up. That always causes jitters. But once it clears, we're okay.

How about the market's expecting too many rate cuts? What are we, 150 at least, in the next year? That may not happen. I think the magnitude and the cadence of those cuts will give us some signals. If we start cutting 50 at each meeting, that's going to send alarm bells to the market saying something is wrong. If it's more gradual and over time, kind of like the mid-90s where you cut, you pause for a while, cut maybe even a hike in there, then that is pretty gravy for the overall market. 95 scenarios is the best case.

Okay. Todd, thanks very much. Todd's own is, of course, the ETF strategist as Stratikis. That does it for ETF Edge, the podcast. Thanks for listening. Join us again next week, or remember, go to etfedge.cmbc.com. How does InvescoQQQQ rethink possibility? By rethinking access to innovation and the NASDAQ 100.

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