ETF Edge - Tech-Themed ETFs, Dow Shakeup & IPO Market

Episode Date: August 31, 2020

CNBC's Bob Pisani spoke with Todd Rosenbluth, senior director of ETF and mutual fund research at CFRA Research, Jay Jacobs, Head of Research and Strategy at Global X Funds, and Mona Naqvi, Head of ESG Index Strategy at S&P Dow Jones Indices. Today they discussed the top thematic tech and software plays, what the world's biggest IPO could mean for ETFs, and why ESG has been so strong and the possible challenges ahead. In the markets 102 segment, Bob discussed the Dow's big shakeup and what it could mean for your money. 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 on all things, exchange, traded funds, well, you're certainly 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 touch on the top thematic tech and software plays that are out there. That's running hot for all the right reasons.

We'll also talk about the world's biggest IPO and what it could mean for ETS and how to own it. and ESG, that's environmental, social, and governance funds. Why it's been so strong and what some of the possible challenges are ahead of it. Here's my conversation with Jay Jacobs. He's head of research and strategy at Global X funds. Todd Rosenbluth is the Senior Director of ETF and Mutual Fund Research at CFRA, and Mona Nockvi is head of ESG Index Strategy at S&P Dow Jones Indices. Todd, I want to start with you.

This is a bit of a historic day for the Dowell. Jones Industrial Average, obviously, a number of big names going in like Salesforce, a number of big names like ExxonMobil coming out. I want to just ask you generically, what kind of impact does a day like this have a big change in an index have on ETFs in general? And why are so few, why is so little money index to the Dow Jones Industrial Average in general? Well, I think that that's a key point here, Bob, is that the Dow Jones Industrial Average, there's one major ETF, that ticker is DIA, that's the spider ETS. about $25 billion in assets. That is very small compared to the three largest ETS,

SPY, IVV, and VO, which are all tied to the S&P 500. Combined is about $700 billion of assets. And then if you think about the smart beta ETFs of growth versus value, dividends, low volatility, the S&P 500 is really the king of the index-based products as opposed to the Dow Jones Industrial average. But this does matter. So, DIA, the weighting and the exposure changes, obviously the stocks change, three coming in, three coming out. But the health care exposure, I think, is what's most notable to us at CFRA.

The weighting went from about 14 percent to 18 percent because Amgen is taking Pfizer's spot, and this price-weighted index, Amgen has a higher stock price. You know, CRM is taking a bit of the hole that Apple, the stock split had. And so it's a reminder that ETS are not static. You need to stick with them. But this is not as big as if it was tied to the S&P 500. Yeah, I think the answer, the short answer is the S&P 500, historically, by the investment community, has always been viewed as a broader representation of the overall market and has always captured

the professional interest. Well, the Dow Jones Industrial Average has been of more interest to the average retail investor. I want to just move on because we've got Jay Jacobs here. and Jay, I keep talking about thematic ETFs really ruling the day. And Global X is one of the big leaders in thematic, particularly tech-based thematic ETFs. We've seen things this year like the video games ETF, E-T-F, Hero, the social media ETF, S-O-C-L-C-L-U, the cloud computing ETF, CLOU. I can go on and on. You go in all of these. Even lithium, this is electric vehicles, is up.

FinTech is up. robotics and artificial intelligence is up, no matter what. These are all controlled by you. What is it about the zeitgeist that this is captured? Is this just exclusively a work-from-home story? Because this has been going on, in my mind, before we even had the COVID issue. That's exactly right. I mean, many of these themes are things that we identified three, four years ago, and we see as multi-decade, they're not just a flash on the pan because of COVID-19. There are things that we expect to continue to grow through the 2020s and 2030s. What we see, however, is that COVID-19 has been an accelerant for many of these themes.

There was already a lot of people that shop online, but people had no choice but to shop online in March and April under state-home orders. And there's a lot of people playing video games, but people had nothing else to do when there was no live sports, couldn't go outside, and certainly you had a lot more people being drawn into video games. So when you look across a lot of these themes, you see that they've already been on these very strong organic growth trajectories, but COVID-19 really changed people's habits and accelerated the adoption of these themes,

such that growth is going much faster than we originally anticipated. Yeah, and even, you know, Todd, things like solar energy, you know, little byways of EST. We'll get in that in a few minutes. But the important thing is even other thematic ETFs, as long as they're tech-oriented, have really been doing very well. Yeah, we're certainly seeing. A wide range of these. Global X has a great suite of these products, but we've seen some other firms with similarly strong performance with different exposures tied to robotics, tied to cybersecurity,

CIBR from First Trust as an example that comes to mind that's performing very well. You are getting a very growth-oriented tilt with these, and they fill a nice hole as opposed to trying to pick individual winners on a stock perspective. You get that benefit of diversification using ETS. Yeah. I want to move on and highlight something about ETFs that I really like, which is that often you can get access to things that would be very hard to get access to if you wanted to try it on your own. For example, obviously high yield bonds might be a good example. But I want to highlight ANCROP and Financial's IPO, which is going to happen very soon. It's going to be a dual listing. It'll be in Shanghai and in Hong Kong, not in the United States. So it's going to be not easy for average U.S. investors to access it, but there'll be several ETFs that will probably own this very, very quickly. They include the Renaissance Capitals, International IPO.

The symbol is IPOS. There is crane shares also has an internet ETF, a China internet ETF, KWBV, is the symbol there. And we even may have ARC, our friend Kathy Wood over at ARTH, having a share in that as well, ARKF. I think, Todd, the key story here is within days, Kathy Smith over at the Renaissance Capital IPO ETF told me that their international ETOS would likely own it within five days. And again, here's another big example of ETFs making hard to get things easier to get.

Right. Individual investors would be hard pressed to try to get exposure to a Chinese-listed IPO coming to market. But through IPOS, as you mentioned, from Renaissance, through a peer product from First Trust, FPXI, that also focuses on IPOs and spinoffs. You can get direct access to this show, and you'll get exposure to other recent IPOs and spin-offs. And this area of the market has been performing really well. IPOS is up over 40%. So is FPXI. And you mentioned the ARC Financial. So this is an actively managed ETF.

and it's global in nature. So it already owns companies like Tencent and Mercado-Libra in addition to lending terrain square within the top ten holding. So it's logical that this is a place that they'll be fishing. Yeah. I want to move on and point out another example of an ETF sort of capturing the zeitgeist. We've been talking about thematic ETFs investing by theme rather than say industry necessarily. And now we're hearing about a SPAC ETF coming, defiance.

has announced they're going to have a SPAC ETF. These are, of course, SPACs are special purpose acquisition companies. They've been on a tear so far this year. They're essentially blank check companies that seek to merge or acquire a private company within a couple of years. There's been 51 this year. They've raised $21 billion. That's a 145% increase. And, you know, this is another example, a SPAC ETF capturing a lot of interest in a particular space. And I guess Either one of you guys can take a shot at this, Jay or Todd, but we've seen some very successful spacks out there. We've seen, for example, the Virgin Galactic. It did pretty well. We've seen others that sort of fade away. It's very hard to determine whether or not these are going to work or not,

because for the first couple of years, you really don't know what anyone's investing in. But the point is that there's an ETF now available for that, just like there was an ETF available for pot and even Bitcoin and social media. It's just another example of the versatility, I think, of the ETF space, guys? Well, SPACs are a structure just like ETFs are. I mean, they're a way of design to bring companies out to IPO in perhaps a more efficient way because they give price certainty to those companies that are coming public. The question, though, is, you know, what are they going to buy?

Are they going to buy a driverless car company? Are they going to buy a space exploration company? Is it maybe a more traditional consumer package good company? You don't really know what they're going to be. They're just a structure. So I think from an investment perspective, investors might be wise to, you know, wait and see what those SPACs ultimately become before diving in. Because again, they're just a structure. You don't really know what you're going to get until they make their big purchase. Yeah, I think the whole thing is a little

bit overblown. A lot of this is simply because famous people have said, come in, let me come in, trust me, and you can essentially avoid all of the problems associated with an IPO and not even have a real idea. You can have a sort of an idea with enough people behind you and simply say, I'm famous. Two years down the road, I'll come up with a great idea. I think it's all a little bit overblown. I want to move on and talk about ESG because we've talked about it a lot earlier in the year. In the last couple months, we've sort of been quiet about it. I want to hit on this a little bit.

ESCs have attracted more than $35 billion, excuse me, of net inflows so far in 20. 2020. Assets across all types of ESG funds topped a trillion dollars for the first time last quarter. I want to bring in Mona Nockfi. She's head of ESG index strategy at S&D Dow Jones Indices, one of the great experts on ESG. Mona, there was a recent Barclays report. We're getting a little pushback on ESG recently. The questions whether funds mark specifically as ESG really offer any outperformers or any kind of sustainability benefit compared to, say, traditional funds. How do you respond to that? Is there evidence that emphasizing ESG can lead to better or at least equal financial performances? Absolutely, Bob.

I mean, if you look at the outperformance of a majority of ESG funds this year to date and over the past several years, I think that really speaks for itself. But on the question of the sustainability profile and what you're really getting with these, I think just as with any investment decision, investors are responsible for doing their due diligence and making sure that they really look at the specific. fund or index subjective. And just like elsewhere in the finance industry, we have a rather large spectrum of ESG investment vehicles available to suit the needs of different investors available in the market. On the one end of the spectrum,

you do have types of ESG investment vehicles that offer a really significant improvement in sustainability profile, but that which you must have to accept a significant deviation from the market and a differentiated return. But on the other end of the spectrum, you are now seeing the emergence of a number of beta-like approach,

like our 500 ESG index, for example, at S&P, that is a bit of a core replacement strategy. And these types of approaches, on the other hand, are really reducing the barriers to entry and making ESG more mainstream, because rather than having to differentiate or devolve from the market, you can get market-like returns and at the same time a meaningful improvement in ESG. So I think the conversation in the ESG space has really moved away from why ESG and really more into the space of why not. Yeah, the criticism in the report here, I'm reading a little bit of the report here, ESG funds typically don't score higher for the ESG credentials of their underlying holdings than standard mutual funds, and they do at the same time have higher fees. Can you address that, that they don't typically score higher for the ESG credentials of their underlying holdings than standard mutual funds? We've often noted how similar ESG funds are, for example, to high-quality, you know, ETF funds,

that they often own similar high-quality assets like, you know, Amazon, for example, or even Microsoft. How do you even address that? Sure. I mean, this is precisely what I mean when I say you really need to look at the specific fund or index objective. Some of those core replacement beta-like approaches are designed to offer only modest, or be it meaningful improvements in ESG. So you're not necessarily going to see a substantial differentiation. But at the same time, that's what allows these products to be so accessible to the broader market

because you're getting that pretty much identical benchmark-like exposure. And so that's really about reducing those barriers to entry and getting investors comfortable with departing from standard indices and standard investment products. But I would say that also there's a broader issue here when it comes to actually how you measure ESG. There is a lack of standardization of data, different folks define. these metrics differently. And so depending on which set of metrics, that study used to actually assess the ESU performance of the funds, you can't necessarily, you know, get an apples to apples comparison when you're really comparing different fruit and oranges in the mix of the actual

ingredients of the specific fund. You really need to use the metrics that were used to design the specific fund when you're assessing the performance. And that's the bigger issue around standardization, I would say. Right. Well, I've had that issue for years. How do you get standardization? I mean, we saw 20 years ago, individuals simply said they didn't want to be involved in tobacco, for example, or big oil. And ESG has come a long way. It's a lot more sophisticated, but a lot of it is still qualitative rather than quantitative. Isn't it, Mona? And that's, by definition, hard to standardize, correct?

I think there are many quantitative metrics involved in ESG, for example. Carbon emissions and carbon intensity is a pretty quantitative. metric. And of course, in other instances, there are a number of qualitative things mixed in. Really, when you think about what ESG is, it's, in my opinion, the practice of incorporating non-traditional sources of information into the investment process because you deem them to add some value that isn't already captured by standard investment analysis. So in some cases, qualitative information is really useful because you're not going to get that from the regulatory filings. But the issue is that, you know, if you look at the way that corporations have changed,

over the past several decades in particular, you have the growth and importance of intangible assets, for example. It's very hard to quantitatively measure the value of intangible assets. And these are things that are really driving corporations value today, whether it's brand, reputation, goodwill. That's really what ESA is trying to capture. And that is some subjective kind of value judgments, but that's what I think adds so much value and intrigue to investors in this market.

It's possible that these assets are mispriced. Everybody has a different opinion, and that's what creates such a significant opportunity there. Yeah. You know, Todd, regardless of all the subtleties about ESG investing, I mean, it's hard to make a case that ESG isn't adding any value this year. I look at all the big ESG funds. I shares select, the I shares aware of Vanguard's big ESG fund, ESGV. They're all up 12, 13, 14 percent this year. They're all outperforming the S&P. I guess I understand the subtleties about arguing at ESG investing, you know, may not be the same. It may not be that much different than overall market investing, but, geez, it sure seems to be doing better this year. Well, it's clearly different than the S&P 500 because in the case you mentioned of SUSA, it's up 14%, that's almost 400 basis points better than the S&P 500. And it's not just that I-Share's product. You mentioned ESGB from Vanguard, also up 14%.

ESU strategies are going to differ in what they hold, same way that growth or value or dividend strategy are going to do so. But they're certainly adding value. And I just want to hit one more point as a counterpoint to that argument that these products are you paying a premium. You're no longer paying a premium. The ESG ETF tied to the benchmark that the Mone is talking about, the SP-500, ESC-E-ETF from DWS-N-P-E charges just 10 basis points. That's one basis point more than SPY, and it's considerably cheaper than any ESG mutual fund you'll find around. So fees are certainly come down considerably. And I'll throw this out to anybody wants to say something.

I've noticed other kinds of subtle pushback against ESG this year. For example, I noticed the Department of Labor has a proposed rule that would remind plan providers that it's unlawful to sacrifice returns through investments intended to promote social or political ends. Todd or Mona, I'm wondering that these kinds of comments from the Department of Labor or any official, a problem for ESG funds in the future? I mean, from my perspective, it definitely can be a problem. It does seem to be in the opposite direction of where the rest of the world is heading in terms of regulation. But, you know, I think that the question isn't so much,

you know, does ESG investing necessarily lead to outperformance, which I think is an assumption in the proposed rule, but instead does it inherently imply underperformance? And the answer to that, from my perspective, is an unequivocal no, not least because there's a lot of evidence that supports the materiality of ESG and the outperformance associated with these types of funds. We've talked about it just now with the various ETS that you've been looking at that have really outperformed this year, but also because of this emerges

of these more core replacement beta-like approaches where there is no trade-off. We're really kind of dispelling that myth of an inherent ESG versus performance trade-off by offering these poor replacement strategies. And I don't really think the rule really has any place to apply to those types of strategies when really you're getting very similar risk in return to the benchmark. I would agree with that. It's interesting that the Department of Labor has brought this up as an issue. Jay, maybe you can come on a real subset of ESD that's doing well. These are these clean energy ETFs. I look at some of them, the Invesco Wilder Hill Clean Energy ETF, Alps Clean Energy, Energy, Spider, S&P, Clean Power, all of them. They're up like 40 percent so far this year.

And again, here's another subset of ESD. You call this thematic. That's really doing well. Not only is the technology getting better, but investors want this more, it seems. I've seen inflows here in all these. Yeah, we would consider this somewhat at the intersection of ESG and schematic, as you alluded to, because some of these are very high-growth disruptive feats. I mean, we're seeing a structural shift from fossil fuels to clean energy sources, which, you know, if you're an impact investor looking to invest in companies that you think are going to have a positive impact on the world,

you're probably attracted to those companies. And if you're a thematic investor looking for disruptive change, you're also probably led to those companies. So it's no surprise to us that we're seeing flows in that space. From a performance perspective, one of the key drivers here is you continue to see the cost of solar and wind fall just year over year. It's getting cheaper and cheaper to manufacture these parts and install them, whereas electricity prices can be relatively flat.

So especially if you contract out of electricity, 10, 20 years out. So that does create opportunity in this space for higher profit margins and in a very competitive industry. Okay, guys, that's it. We've got a little long, but look how much we've covered. Folks, we get to the best people in the entire ETF business. I know we cover a lot, but listen again, and you're going to learn a lot. Now it's time to round out the conversation with some analysis and perspective to help you better understand ETFs. This is our Markets 102 portion of the podcast. Today, we'll be chatting about the Dow's big shakeup and what it could mean for your money and

ETFs. Here's my producer Kirsten Chang. So Bob, today was obviously a milestone day for the Dow Jones Industrial Average, swapping out age old titans of industry like ExxonMobil for new era names like Salesforce.com. What kind of impact, if any, do you expect that to have on ETFs? Do you expect any major re-waiting to have to happen here to reflect some of these changes? You know, Kirsten, normally I would make a big deal out of something like this. And I think it is very important for the Dow Jones Industrial Average because you're adding a big software company, Salesforce, and reducing the weighting of another big tech company, which is Apple. You're also adding another tech-oriented biotech company in Amgen, and you're removing Pfizer, which is a more traditional pharmaceutical company. So it's a little more growthy, a little more tech-oriented.

Unfortunately, it doesn't really mean much for the world of ETFs, and there's a very simple reason. In the world of professional investing, the Dow Jones Industrial Average is really a lightweight. It's true it's the most popular index in the world. It's true. It's what the average investor looks at. But in the professional investment community, the Dow Jones Index isn't that important. What matters is the S&P 500. And the reason it matters is because, number one, the S&P 500 is,

500 stocks. It's a broader representation of the overall U.S. investing universe, number one. And number two, frankly, most of the companies that are invested there, the important thing is they matter a lot more because the nature of the Dow Jones Industrial Average is that it's a price-weighted index. Most investors don't consider that to be a very good way to weight indexes. the professional, more modern way is to weight them by market capitalization. So the bigger names, bigger money, more money involved matters more than just what your price is, which is what the Dow Jones Industrial average does. So this has been the case for many, many years, but ETFs have exacerbated this trend in terms of what's winning in terms of a popularity contest. So there is only about

$30 billion index to the Dow Jones Industrial average. It's very, very spoiled. There's really only one major ETF. But if you look at the S&P 500, well, there's about $11 trillion that is indexed to the S&P 500. And there are a whole bunch of ETFs that are indexed to the S&P 500, including the biggest one of all, which is the spider S&P 500 ETF, the symbol being SPSY. And again, there's several other them out there. So the S&P 500 is, you know, almost 80% of the market capitalization of the entire U.S. stock market. It's true there's roughly 2,500 stocks that matter in the investing universe in the United States. And the market capitalization is $35 trillion or so.

But the vast majority of it, and I'm talking north of 80%, is in the S&P 500. So what happens to those other 2,000 stocks? Well, they're, you know, in the other indexes, the Russell 3,000, for example, is a combination of the Russell 1,000, the 1,000 largest stocks, and the Russell 2000, which is the next 2,000 stocks, which are considered small-cap stocks. But don't kid yourself. The combined market value of the rest of the market outside of the S&P 500 is 15 to 20% of the total value of all stocks. So the S&P is really what matters. If you own the S&P 500, you own virtually the entire investable market, I mean, outside of perhaps 15%.

And that's why there's a lot of money that's put into that particular index. That's it for today. I'm Bob Vazani. 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.