ETF Edge - The Long-Term ETF Investor

Episode Date: May 23, 2022

CNBC's Bob Pisani spoke with Gerard O’Reilly, Co-CEO and Chief Investment Officer of Dimensional Fund Advisors along with Dave Nadig, Financial Futurist at Vetta-Fi – formerly ETF Trends. They discussed how to navigate the market turmoil and where some ETFs investors can turn to weather the storm. They also discussed the perils of market timing and what history tells us about investment returns after previous sharp downturns. In the ‘Markets 102’ portion of the podcast, Bob continues the conversation with Dave Nadig from VettaFi. Hosted by Simplecast, an AdsWizz company. See https://pcm.adswizz.com for information about our collection and use of personal data for advertising.

The ETF Edge podcast is sponsored by InvescoQQQ, supporting the innovators changing the world. Investco Distributors, Inc. Welcome to ETF Edge, the podcast. If you're looking to learn the latest insights on all things, exchange traded funds, you're in the right place. Every week, we're bringing you interviews, market analysis, and breaking down what it means for investors. I'm your host, Bob Pisani. Today, on the show, the stocks skirting around bare market territory, will do a deep dive into how to navigate the market turmoil and take a look at some

E.F investors can turn to to weather the storm. We'll also drill down on the perils of market timing and what history tells us about investment returns after previous sharp downturns. Here's my conversation with Gerard O'Reilly, co-CEO.R CEO and Chief Investment Officer of Dimensional Fund Advisors, along with Dave Nautic, Financial Futurist, at VETIFT-F trends. Gerard, even the long-term investors might be tempted to pull money out of the market right now. What are you telling your investors to do now? What does history tell us? Well, Bob, it's always important to set expectations correctly. And the right expectation for investing in markets is that they're risky.

You wouldn't get a higher rate of return investing in the stock market than the money market fund if they weren't risky. And that's in all times they're risky. So our view is you've got to stay disciplined. You've got to stay well diversified. Have the right mix of stock, cash, and bonds that fits you. And write out these volatile times. And a financial professional or a financial advisor can really have. help you do that. There are ways to make it more risky, and that's by trying to time markets,

by sacrificing diversification, chasing fads, or by sacrificing discipline for panic when markets are volatile. And all those things make it such that time stops working for you. And really staying disciplined is what's important right now. Yeah, I want to talk about the perils of market timing later on. But Gerard, I've heard your founder, David Booth, say, Dimensional is dedicated to implementing the great ideas in finance. What are those ideas? What's the ideology behind dimensional? I think it's important we remind everyone

about what you stand for. There's a couple of aspects there, Bob. One is that prices in publicly traded securities are forward-looking. They're looked to the future. And that means there's a lot of information in market prices that you can use to manage risk and increase expected returns.

The second is, optionality has value, and it's important to stay flexible because if you know how you can capture that value on behalf of your clients. And those two principles we apply through systematic strategies. So you can think indexing, but then indexing beyond what an index can do in applying flexibility to add value. So it's low cost, well diversified, reliable, repeatable, but with value add over conventional index approaches.

Now, Dave, what about that investment thesis? You know, we've often heard Gerard talking about the tilt towards value and small caps. And certainly that's in line with all the long-term research that exists, but we've seen underperformance for several years in those two asset classes. Just their time to outperform? Where are you as an ETF watcher stand with all of this? Yeah, I mean, it's hard not to look at what's gone, particularly with international value and not get a little bit excited there.

And Gerard didn't mention them, but DFIV, which is one of the funds in their line up there, International Value Fund is not only the best performing international value fund out there, it's about the best international or value fund that you can find out there, trading about flat on the year right now, which is honestly a victory given the markets that we've seen. There have been recent polls that Bloomberg did looking at the propensity of folks to want to be a value investor in a down market like this. There's no question that there's a lot of folks looking for that in this kind of environment. But I think the core point Gerrard's making there about diversification and

cost control being really the secret sauce in a bare market, I think is very true. We've seen this before when we've had big pulldowns in the market. Folks go to lower cost products. Sometimes that's switching into an ETF out of a mutual fund, and they go towards broad diversification. It's the two things that we know work over the long term, and there are two things you can actually control. Yeah. You know, Gerard, investors are a little bit spooked that the Fed is going to overshoot and induce a recession. Tell us about what your research indicates about investment returns after sharp downturns. So, Bob, and thanks for the shout-out, Dave, on international value. Appreciate that. You know, after a sharp market downturn, Bob, you can look at subsequent

one-year, three-year, five-year returns. And what you find is that they, on average, have been positive. So a sharp downturn may indicate that a recession is in store for the real economy, but not necessarily. There's many examples where markets have gone down and not been followed by a recession. But they do not indicate that you should expect future declines. It may happen, but on expectation, staying invested for the long pull, you'll likely be rewarded with those positive returns. So I think the point, Gerard, is a negative year, which we may have this year, does not imply another negative year, right? And also address this inflation issue. You've said, I've heard you say, say before, that there's two types of inflation, expected and unexpected inflation. Can you

sort of clarify what you mean by that? Yeah, there's expected inflation, Bob. And you can look at market prices to understand what's expected. You can look at break-even rates of inflation to see what's expected over the short pull and over the long pull. And in particular, for the next year or so, inflation is expected to be higher than average, you know, 5 or 6 percent if you look at break-even inflation rates. That's already priced into markets, and it's expected. Now, markets can't predict the unpredictable. Nothing can. So when it comes to inflation, I think the key things to keep in mind are you can outpace it or you can hedge it. Stocks, bonds, those types of investments have tended to provide positive real rates of return, even periods of high inflation. And then you can buy inflation linked products that allow you to hedge it. So you can plan for unexpected inflation. You just can't predict when it's going to happen.

Yeah, Bob, I think it's also important to point out we're looking at a couple different kinds of inflation hitting us all at once here. Everything from food inflation and energy inflation coming out of the war, but also increasingly it looks like we're going to have substantial supply chain hiccups coming out of Asia for the foreseeable future. It's really difficult to get a point solution that's going to protect you from all of those potential sources. So again, I reiterate a good, well-diversified portfolio of low-cost alternatives is probably your best bet. Yeah. I want to talk about your ETFs, Gerard, a little bit. Dimensional has become one of the top 10 ETF providers out there. You've achieved that a short while ago. You've converted several mutual funds to ETFs in the last year. What was that journey like? You're sort of the leader in this conversion space. Yeah, Bob, we have 24 ETFs now, seven of which used to be mutual funds. We converted into

the ETFs and all the remainder were new launches. So we have 19 equity, four fixed income, and then one REIT fund. You know, it's been a world win 18 months, and it's amazing to be in the top 10 after just 18 months. The conversions were largely driven by what was the right thing to do for the clients. We realized that we had tax-managed funds, that we could do a better job achieving the investment outcome if we converted those to ETFs. It was quite a journey. We had to do that and orchestrated across 45 different markets

around the world, over 50 different platforms here in the U.S., so that our investors went to bed on a Friday night with mutual fund shares and woke up on a Monday morning with ETF shares. And we just went through the most recent one a couple of weeks ago, went smoothly, and so far all the feedback has been very, very positive about that conversion. Well, you've been a leader in this space, so that's good to hear. Now, you've got several equity ETFs. Your largest one is the core equity to ETF. That's DFAC is the symbol.

I'm looking here, the largest holdings, Microsoft, Apple, Amazon, Berkshire, Johnson, and Johnson. This looks like a quality portfolio. Describe what the methodology is. How do you choose what goes into this? So in that particular strategy, what you'll find is that we sort stocks based on their market capitalization, so how big they are, from big to small, on how, cheaper, expensive they are, so price-to-book ratios from high prices down to low prices, and then from profitability, those with the highest profitability, those with the lowest.

And then we tend to overweight those companies that have smaller market capitalizations, lower relative prices, or higher profitability, so a combination of all those three. But it's overweight with respect to their weight in the market. So what you find is that large-cap stocks are generally held underweight, growth stocks are generally underweight, or stocks with lower profitability are generally underweight relative to their weight in the market. And we believe that that improves the expected return of that strategy. And in periods like what we've had, Dave alluded to it, where we've had strong value premiums,

those strategies then tend to outperform the market when value stocks or small-cap stocks are outperforming. But Gerard, I think it's also important that you're not actually indexed to a specific benchmark. How much flexibility do you sort of implement when we have big trading days like we've had? Stocks like Walmart and Target moving 10-20 percent is a pretty unusual environment. Are you actively trading in and out of positions in those types of markets? Yeah, you're 100 percent right, Dave, where we're not indexed to a particular index. We're broadly diversified. We have low turnover. But our view is that you should implement that turnover over all 250 trading days of the year

rather than two or three times during the year. And in time periods like what you mentioned, Dave, I think they're very illustrative of being able to put client flows to work because stocks or reordered themselves. What was growth becomes valuing. What was value becomes growth. So by looking every single day, what it allows us to do is work our way out of positions of stocks that have gone up relative to the market and into positions of stocks that have gone down and are now value-type stocks.

And I think that stands to keeping the strategy focused on the asset category. Because what you find from our strategies when compared to indexes or when compared to our peers is that when things like value or profitability or company size, those premiums are positive, we're outperforming our peers and benchmarks. And that's in part because we can stay focused on those asset categories much more efficiently than an index-based approach, as you alluded to, Dave. So if somebody were to just look at this and say, well, look, you've got Apple, Microsoft, Amazon in here, the three of the biggest stocks that are out there, your point is they're in there,

but they're actually underweight their actual market weighting. And so other stocks get higher proportional weighting overall. I mean, that's the point here, right? That's the point, Bob, because every investment, every limited liability investment is a good investment at some price. Just different investments offer different expected returns to investors. And our objective is to, in a risk-controlled way, improve the expected return or the expected outcome that investors can enjoy.

And that's what a lot of our strategies seek to do. We think the market is a great place to start your asset allocation from. But then, if you're in pursuit of higher expected returns or you want to manage risk in some particular way, having these weights that deviate from market weight to increase returns, we think, is important. Yeah. Now, you've got, I want to move on to the bond ETFs and talk a little bit about fixed income. You've got several diversified bond ETFs. Tell us a bit about what investors, first off,

should be thinking about the Fed and about interest rates right now? Well, I think there's a lot of focus on the Fed, as there always is. But the market understands what the Fed is saying, and the market has that priced in, and you can look at the market for what the expected increase in Fed Funds rate is by the end of the year, and it's over 2%. That's already reflected in market prices. Our view is the Fed Funds rate is one rate, but there are many hundreds of rates that are going to drive the returns of a well-diversified portfolio.

And so what we try to do is have a systematic approach that inputs those many hundreds of rates from around the world and then improves the return characteristics of the portfolio. So for example, you have bonds issued in euros, in British pounds and so on. You have different credit quality bonds. You have different duration bonds. And again, the market tells you who has high expected returns right now and who has low expected returns. For example, if you're in the short end of the market, the highest expected returning play

is from two years to one and a half years. So you could have a short-duration portfolio that doesn't have to go all the way out to five, but still have high expected returns because that's what the market is telling you. It's offering right now. And, Gerard, we've often heard people coming in our air trying to pick bottoms.

This is, of course, an obsession with active stock pickers. They talk about buying opportunities. We hear this all the time. It's useful now to reiterate what the academic research. research says about this. What do you say to people trying to pick bottoms or time markets? If you're trying to time markets, Bob, you're just increasing your overall risk of investing in markets. And that's in part because when those positive days show up, they show up fast

and they often are big. So for example, if you were to look over the last, you know, 30 or 40 years and you were to invest in the S&P 500 and you were to put $1,000 in, as you're showing on the screen here, it would have grown to $138. or $140,000. You miss five of the best days, and that's down to $90,000, so a 30 to 40% reduction. And that's not to tell you that you should or shouldn't be timing markets, it's tell you how challenging it is to time markets, and that it's not a game that's worth playing. You're probably going to end up losing relative to a strategy that stays the course. And that's why, Bob, we've introduced these 24 ETFs, because it allows us to build

models and allows the financial professionals that we work with to build models across a broad range of asset categories in equity and fixed income and kind of ride through those various different times in the market. Yeah. Dave, you have written about this yourself many, many times. And Gerard's point here about the 25 best days and the five best days, it doesn't really matter what time period I've noticed. You could take it over a year if you're not. not in on the five best days, your returns are noticeably different. You could do it over a 10-year period if you're not in on the five best days. You could do it over a 25-year period. And it doesn't

matter whether the market's really rather remarkable. It's a very simple way to understand this. This is why I like doing it this way. It's very easy to understand. Well, you know, it turns out the only market timing that really works is dollar cost averaging, right? If you're always buying, then you have the opportunity to pick up those down days in the market and to be a buyer on those days as well. So, you know, staying invested and just keep buying has been a pretty tried and true strategy for the last 30 years. Yeah. What else, Gerard, at this point, would you have in terms of advice about things like market timing? This is a kind of situation now where I think you really do want to emphasize what the academic literature indicates. We know that generally market timing

it does not work. And you've demonstrated that, just in that simple way. But what else, what other kind of advice would you give to people now? For example, risk profile is a major issue. People have a hard time understanding their risk profile, actually, I find, because people are used to the market going up for the last 13 years. Some people say, yeah, I have a high risk profile. And now the market, you know, is 20% off its highs. And a lot of people are finding out that their risk tolerance may not be what it was or what they thought it was. Any advice on that front, on the risk tolerance front, understanding it? Yeah, I think that after you've experienced a time period like this, Bob,

you may learn something about yourself on your own risk aversion or your risk tolerance. And that may be a reason to change your acid allocation, because you've learned something new about yourself. What you've filled out in a risk questionnaire is not actually how you react in the real world. But absent that, I think generally you want to stay the course. And that goes back to some of the remarks that Dave mentioned, which is about time and time in the market, not timing the market. As Einstein has attributed to have said, you know,

those who understand compound interest earn it, those who don't pay for it, and compound interest being the eighth wonder of the world, I think it's really important to get that time in the market in a disciplined fashion for you to achieve investing success. I agree. Compound interest is the most important thing to understand for the stock market, which is why whenever I have to write some introductory course to long-term investing or introductory article for CNBC.com, I always start with compounding interest.

And, you know, 5% of $1,000 over one year, doesn't sound like much, but compounded over 30 years, the numbers really get big at the tail end. That's what always amazes people. When I do this on a chalkboard in front of a room full of people, you know, 5% of $1,000 is $50. and 5% more after that doesn't sound like an awful lot, but over 25 years or 30 years, the numbers get very big, they get eye-poppingly big once you start getting out into the couple decades area.

And that's when people really sort of grasp the concept of compounded interests. So I think that's the most important thing. I agree with you, Bob. You're going to say something, Gerard? Yeah, I agree with you. And I think it's kind of the illustration is that if you jump off that curve, you get onto the steep part, you're starting all over again. And so you've got to stay on that

curve if you want to get to that steep part of the curve where it really makes a big difference. It also means capital preservation is incredibly important, right? You don't want to be the person who's, you know, sort of selling out right now, putting everything in cash, and then waiting until the markets, you know, had a 20% recovery before you get back in. You know, I'd point out a 60-40 portfolio still beating both bonds and stocks this year. Yeah. One of the most heartbreaking things I've been at CNBC 32 years. and the stocks correspondent for 25 was what happened in the, from December 2008 to March 2009, you'll recall,

of course, gentlemen, you were there, that we were down almost 50% from the, I think it was September 2007 to December 2008, and that's a big drop. People were traumatized, and there were, at the end of November, a modest rally began, and it continued for several weeks into December. I think we rose 15%. And a lot of people, all the technicians came out and said, well, okay, there's now some bottoming process coming in.

And of course, it didn't happen. In the beginning of January 2009, the market went down again until it didn't stop until I believe it was March 6th of 2009. And in that period, in that two months, that's when I saw the most despair. That's when I saw people selling. And that's when I became a believer in behavioral economics. a true believer in it. I'd known about it before, but selling with the market down more than 50% is certainly not terribly rational behavior. And yet we saw that mutual fund redemptions actually increased during that time period. So I take these moments are especially meaningful to me because I saw a good part of my generation, the baby boomers, sell at the bottom. And we didn't know where the bottom was. Nobody knew. I didn't either. But I know that the market's down 50% is not when you start selling. selling. So, Gerard, I know you've had this conversation with many people, but we really appreciate your, the steady hand and the sobriety associated with it. Dave, your firm had a big announcement

last week, changing the name from ETF trends to VETify. What's that all about? Tell us about that. Yes, so VETify is an umbrella brand now, brings in ETF trends, a couple of other firms that you may know, like Illyrian and S networks. But what you can think about us as is really a fintech company, with deep thought leadership, deep expertise, deep data and deep technology that really help us connect investors and investment managers. So our goal is to sit in between the average investor, financial advisor out there, and all these folks who are cooking up products out there in the street and helping everybody understand each other, hopefully that leads to better outcomes for everyone.

Well, your ETF has always been one of the more, your company has always been one of the more dynamic ETF companies that are out there. So I appreciate your change and of course I'm going to be following that very, very carefully and see what's going on with what you guys have been doing.

Now it's time to round out the conversation with some analysis and perspective to help you better understand ETFs. This is the Market's 102 portion of the podcast. Today we'll be continuing the conversation with Dave Nautic from Vetify. You know, Dave, one of the things we didn't get to talk about

on the show was this whole brew with Elon Musk and ESG, with Tesla being removed from S&P's ESG index. And I want you to comment on this because this is a great teaching moment about what I call the politics of indexing and indexing construction. On the one level, Elon has a point in that it doesn't really pass a smell test. How can, for example, ExxonMobil be in an ESG index and he, Tesla, who is a champion, of solar, for example, be removed. So on one level, it doesn't really pass a smell test. On the other hand, Mr. Musk, he's either deliberately or not deliberately is sort of ignoring what the rules are for this particular index, this particular ESG construction. Can you

sort this out for us? Yeah. So look, you know, I think there's an umbrella comment here, which I would endorse, which is the world of ESG is confusing. That's fine. That I'll give you. The specifics about Tesla, though, to your point, it is a great learning experience. So the specific funds that it got kicked out of were the ones, S&PE and EFIVV. They both tracked the same S&P 500 ETF ESG index. It had like a billion dollars between those two funds. And Tesla had been in there, had been a large part of those funds, and it got kicked out in this rebalance. Now, it's important to recognize the reason it got picked out is because those funds, that index, has a pretty comprehensive method.

It's not just a low-carbon ETF. It's not just a net zero transition ETF. It is an ESG ETF, and the S and the G have just as much weight in those scoring systems as some of those environmental issues. So the kinds of things that companies get penalized for are, for instance, when you have consumer problems, i.e. people getting hurt because of your products, or you're being sued because people are hurt because of your products, or you have regulators looking at you because they're uncertain about your products. All three of those things are true with Tesla right now. They've been very high profile on lawsuits out there.

There have been obviously a lot of investigation by the NTSB on some crashes. That's like very much in the news. You can't just pretend that that's not happening. And at the same time, we've got governance issues, right? It's very clear that Elon Musk is a passionate and creative leader, but he's also a wildcard. And having that kind of wildcard at the top of a company presents a bit of a governance risk. So for all sorts of reasons, I wasn't super surprised to see some of the bloom coming off Tesla. Just because the product you make is greener than a regular ICE car doesn't

mean you automatically get a free pass on everything else, on your working conditions, on how you treat people, et cetera. So it makes sense to me that it got kicked out. It's important to point out it is still in a lot of other ETFs that have ESG in the title like XVV, which is just exclusionary. Tesla's still in there. Yeah. So let me just recap this because I want to make one other point. Your point is ESG is not just a low carbon. It's environmental, social, and governance on a number of issues, particularly on the governance side, there are issues with Tesla. Regulators are looking at them. They've got consumer issues as well. Just on the environmental, I would point out that, as I recall, S&P 500 includes a, companies from all 11 sectors and ranks them individually. So, for example, Exxon and, say, Occidental Petroleum may be in the index because they provide lower carbon footprints, for example,

than their other competitors, not necessarily than Philip Morris. Can you point that out as well that the index actually requires some inclusion? Yeah, I think that this is the other issue is that, you know, people pick an ESG product to serve a particular purpose in their portfolio. And for a lot of investors, what they want is an ESG overlay into a way they already wanted to invest. So maybe they want to be fully invested in the global economy. They just would like to do it with lower impact than they might have otherwise. In that case, you do need to do things like neutralize your sector imbalances.

Because if you just wipe energy out of your exposure entirely, well, you know, you wouldn't have had a great couple weeks, right? It was one of the only sectors that's actually been going up. So there is, I think, some truth to this idea that it is a valid approach to try to look like the market while still being ESG. It is also a valid approach to have an impact fund which doesn't care what industries it's in and doesn't care what its beta looks like. It's only trying to invest in companies that are doing good. Both of those things are valid approaches. Investors should get a choice. Right.

So what's the point here? The thing that's mystifying to me is, I would assume that Elon Musk knows this, that he knows this about the index and the way it's constructed. You could say, well, he's making the fundamental mistake. He doesn't really understand how the index is constructed. Like we just explained, you just explained to everybody, and now it makes sense. Oh, now I get it.

Do you think Elon Musk knows this and he's just trying to divert attention? I mean, what do you think is going on here? I mean, not that I'm going to play psychiatrist about this. You know, my job isn't to analyze single stocks, but it's pretty obvious if you look at the other things going on in Elon Musk's Twitter feed that this is part of a swing he is making politically on a number of issues. And so it's not surprising for him to use this one as another, like, gosh, all this ESG stuff is a scam and it's just woke garbage and all that stuff. I get why he's making that position. To your point, if he's the CEO of a huge public company with massive interest, and he doesn't know this, then that's a governance issue by itself. Of course, he should know that.

Yeah. Thank you. That's exactly the way I feel about it. I think he's perfectly aware. And for whatever reasons, political, I don't know myself either, but I agree with you. I think he's perfectly aware of the index construction that's around this. I think the bottom line is S&P was perfectly, from what I understand the way the index is constructed, they were perfectly following their methodology here. You don't think S&B did anything strange or weird. This wasn't an active manager who just woke up one morning. It didn't like what he saw in Elon Musk's Twitter feed and kicked the stock out. There's a methodology here. There's dozens of data points on what the risks of lawsuits are, what the risks of board issues are, how you're

treating, do you have unionization issues? Are you under investigation by later? neighborhoods. They're rules for this stuff. And Tesla now checks a lot of those unfortunate boxes that means they're not going to get into all these funds anymore. Turns out you have to run a company well, not just run a company that's trying to do well. Yeah. I want to move on to another subject because you wrote a very an excellent piece on the ethics of indexing that you talked about. can you, and it's an ETF trends, those of you want to look for it, by the way. Can you just summarize this? We've gone through this so many times, but, you know, there's again,

Kathy Wood brought this issue up about, you know, is indexing getting to be too powerful. Could you summarize what your thoughts were in this piece for us? Absolutely. And, you know, you and I've talked about this many times over the years. I've always been very skeptical of claims that passive was going to eat the world. that conversation over and over again. There is, however, some increasing evidence and some really solid academic research suggesting the indexing flows, that is the buying activity of new money coming into indexes, has a disproportionate effect on the pricing of those securities at the

moments of those flows. Now, sometimes that people get a little bit lost in the weeds there, it really is as simple as if I show up with a million dollars to buy GM, it's easier for me to find a then if I show up to buy a basket of 500 stocks on the exact same second all at the same time, because not every market maker has all of the same inventory. So on average, what the research is suggesting is that when index flows hit the market, they increase valuations by about 5x. When single stock flows hit the market, they increase valuations by about 1x, meaning a million dollars going into GM.

On average, means GM's worth a million dollars more, meaning you're not actually, you're not just having a value. list exchange, the price does go up to represent that new money wanting to buy shares. It has more of an effect when it's the whole index. Now, the big question is, well, once that's priced into the market, does that then unwind? Is that a temporary price distortion? There's actually some evidence that there isn't. That simply being in the index and being available with that kind of liquidity means those stocks are probably worth more, meaning they should actually be going up because of positive index flows. So what's the implications of this?

I mean, why does it have this effect? And what's the implications of that? I mean, none of this terribly much surprises me that index flows can influence the price of a stock. Right. So the thing that you would expect, if this is true, if this hypothesis, it's called the inelastic market hypothesis, is how people are talking about it.

You would expect to see increased single-stock correlation, increased valuations overall, just regardless of fundamentals, increased concentration risks because of momentum effects and indexing, fewer IPOs, and reduced market elasticity, meaning the prices will move more quickly on new information. All of those things seem to be being borne out. We have the evidence that those are happening. The challenge is, then what do I do with that information?

If that's what the market looks like today, how do I invest differently? Well, what you should expect is, in my opinion, more event risk, meaning you really don't want to trade around earnings announcements anymore or M&A. We certainly saw that in the last couple weeks, right? Just unbelievable moves in some huge companies based on, you know, not that surprising information. We'll see more of that. Fewer people setting those prices means that they're going to move more. Everybody has the same investment thesis.

It also means you should probably put some convexity in your portfolio to deal with that. Markets are going to have this melt-up and melt-down quality for the foreseeable future, having some way to either profit from that, whether you're using options, whether you're losing a strategy that's got some way to add convexity of your portfolio, or whether you're just trying to manage for larger tail risks, both of them are valid. So I think it describes the way the market is. It certainly rewards traditional, low cost, highly diversified investing. But it also means I think we have to be a little bit more careful than we might think otherwise. But does this play more into the hands of people who are active managers and hate passive or indexing to begin with? Not really. I mean, again, I think we get trapped in this discussion about like, well, we should do something about this. Like, we're going to ban indexing, which is just sort of a silly idea. Like, how do you ban an idea? It's like Orwellian, right? So I'm not, I don't think that there's like a giant policy solution that needs to happen there. I think there is some discussion. to be had about how the retirement system works, right? We've now shoved so much energy into the

401 system, which has really just turned around and shoved it right back into target date funds. That becomes very predictable, one-way flow over and over again. We should expect that to continue to accelerate markets until we get into an actual drawdown period where we're getting net sales of equities because of retirements overwhelming the amount of money coming into the system, at which point we should expect it to go down fairly quickly during those drawdowns. Again, sort of a five to one ratio of index flows versus what you would just expect from normal randomized selling. Yeah. Now, just to finish this point about flows and indexes, we're at a period of extraordinary market volatility we haven't seen in a long time. We've got three big events here. We've got the Fed and raising rates. We've got the Ukraine-Russia war. We've got lockdowns in China.

it's not surprising to see very, very high volatility. The VIX has been verging on 35 for a while now. I'm trying to understand your key point here about whether you think something new has happened with indexing that's different than before. Why is this different than two years ago, pre-COVID, for example? Yes, well, so it's not that different than what happened with COVID,

but what's the lesson we learned in COVID? The lesson was, holy cow, was it different? for the market to sustain a drawdown. Right? We sold off hard and we bounced real hard. Now, we're obviously dealing with multiple issues here. I think you're right. I think this is worse, honestly, than the onset of COVID. We have more information.

We have more economic data that's looking negative. So I think this is going to be worse than COVID, but I think that the relentless bid of money still showing up payroll after payroll is going to put a floor in this market with, I think, some authority that will surprise people. I'm not going to call the bottom. I'm not going to tell you it's today. But I think the likelihood of it just being this sort of volatile random walk for two or three years,

which some people are talking about, I don't buy it. I think we'll bottom pretty clearly. And then I think that we're just going to grind right back higher because that flows is still going to come in, payroll after payroll after payroll. Yeah, yeah. Thank goodness for young people still want to put money to work that are not terribly spooked by it. Great time to do it now, right? I, of course, emphasize that there.

Yeah. Absolutely. Dave Naughtick, thank you very much, an old friend for joining us. Dave Naughtic, folks, is the financial futurist at the new VETify. Thank you all for joining us on the ETF Edge podcast. InvescoQQQQ believes new innovations create new opportunities. Become an agent of innovation. InvescoQQQQ, Invesco Distributors, Inc.