ETF Edge - The Power of Indexing with S&P Dow Jones Indices' CEO

Episode Date: August 16, 2021

CNBC's Bob Pisani spoke with Dan Draper, CEO of S&P Dow Jones Indices and Tom Lydon, CEO of ETF Trends. They discussed all things indexing – everything from ESG to cryptocurrencies, thematic trends and the the secrets behind the power of indexing. In the Markets 102’ portion of the podcast, Bob continues the conversation with Dan Draper from S&P Dow Jones Indices. 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 exchanged, traded funds, you are in the right place. Every week we're bringing you interviews, market analysis, breaking down what it all means for investors. I'm your host, Bob Fassani. Today on the show will be unearthing the secrets behind the power of indexing and the man who decides, or at least, is in charge of what. goes into the Dow Jones Industrial Average and the S&P 500.

In fact, we'll cover all things indexing, everything from ESG to cryptocurrencies and thematic trends. Here's my conversation with Dan Draper, CEO of S&P Dow Jones Indices, along with Tom Leiden, CEO of DTF Trends. Dan, the Dow Jones Industrial Average turned 125-year-old, years old this year. Congratulations. We have $13.5 trillion benchmarked or indexed to the S&P 500. Indexing and passive investing is winning over actually. in terms of money flows. Can you give us a sense of where this is all going? And you know, I hear the haters, the opponents of indexed investing. They're now complaining

that we need active investors to make an efficient market, or it's not going to work anymore. How do you think about all of this at S&P? Oh, thank you, Bob. Look, I mean, it's been a long journey since Charles Dow, again, looking for a barometer of the whole economy and kind of created the Dow Jones Industrial average 125 years ago. Where we're going today, absolutely, a record year in ETS, inflows globally and the U.S. The active to pass the debate continues to move forward. Look, we look particularly where, who's benefiting, end investors.

357 billion dollars, we estimate, $357 billion of lower fees have gone into the pockets of end investors, of passive, the shift of passive from active. So we continue to see it moving forward, and we don't estimate that any market impact really until active, until passive constitutes about 80% of the overall market. Today, it's 25 to 30%. There's a long runway for passive to continue to grow versus active. 80% is what you said. Now, that's a very interesting.

It's first time I heard somebody put a number on that. We'll talk about that a little bit later. But we do have a new regulatory regime in Washington. I'm wondering if you met with Gary Gensler, the SEC head or his staff, and what if any concerns that might have about this growth of indexing? Obviously, they're concerned about the growth of day trading. Is Gensler an ally of yours, or is he neutral, or how do you view that? We can't comment on, you know, speculate on kind of regulation, but we are engaged.

We want to make sure that any policymakers in the U.S. or abroad have the best information possible, and particularly our role as an independent provider, transparent provider of indices and benchmarks. Okay. Tom, let me bring you in and talk a little about here. I want to talk about some new innovations, but I want to ask you one question. Gensler wrote a book, Tom, about 10 years ago, called The Great Mutual Fund Trap, where he advocated for passive investing in which he said day trading is one of the four dumbest ideas in human history. It seems to me like Gensler would be an ally here for the whole indexing business. You got any sense of that?

I think so, absolutely, Bob. And everything that Dan's saying is right. I mean, when you think about $9 trillion in ETFs now globally and built on the back of traditional index, But today, when you think about modernization and innovation, I think Gary Gensler's a big fan. I mean, you take crypto alone, and I know you talked about that earlier, I think he wants to see crypto-related ETFs, but he wants it on his own terms when you think about areas like futures where he came from the CFTC makes a lot of sense. He also gave guidance for a 1940-act structure, which is the most time-tested

structure as well. So I think he wants to compromise. I think he likes innovation as well. And with continued innovation in areas like thematics, we need innovation in fixed income, there's nothing but upside from here, Bob. Yeah. Let me talk a little bit about, and both you can jump in here, but maybe to you, Dan, first, innovations at indexing. A good example of the power of indexing is the growth of ESG, environmental, social, and governance. There's a billion of dollars benchmark the ESG indexes, including the S&P, but there's a lot of confusion about what ESG is. This seems to be a real problem to its advancement. Gensler's had a problem with it. Dan, what role, if any, does S&P play in clarifying this confusion?

Absolutely, again, bringing our independence and transparency in this long track record of bringing, you know, additional information, putting it in benchmarks, indices in the hands of investors, traders, market participants, and we're again treating ESG is one of our biggest growth opportunities, but it's also to be able to take, you know, this long story of innovation and indexing. And particularly if I look within ESG climate, I would say it's probably the most advanced in terms of the three areas. And really where S&P made an acquisition a number of years ago with true cost, that gives us a really interesting capability. And we're seeing a lot of demand in Europe around climate specifically. And now it's starting.

to translate in the U.S. as well. Yeah. And just to jump in here, Bob, I mean, you look at the way S&P looks at ESG and they do a fantastic job, but they're different than MSCI. They're different than Futsi Russell. And right now we're so far along with so many different benchmarks and strategies, it's really going to be difficult for the SEC to set standardization and regulation over definition over ESG, I think.

Yeah, but that's not going to prevent them from trying, I think. Gensler's indicated he wants to. Speaking of having a hard time defining things and regulatory, getting your hands around something regulatory, I want to ask about crypto and crypto indexes. Then I want to ask you what S&P is doing in that space. But Tom, I want to start with you. It seems like the real growth business for the ETF business is launching all these new ETFs and the indices around them. Now, you recently announced the sale of your company, ETF trends to Alarian. including a deal with Mike Novogratz to develop crypto and blockchain indexes. What's behind that and what was behind your sale? What are you thinking about where the ETF business is going right now?

Well, when you look at the advisor marketplace and do it yourself investors, they look online for research, strategy ideas, and education. And luckily, we're one of those trusted sources, Bob. And as you know, we can see through flows publicly shared, information, along with the interests that we see on specific stories or interests, where the interests among advisors and investors are going. With that, I'll give you a great example. Last year, there were a lot of advisors that were looking at commodities.

They were concerned about higher interest rate. They were concerned about inflation. They were also looking at infrastructure. And all these areas were a bit ahead of their time. With that, we can share that information. with issuers out there to help them maybe do a better job of some of their current indexes, but also help them fill holes or gaps in their lineup specific to what advisors and investors are looking for. We're not going anywhere. We're going to do more of the same, but it was a great

partnership and we're really excited about it. And what about this deal with Mike Novagrat? You're going to develop crypto indexes as well? Just give us a very brief summary of that. They're already in place. There are eight different indexes, and they're based on, everything from blockchain and crypto owners, enablers, miners. We're also going to have futures as a part of that, too. And other ETFs that can be invested within those ETFs. So very innovative and obviously having Mike Novogratz and the team coupled with Alarian and their powerhouse, really excited to be a part of that.

Dan, what's S&P's plans regarding crypto indices? What are you doing with that right now? Yeah, no, we're a very early mover in that space. We launched our first crypto entity at the end of last year on Bitcoin, Ethereum, a broad-based, and kind of a larger, you know, kind of market-cap-weighted type of approach, if you will, in crypto. So those are in market. It was crucial for us, the underlying data, making sure that we can put together initially benchmarks and then later indices that could be licensed into investable products,

but making sure that they reflected kind of the best data in the marketplace. And we have a partnership with Luca to be able to do that. So we're excited. Those indices are in market. They're building track records. And as Tom mentioned, we're excited to have the indices available for various types of investable products, derivatives, ETFs, what have you. Yeah. I want to move on and talk about China a little bit and what's been going on there. A lot of questions from the investors. Are the recent comments from China about increased regulatory scrutiny from their end? Is it making it more difficult to set up global indices? Some are arguing China should be considered a sort of separate asset class from the U.S. and the rest of the world.

Is this really an issue? Dan, are we going to see indices that are the world ex-China? And I mean, maybe you're neutral on all that. But talk to us a little bit about that. Yeah, I looked at a high level. I mean, what we want to do is make sure, again, we're not, we're basically reflecting kind of the playing field appeal. Once policymakers and regulators around the world kind of set those guidelines, our job is to go in And then once the guidelines are set, is go into, and it's addressable markets.

And being able to build benchmarks and indices that really reflect the investable markets there. So we continue to do that and really kind of engaging, really with our clients, where there's demand. We can build on the standard benchmarks, but we have sophisticated clients that may want custom indices. So it's really kind of the engagement, you know, based on kind of client demand where we want to move forward. So, Tom, what Dan is saying is they're sort of neutral on this. They build indexes. You want an index. One way.

We'll build it this way. We're not ideological on this issue. But I'm wondering how you feel about this, because for 20 years, you and I have been talking about growing the global portfolio, making it easier to invest, believing largely in passive indexes, but also to a certain extent on some active management. And we all should have an allocation globally. It's gotten easier because of ETS and because of indexing to do that. We've all thought, okay, so, you know, all world, you know, XUS, China should be 5% by market cap.

So we should have indexes with 5%. If you want emerging markets, China might be 40%. I'm wondering if given what's going on with China, what you're telling your clients, is China, first off, still investable, number one, number two, if it is, is there much greater regulatory risk? And number three, is the idea of just investing by market capitalization, perhaps not such a good. idea or does it not matter? Well, so Bob, we had Brendan Hearn on last week talking about China. You know those folks over at crane chairs. They do a great job.

He pointed out that every year or so there's a lot of saber rattling going on between the U.S. and China. There's no way that we're going to separate the capital markets of China and the U.S. They're too intertwined at this point. But everybody's in a competitive spirit. There's a lot of innovation involved. And that's really key and critical. So it is going to be all about choice.

If you've got a problem with China, there's some great indexes out there that are X-China. But China is the second largest power in the world, and they're going to continue to innovate. It was very, very telling when we did see the dip in the Chinese stock market because of the recent tension, two to three billion dollars came into Cabeweb that China Internet ETF. I think a lot of people are buying on the dip for all the right reasons. Well, it's a value trade. You know, like my value friends always point out to me, you know, China's a value play. So it trades, I don't know what they trade at.

You know, the emerging market's 15 times forward earnings. The U.S. is 20 times forward earnings. So all my value friends, you buy these stuff when it's down because it's a value play. But to me, that's like almost a not quite a technical play. There's fundamentals involved in it. But it's very different than saying, okay, China's 5% or 10%. 10% of, you know, global market cap, and we ought to hold it on that level. It's just an interesting debate to have right now.

Sure. I think it's very clear. And China wants, China wants U.S. investors. They may be competitive. They may, you know, stab, you know, fight back and forth with words. But, again, the amount of money we bring to China companies is huge for their overall economy. Yeah. Dan, I wonder if you could shed some light on the investment committees, because I get this question every time. Every time there's a change in the Dow Jones Industrial Average,

I get several dozen emails from people saying, gee, this is really opaque. How do they make these decisions? And who's on the committees and who's on the S&P committees? Can you, I know you don't like going into a lot of detail, but could you just explain how the committees work? Perhaps the Dow Industrials and the S&P 500 committee? I mean, it's a joint venture, right, between S&P Global, CME Group and News Corp, right?

Who decides who sits on the boards and how often do they meet? Could you just give us some bare bones explanation so the viewers don't keep harassing me every time about it? Yes, so our ownership, yeah, we're owned 73% by S&P Global and then 27% by CME. And in terms of the committees, look, you know, our, again, this history we talked about with the Dow through the S&P, it's built on independence and transparency. So our committee structure is set up, and the governance we have is that way. So we, if you will, separate any of our analytical, the decision-making in those committees, you know, with our commercial activities.

And even on the committee structure, I'm not part of that, even as CEO. So that's something that has really stood the test of time, not even decades, but over, you know, more than a century of that process. But what we do in return is to make sure when new information comes to the marketplace that's relevant to any of these indices, we hold periodic public consultations, we've taken that information, but it's absolutely crucial for our brand and independence, is then we want to disseminate information from those committees that it's done in a responsible way to the public. So again, it's something we put in place and creating not only the benchmarks,

but now all these investable products, you know, the indices for these investable products we're talking about, it's really an important process for us. So the Dow Jones Industrial Average has a committee, right? The S&P 500 has a committee that meets. Who who's on the committee? I don't mean, I know you don't give out names, but is it, is it, is it, is it, is it S&P employees that are on, it's S&P people. It's not a separate board of completely different people. Explain us on that. We don't, we don't, we don't disclose kind of board membership as part of that. But again, any, any relevant information, things that change, or you mentioned new asset classes like crypto or as ESG, I mean, these committees, you know, do

evolve. They take in the information. And again, it's things you're, done, it's very important for us responsibly to kind of disseminate in a public fashion. So that's, but in terms of getting kind of the composition and information, it's not made public. And how often do the boards meet? Do they, they have regular meetings where they sit down and talk or is? There's a formal kind of governance structure around them. And, again, a number of committees that handle, you mentioned, you know, two of the biggest,

but obviously, you know, we have a lot of indices out there in the way that they meet and the governance process. It's reviewed regularly. and we have, you know, third-party auditors who come in, and we basically kind of work under IOSCO International Principles for that. It's something we take very serious, and it's really at the heart of our brand, and something we're very proud of. Oh, I know, and believe me, I've been doing,

I've been the stocks correspondent for 24 years, and it's an eternal source of inquiry about the process, because, as I said, indexing has become so much more important. People that make those decisions have become more important, and I think for all the right reasons. Guys, thank you very much. Now it's time to round out the conversation with some thoughtful analysis and perspective to help you better understand ETFs with our markets.

102 portion of the podcast. Today we'll be continuing the conversation with Dan Draper from S&P Dow Jones Indices. Dan, thanks for sticking around a bit. You know, I always like to say you're the guy behind the indexes, particularly the Dow Jones Industrial Average and the S&P 500. Of course, there's committees that decide what goes in and out of those indexes. as you've made it clear, you don't sit on those committees. You want to just clarify that for us?

No, look, it's really important. I think the principles which have really led to the longevity of 125 years in the Dow, 64 years in the S&P 500 is the independence, that this is a benchmark when investors around the world, traders, market participants, are trying to understand the barometer of the market, and then now we see increasingly using the index to, build investment products, that independence and transparency is crucial. So the principle at the heart of our governance is we separate our commercial activities from the analytical. And those committees

with longstanding industry expertise from many different backgrounds and disciplines are able to take in a public manner relevant new information on equities, fixed income, now today, cryptocurrencies, other, taking that information, you know, put it into the, in an important way in building these benchmarks and indices, but then to disseminate it in a public way as well. It's a big responsibility. But like I said, we've invested a lot of time and have a very long track record of successfully building these independent benchmarks and industry. But they are, they are committees, right? They do meet regularly. So, for example, the S&P 500 committee would meet, and they'd be aware of trends in M&A, companies that might drop out of the S&P 500, or

want to or be eligible to drop out and companies that might be eligible to come in. I mean, there must be a lively discussion amongst the committee all the time about candidates for inclusion and candidates for exclusion, for example. Yeah, look, I mean, I'm again, I'm not a committee member, but I can certainly say they're professionals who dedicate the time, resource, but also have the governance process where they can hold, you know, periodic consultations with the public of any type, you know, of a type of investors and market participants to get relevant information to be able to analyze that. And then, crucially, once decisions are made in the committee, to then disseminate it, you know,

and again, in a public fashion for all market participants. That's at the heart of what they do. And look, they do it, I think, very well. Yeah. Let me move on to talk about the amazing statistics about passive versus active. $13.5 trillion now indexed or benchmark to the S&P 500, and benchmark being people don't officially pay you necessarily, but they do use you as a bogey. Ninety-four percent of large-cap U.S. managers lagged the S&P 500 over a 20-year period. That comes from your yearly SPIVA report,

which is sort of the gold standard for looking at active versus passive. 94 percent, that is a startling statistic. 357 billion of management fees saved by using index funds over the last 20 years, 25 years, those are your estimates. I have no reason to doubt those numbers. These are remarkable.

And yet, you have the haters out there, the active managers who keep saying, this is just wrong. America's based not on people, you know, just buying into mediocrity, but making a bet. And now they've come up with this idea that if we have too much indexing, the market's not going to be efficient anymore, that

suddenly if everybody becomes an indexer, how do we know what the price of anything is because people who buy indexes don't really care? I mean, they're not investing on fundamentals and market cap. Is there any—what do you say to this argument, and what, if anything, would it take for the market to have too many passive investors? Yeah, well, what I can say is that I think academic research and consensus has proven over time that for your long-term investors, getting the right asset allocation and diversification strategies really matter to future goals. And I think, you know, indices, you know, and particularly now products based on those indices have really, especially ETSs over multiple decades now have really proven they're able to provide, you know,

more precise asset allocation being able, and now at lower cost, you mentioned, $357 billion of cost savings, you know, over 25 years. But what I'd also say, though, is the, you know, today, the passive industry despite its spectacular growth, you know, only constitutes 25 to 30 percent of the equity trading volume in the U.S. on a given day, okay? And if you really look, because generally a lot of the passive, you know, funds and ETFs based on our indices are lower turnover. If you look, the active community still has higher turnover on average. So by our estimates, and these are only estimates, that even if passive trading volume grew, you know, so much and the related trading volume up to 80%.

You know, it'd only be at that level that active trading volumes would fall to even 50%. So overall, price discovery, the active community, and all of that competition still has a big impact on price discovery in the markets. And that means there's a long, still runway for passive to continue to grow in the current market structure. Yeah. This isn't the place to get into how you came up with the 80% idea, but that certainly makes. makes some sense to me. I want to move on to China and get you to clarify something for us because, unfortunately, the whole China debate got very political there in the last year, where there are people coming out saying, first off, we don't want the U.S. government or anybody involved in U.S.

government pension funds to invest in anything that has to do with China, and implying somehow all these people who are investing overseas were... maybe not patriotic or something like that. First of all, I think that is nonsense, number one. But number two, the implication was somehow, who are all these people allowing American investors to invest overseas? I want you to clarify this, because what you've said to me time and again

and your competitors as well is that you are not ideological about any of this. If the world suddenly wants indexes, world stock market indexes ex-Chinese. you can provide that, but you don't have any particular position on these kinds of issues. Am I characterizing that correctly or not? That's correct. I mean, within the benchmark and index universe, if, you know, we actually try to engage with regulators,

policymakers on these to just frankly give our views and input. But after that, I mean, that's really in their hands to make those decisions. But once decisions are made, we take them, you mentioned these committees, we take them into our rules, our methodology and adhere to that. But our real job is markets around the world is once that's defined is to really represent the investability of those markets. And again, we have different types of investors who benchmark or license, you know, our indices. Many of them, you know, are trying to find better diversification. They want to have a reflection of kind of world economies and equity markets and other fixed income classes. And so that's what we're really trying to

to represent there. But our job is to, again, bring, we hope, you know, better information in the form of data, in the form of benchmarks and indices that really can help frequent active traders, but on the other spectrum, long-term asset allocators, really to meet those goals. And that's what we want to push forward on, the best of Dillon. Dan, you've been a friend of mine for more than 20 years, and I really appreciate you coming on and enlightening us. It's always interesting. My pleasure, thank you. Thank you for a much. Dan Draper was the chief executive officer at S&P Dow Jones Indices. And everybody, thank you for joining us on ETFA.

InvestcoQQQ believes new innovations create new opportunities. Here's the greater possibilities together. Learn more at investco.com slash QQ, Invesco Distributors, Inc.