ETF Edge - The rapidly growing $18B world of single-stock ETFs 1/6/25

Episode Date: January 6, 2025

Since single-stock ETFs debuted in 2022, the category has exploded. Global interest in U.S. tech stocks is poised to push growth even further in 2025.           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 InvescoQQQ. Let's rethink possibility. 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 are in the right place. Every week we're bringing you interviews, market analysis, and breaking down what it all means for investors.

I am your host, Bob Bizani. Since single-stock ETFs were introduced in 2022, the category has exploded. Will 2025 see even more of an expansion of that universe? Here is my conversation with Will Ryan, he's the founder and CEO of Granite Shares, who runs the largest suite of single stock ETFs, and Ben Johnson, head of client solutions at Morningstar. Will, your Nvidia, two times long, NVIDIA, ETF, single stock ETF, it's the leader. You've got $6 trillion in assets under management. I'm always curious, given the short-term nature of these, who owns them and what are they doing with them?

Explain to us. So in terms of the ownership, what we've found is actually it's something of a worldwide phenomenon that you've got investors not just here in the United States, but around the world. And in terms of those investors, that's everybody from retail investors all the way through to your most sophisticated hedge funds and proprietary trading firms in the world. Yeah, so most of these investors, we've covered this and Ben's covered this for years. Most investors last year, they put money into plain vanilla index ETFs. That's where most of the money goes.

But there's this increasingly retail component out there that wants to trade volatile tech stocks despite the fees and the risks that are out there. You've called this retailization of it. But it's fascinating how there's a global component to this. Explain what's going on. That's right. So another word for retailization is self-directed. And this is about more and more people taking charge of their own finances. Now, as you rightly point out, that's not going to be necessarily for the bulk of their.

portfolio, but increasingly that's for a smaller amount of portfolio where they feel like they want to have a bit more control, they want to be able to actively manage that and maybe try and outperform. And that's where we see things like leveraged single stocks really playing. And as I said before, I mean, this is something where it's not just the US investor, this is a worldwide phenomenon because we have investors all around the world, they're looking to the US ETF market first because that's the biggest source of liquidity, but they're looking to the names that they know and love. The Teslas are the world, the invidias of the world.

They're only available here in the U.S., and that's why people come here to trade them. So you have this group of young people that have grown up watching TV in South Korea, in Malaysia, in Japan. Their own markets aren't that vibrant or interesting. Is that your point? And China is difficult to invest in, and there's not a lot of tech stocks in Europe. So they grew up listening to Elon Musk and to Nvidia and Tesla and that's what they want. There's a theme here that's very interesting. Yeah, absolutely. So you've got, for me, two things happening.

First of all, the domestic equity market, the domestic stock markets may not have performed as well as the US. In their countries. So therefore, the US is attractive. The second thing is when we think about global technology, Chinese technology is uninvestable now for a lot of people. Europe has no technology really to speak of. It's all here in the United States.

And so people increasingly are accessing the US market and US technology stocks in particular from all over the world. Ben, I want you to weigh in here. There's a lot of big themes here. One is this sort of globalization of trading. But there's two big objections that Morningstar and you have written about over the years about these kinds of products, leverage and inverse and single stock.

First of the high fees, and Will charges 1% for his products, 1.06%. And the second is the daily reset. So investors holding this more than a day don't necessarily get the leverage or inverse coverage indicated. Tell us where does Morningstar come down on all this? What's the right way to look at this? Yeah, Bob, what I would say is at risk of this reference being lost on a younger, more global audience. In many ways, I think of these ETFs as being sort of the George Costanza of the ETF world

and that most investors would learn to do the exact opposite of what they're doing. First and foremost, they're designed to work on a daily horizon. Investors need to think long term. These ETFs offer exposure to a single stock. Investors are generally best served by diversifying broadly. Investors also should probably pass on leverage more often than not. And I think importantly, investors need to be always focused on fees because investing, as we've learned from Jack Bogle,

you get what you don't pay for. And what you pay for here is many, many multiples what you can get from a very broadly diversified, unleveraged total market index ETF. Now that said, let's not conflate investing with speculation. And I think what you have here is a tool that's most useful for speculators. And what we see in the data is that these ETFs

have generally been used as advertised. If you take Will's own flagship fund, NVDL, for example, my calculation showed that last year, that entire share base turned over once every five days. So generally speaking, what we're seeing is that people are using these to take a punt and not necessarily to invest for the long term. If you're doing that with eyes wide open, and when I mean eyes wide open, I mean clockwork orange style eyes wide open. And in a way that isn't adversely affecting the bulk of your portfolio, then there's a use case here. You know, I'm not sure you would disagree with a lot of what he actually says there.

I mean, the daily reset and the high fees, you've acknowledged all that. And it hasn't seemed to be a deterrent for people investing in this. Why is that? And what do you have to say about those sitting concerns? Honestly, what Ben has just said is to me the exact sort of thing that people should be doing for long-term investing. And that's no different to the way that we see it. As I said, I think the majority of people, the reason why your S&Ps, etc., the world, maintain the highest number of inflows is because that is what people are doing.

What we can't ignore is that there's an increasingly larger amount of capital going into shorter-term investments. These are self-directed. These are people that are looking to manage, you know, some of their play money, whatever you want to call it. And that's where this kicks in. And when you look at the fees charged by, you know, our products, for example, they're incredibly inexpensive for a short-term investor who's comparing it to the equivalent cost of, say, using leverage in a traditional brokerage account. So you always have to compare apples for apples. And from that perspective, as you can see from the trading volumes and the assets, these single-stock ETFs like NVDL are incredibly popular.

Right. So your point is that if, first off, the people who are doing this aren't worried about the 1% fee because they're in and out on a daily basis. So it's a minuscule aspect. Absolutely. And comparatively, if they wanted to actually reproduce this in a brokerage account using options, it would be 1%. It would be more.

It would be more than that. You run long short leverage inverse ETFs for several companies. They're pairs. You have one for Tesla long short, Coinbase long short, AMD long short. And then I'm showing the assets under management. Here's the Tesla daily long short here. And what's going on is the short ETFs are a fraction of the long ones. And this is true of all the other two that you own here.

It's just curious to me why is because of the momentum. Look, you've got a billion dollars in the coin base long and five billion or so in the short. Is this because it's a momentum play, right? The stocks have been going up, so there's not much short. Is it that simple? Look at it here for. I think it is that simple that, you know, we are in a bull market. So naturally, we're going to skew even more to the long side.

But I think if we wanted to take it back and be a bit more balanced, the market skews long anyway. And shorting just by definition is something that the vast majority of people are not familiar with and don't do. Even the professional advisor-manager class don't typically use short instruments or aren't able to go short. So it's actually something that only a very small number of people in our markets use, typically hedge fund managers and other institutions. So this is providing those kind of tools, but naturally they're not as popular as the long versions, which people are more in-shutely. which people are more intuitively familiar with. And Ben had a point about turnover in these funds. And you, when we were talking earlier, made a good point to me.

You managed 10 billion of the 18 billion. And how much does that turn over on a daily basis? Roughly a third of it turns over on a daily basis. So if you think about 10 billion, somewhere around $3 billion turns over every day. So it's an incredible amount of trading activity. And again, I think that goes to the shorter term nature of the investors, the traders, that uses of these products. So, Ben, way in here.

I mean, what could go wrong with all this? I mean, you saw the assets under management there. They're all skewed to the long side because, well, you know, these stocks have been up recently. But what's the downside here? What can go wrong with all of this? Be Jack Bogle for us, as you often are on our shows. Bob, where there's lurking risks is just in instances

where you have, especially retail investors that conflate speculation with investment, that don't adequately understand exactly how these products work, especially that daily resetting of the leverage factor that underpin some of these leverage products. They hold them for longer periods of time, and what they get is not what they would have naively expected. So I think if anything, if I can look at that as glass half full, you know, maybe they learn some painful lessons along the way and they come full circle a bit faster than they may have

historically, you know, learning from these casanzas of the ETF world. But generally speaking, you know, is I shared my own data as will's validated, you know, what we tend to see just based on the sheer trading volumes here is that most of the investors who are using these products are using them in a way that at least seems to show that they know exactly how they were. and they know exactly what they're doing. You know, they've read the user's manual for this particular set of chainsaws. Yeah, that's why I sort of moderated my dislike

for them over the years, because in the early days, with the index long and short, we had big problems. I mean, I know viewers had a hard time getting their head around the reset, the daily reset. They couldn't quite get that. But I think investors are getting a little more sophisticated. I don't, I don't,

I'm not in love with these for the exact reason that you said, but I'm particularly alarmed when people do this and think they're going to get a different outcome because they don't understand the product. I think that's a little less likely now as people get more sophisticated about what these things are doing. Yeah, that's right. I mean, single stocks are new in terms of the category

of leverage single stocks, but leveraged ETFs are not new. I mean, they've been around for 15 years now. We've been through peaks and troughs, we've been through financial crisis, COVID, et cetera, and these products have, of delivered through that period. So I think the point is well made that like any investment, you have to understand how the product works

and the associated risks involved. But this is not something that is new. This is a new category within the leveraged ETF business. And of course, when people look at, for example, an advantage of having a product that has no margin calls is able to deliver two times leverage, if that's the leverage factor every day, that is the pro to some of these comms.

And I don't want to get too deep in the weeds, but give us 30 second on how you actually accomplish this two times long. What kind of derivatives are you using to actually make this magic work? So it's typically a derivative contract known as a swap, which is a type of derivative that effectively provides that leverage, provides that funding to the ETF to enable it to try and achieve its daily investment objective, which is two times leverage. And your counterparty is charged. you a fee to do that that is built into this 1.06 percent that's

typically large investment banks of which people would be familiar with but that's the the way that the funds are achieving their leverage and again it's the same for all leveraged ETFs regardless of whether it's single stocks or whether it's broad equity indices and there's a sort of another theme here that's very interesting the globalization of trading and this is what is driving interest in what is generically being called 24-hour trading this is particularly What they're really talking about here is 24-hour trading of U.S. markets and U.S. tech stocks. So we don't have a launch date yet set, but the 24X National Exchange recently received approval from the SEC to operate 23 hours a day, five days a week.

And don't have a time for the launch. And the NYSE also announced interest in extending its trading hours to 22 hours a day, as I recall, five days a week. So the important thing here is this is all sort of wrapped up, this whole idea. When I talked to Dimitri Gallinoff, who was running the 24X exchange, I said, who wants this? Where is this demand coming from for to trade 24 hours? The institutions don't want it at 11 o'clock at night. And he said, well, Bob, there's a lot of young people in Asia that are very interested in all this. So there's a sort of parallel story going on here.

Absolutely. So again, this goes back to this idea that we're talking about a global phenomenon here, not just about U.S. investors in U.S. stocks. This is already happening. You know, you've got pre-market session, you've got the post-market session, you've got ATSs out there that already provide access to the US market in Asian time zone. And so this is another step in the evolutionary process to bring that, you know, legitimize that even further through the exchanges.

But I think a lot of investors have learned from the crypto world as well that, you know, now if you've got access to an iPhone, you can be trading cryptocurrencies 24-7 anywhere in the world, and they want to do that with ETS. Ben, weigh in on this. Do we need 22 hour a day of trading? I know institutional firms don't seem to think so. I know big firms out there that want to see less trading, less time on the markets,

and their complaint is finding deep pools of liquidity is increasingly difficult. Do we need 22 hour or 24 hour a day trading? Yeah, I mean, my own take here, Bob, is less is more. And I forget who first said it, Your portfolio is like a bar of soap. The more you handle it, the more you trade it, the less you wind up having it at the end of the day.

That said, I think the key theme here is a theme that really is underpin the ETIF ecosystem for decades now, which is that this is a global market. And even U.S. listed ETF shares, as we see here, with the leveraged single-stock ETFs, have appetite from investors, in all corners of the world of all shapes and sizes from large institutions, some of whom are showing up among the roster of the largest owners of actively managed ETFs, broadly diversified ones in the U.S., and now even retail investors in single stock leveraged ETFs. So I think this is all kind of intertwined and just reflective of the fact that the ETF as a wrapper as a vehicle by virtue

of being listed and traded on the exchange really opens up different markets, opens up different opportunities not just to US investors but investors around the world yeah there's a wrinkle on this another wrinkle got a lot of wrinkles here folks there are variations on single-stock ETFs there are covered call strategies now that exist and essentially folks if you don't know is that there's basically two parts of this first is the the ETF would go long a reference stock like a Tesla for example and second they would sell a call or put option against it normally near-term with something like one-month expiration

So you're selling the option and it generates income for investors. You just started a product around this recently. TSY, NVDI, I believe. T.SYY, that's the Yield Boost family, which is our new family of high income generating, high yield generating ETFs. And those are mixing options, like you said, with leverage. So here you're your own Tesla, and you're selling a put here for Tesla?

a put yet but it's on the actual levered Tesla single stock ETFs so you're selling put options against underlying leverage Tesla ETFs and that generates a lot higher level that's how you get higher yields right now you haven't had a distribution right yet we haven't had a distribution we technically had a tiny one for the treasury income but um first distribution will be sometime this month and again this works great theoretically we'll have a great distribution on two times selling, you know, put options, as long as it keeps going up, right? I mean... That's right.

And we sell out of the money puts, so the idea behind that is to provide some capital protection, meaning that if you're just selling, you're at the money options, then you don't have any capital protection against the downside. And if you look at the performance of TSYY, I know it's only been a few weeks since inception, but you can see against Tesla and some of the other competing products performed very well. And Ben, the increasing complexity of the whole ETF world, just covering buffered products and JEPI and all of that and just explaining it to the viewers and the readers,

it's getting tougher and tougher. Some of the stuff's getting very complex. And yet there seems to be an appetite for it. How can you explain that other than the ETF industries needs to grow and collect assets under management and higher management fees? That's perfectly understandable, but what's the right way to look at all these new products

that are out there? Yeah, I think there's just generally and has been for quite some time, Bob, just an appetite for regular income among investors. And in the secular trend, as most of the investors that have most of the money shift from accumulating assets to spending down their assets in retirement, that demand for just regular sources of income, I think is only going to continue to grow. I think the other secular trend you see at play here is really just a rewrapping of strategies, of tactics of trades, that many investors, many advisors may have done sort of independent

or outside the context of prepackaged single trade solution like an ETF coming to market in a sort of do it for me package, whereas previously it would be a DIY or do it yourself model. So I think there's two key secular trends there. I think there are also important things that investors need to keep in mind. first and foremost, when they see these very large, you know, double-digit distribution yields that many of these firms publish, it's important to understand where that income is actually coming from

and what it is composed of. So in some cases, it's the income coming from selling call options over whatever the portfolio or single security might be. In other cases, it's actually just a return of capital. So investors are kind of paying for the privilege of having their money sent back to them. So understanding, the composition of these income streams, their durability, their volatility, and all of the

various tax considerations is absolutely essential if you're going to use these well. Well, in this case, you're selling a put, right, on the two times in PIDIA. In theory, you're going to have a nice distribution. Yeah, and we're trying to take advantage of that implied volatility difference, that if you think of the implied volatility, say, on Tesla options, say, for argument sake, it's around 70. Now you're turbo-charging it. Yeah, now you use the leveraged... And this is how you can get 20, 30, 40% distributions.

That's right. And then you can... And sounds fantastic. It's like free money, but what's the downside? Try explaining that to people. Like, oh my God, I'm gonna get a 40% distribution on this or something? You haven't done it yet, so I'm making this up. The downside is just like any other product that, you know, the underlying, the value of the underlying, in this case, the value of the underlying options fall or can fall over time.

according to the price. That's why we sell out of the money to try and give some protection against that downside but that's clearly just like any other investment these things will go up and down. Yeah. What's next? The race is on to find the next big volatile name I gather here. What's what is there anything on the horizon you've seen unusual activity, palantere? I don't know I'm making it up but I think there's there's two things going on. So one we'll expand the leverage single-stock universe because that's where we have a huge huge amount of demand and there'll be demand for different names, different sectors, etc.

overtime as market conditions change. We'll also be expanding our yield boost family, so providing access to those really high levels of yield and that won't just be on single stock such as Tesla. That will be against other sectors of the markets, broad indices, etc. I think that's got a lot of potential to be a big family. And then broadly, we've got a new administration coming in. We know that there's going to be some big policy change. you know on the horizon those affect markets and that will give birth to another set of new ETF I guess 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 Ben

Johnson head of client solutions at Morningstar continues with us now Ben great discussion on single-stock ETFs but I wanted to get your thoughts you're one of the great ETF watchers I know on broad themes worth covering and discussing in 2025. I guess I have to come back to the big theme in 2024, other than money going into passive investing in a large scale, is the continuing growth of active ETFs. Anything that looks like a potential breakout or change for 2025? Yeah, I think, Bob, at least in my own books, 2024 will go down as the year where we stop thinking of the idea of active ETFs being an oxymoron, which was the question I would get for years and years and years, because

For so long, the growth of ETFs, the ETF category was synonymous with broad-based passive indexing. What we see and what we continue to see in 2024 is a lot of investors' favorite portfolio managers coming into the ETF arena for the first time. And finally, recognizing that this is the direction of travel for the investors that they're trying to serve, that they're trying to invest for. And it's the direction of travel for all the reasons you know well. It's all of the benefits of the ETF wrapper in terms of its dynamism, it's low costs, it's tax efficiency. So, you know, recent additions to the ETF menu, right, you look just down the street from me here in Chicago, and the Oakmark team made their ETF debut.

So you've got Bill Nygren and team now managing a version of their flagship strategy in OAKM. think you're going to continue to see more of that as we go into 2025 and beyond and live through this saga, which I've called life after mutual funds. The reality is that investors are allocating all of their new money to something that's not a traditional mutual fund, and ETFs have been playing a starring role in this saga. Yeah, when you see Oakmark going to the ETF business, that's really something to see. Of course, Oakmark being a classic value investor. Second theme I want to chat about is ETFs as a share class. Vanguard had this to themselves for many many years.

Their ETFs shared essentially the same share class as their mutual funds and that patent expired that they had and now it's up for grabs. Any sense, the SEC would have to make a ruling approving this, any sense on what might happen with that and what the implications of that if it would be approved? Yeah, so Bob, to your point, Vanguard enjoyed a patent on this structure that was dreamt up many years ago by then Vanguard CIO, Gus Sauter and team.

That patent expired in May of 2024. And what we've seen since is that as of today, there are 43 different firms that have filed for exemptive relief with the SEC to be able to either attack an ETF share class onto their existing mutual funds or vice versa. And I think for a variety of reasons that this is ultimately going to get the green light from the SEC because at the end of the day, it's the right thing for investors. The SEC has made clear and made clear in the ETF rule what its concerns were at the time

and why it set aside, you know, Vanguard's unique ETF share class from the broader rule. Rule 6C-11. But I think they're going to have to come back to it now. There's, again, 43 filings sitting on their desk more every day and more I know, you know, just waiting to be pushed across to the SEC. And I think it's, again, it's the right thing to do for investors. It's also an area where if you look at the U.S. market, we're actually out of step with other fund markets around the world.

Just look north of the border in Canada, where ETF is a share class has been a thing for many, many years now. a thing over in Europe. I think it's more efficient for asset managers. It's going to deliver better outcome for the investors. And I think it's kind of a wildcard in the growth of active ETFs because what we could very well see is if and when ETF share classes get tacked on to existing active mutual funds, investors in those mutual funds will be able to convert into ETF shares in a tax-free transaction and immediately gain most of the benefits. that they would enjoy now holding those assets in an ETF wrapper as opposed to a mutual fund wrapper.

And that would be a big leg up in the growth of the active ETF space. Would it also avoid these unwanted distributions that you get from mutual funds that often happen in December, for example? I mean, practically explain what it would mean to have an ETF share class alongside the same mutual fund. You could convert in. And one of the unpleasant surprises you get in December is you're actively managed mutual fund. suddenly has a major distribution and it impacts the share price there. How would that change at all if you had an ETF share class there? It would absolutely change, Bob.

So what the ETF share class would do is it would give asset managers the opportunity to send out lower cost basis lots of different securities via in-kind redemptions of the ETF shares and step up the cost basis of the mutual. funds. So if and when there were, you know, any sort of exodus from the mutual fund share classes, there still could be the potential. That risk has not gone away. We even saw that in one instance with one Vanguard fund many years ago. So you can't immunize yourself from the risk that taxable capital gains distributions will result from shareholders selling the mutual fund shares. But certainly you can bring sort of the impact of those distributions down pretty dramatically. And

over a longer time horizon, as more and more of those assets show up in the ETF shares, as they're more trading in the ETF shares, is just the asset managers get their hands around what it means to manage for tax efficiency with that ETF share class, you're going to have a very different and much more pleasant tax outcome each and every year than certainly you're having in recent years where investors have been regularly finding a massive lump of coal in the form of big taxable capital gains distributions in their stockings around year end. And just a slightly separate topic here, private markets.

The ETF community seems to be tying itself into knots, trying to figure about private equity, private income, and ways to get it into an ETF wrapper. Does using an ETF makes sense when you're dealing with private equity or private credit? And how could it be done briefly? We'll see, Bob, right? You think of all the tough nuts that the ETF market is cracked over the years, even just going back to the launch of the first aggregate bond index ETFs.

More recently, you looked at 2011 in the launch of BKLN, rewrapping bank loans, which once had been like monthly liquid, by way of appointment into a daily liquid instrument. Nothing is going to stop the ETF industry for trying to innovate, from trying to tap into new markets. I think the question here with private credit, private equity, venture capital, you name it,

is have we finally gotten to the point where the ETF isn't necessarily the best wrapper? And investors should consider getting exposure to these corners of the market via other more suitable wrappers, something like an interval fund where we've seen loads of filings over the course of the past 12 months. Yeah, yeah, okay. Ben, I appreciate your help, as always, and your expertise.

Thanks very much. That does it for ETF Edge, the podcast. Thanks for listening. Join us again next week or, again, go to etfedge.cc.com. How does InvestcoQQQQ rethink possibility? By rethinking access to innovation and the NASDAQ 100, let's rethink possibilities. Invesco Distributors, Inc.