ETF Edge - The rise of single-stock ETFs

Episode Date: April 18, 2022

CNBC's Bob Pisani spoke with Dave Mazza, Direxion head of product, Will Rhind, GraniteShares CEO, and David Nadig, Financial Futurist at ETF Trends. They discussed the rise of single-stock ETFs, particularly leveraged and inverse single-stock ETFs. They debate the pros and cons, cover the regulatory and investing hurdles ahead and break down what to expect as more and more companies apply for these complicated products. In the 'markets 102' portion of the podcast, Bob continues the conversation with Dave Nadig from ETF Trends. join ‘Halftime Report’ to discuss the rise of single-stock ETFs. 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 all means for investors. I'm your host, Bob Pazani. Today on the show, we'll talk about the rise of single-stock ETFs, particularly leverage and inverse single-stock ETFs. sound controversial, but we'll debate the pros and cons cover the regulatory and investing hurdles

ahead and break down what to expect as more and more companies apply for these complicated products. No doubt Wall Street watchdogs will have a lot to say about this one. Here's my conversation with Will Rind. He's the CEO of Granite Shares, Dave Mata, is the head of product at Direction, and Dave Nottig is the financial futurist at ETF trends. Dave Mata, in February, a direction filed for 21 new ETS, each offering at exposure to the daily inverse or leverage returns of a single high-profile tech stock. I see Nvidia, Meta, Netflix, Apple, Microsoft, Amazon, Google. Explain, for viewers who are still a little fuzzy, how would this work?

Yeah, no, that's exactly right, Bob. So to be clear, these funds are not yet in the marketplace. They have been filed for. What they're intended to do is provide amplified exposure on individual securities. But they're structured in the same exact way that traditional, leverage and ETFs are structured, meaning they provide a daily reset mechanism. So they're really intended for traders. So if someone does not have the ability to monitor their portfolio to make a buy, sell or hold decision on a daily basis, these alongside other leverage ETFs are not for

them, but it's really a natural extension of the ETF marketplace. And as we've seen, as ETFs have entered into new spaces, traders and investors have tend to look to them to provide solutions for them. And this is a solution for the trading crowd. Yeah, Will, you've also filed for a similar series of leverage and inverse ETFs, but you've already got some of these products operating in Europe. You have three times long and short alphabet and Amazon and Apple, Facebook, Microsoft, and NVIDIA. Now, how do the products trade in Europe and who's using them over there? Yeah, so we have over 100 of these trading in all the major European markets and have been

for the last of two and a half years. And I would say, you know, having experience with these products over the number of years in my career, that it's a similar profile of investor, whether you're talking about Europe or whether you're talking about the US. What we call them sophisticated investors, but I think that means that it's somebody

with good financial knowledge, somebody who trades a lot, who's very active in the market, and somebody who's comfortable with taking risk, and especially in a levered product like this. So I think that profile is something that is fairly consistent across the board. That doesn't mean to say that you don't get institutions that trade these products. Certainly we see a lot of those kind of investors.

But I think the general feeling is that it's a sophisticated investor in those markets. Dave, Dave, Nordic, I wonder how receptive the SEC is going to be to all this. You and I have talked about this before. We did a show on this a few weeks ago. It beats complex products. Gary Gensler has been wary specifically on leverage and inverse ETSs. Months ago, he said, I'm quoting, these products can pose risks even to sophisticated investors

and can potentially create system-wide risk by operating in unanticipated ways when markets experience volatility or stressed conditions. This is Gary Gensler speaking. And, Dave, it seems to me there's a chance. The SEC may turn these guys down. Yeah, I think that's a reasonable guess. I mean, we've definitely seen a significant interest by regulators, by FINRA and the SEC,

on any products that don't necessarily make a lot of sense when you look at them right up front and you really have to dig in. And I think that these products definitely fit that bill. I'm not against these products. I think if we're going to let people trade leverage volatility or any of those things, then these belong in the mix. But I do think that there's now a risk of some level of contagion on the ticker front. Dave, can you pick up on that?

I wonder if what real risk there is to these products. You know, the biggest problem I consistently have explaining these products to investors is what you just talked about, this daily reset. If you don't have the ability to understand that, and it seems like a lot of people don't, because I've had to explain it for years when these products have had problems in the past, this is not a product for you. Is there some kind of systemic risk around this like Dave was trying to get at right there? Well, I think the biggest risk is that, to your point, is that someone uses these products and doesn't quite understand them. So, you know, perspectives exist for a reason. As boring as that work may be, it's all spelled out how these products work. And it's just at the end of the day, simple math. With that being said, you do have to recognize that they are not intended to be buy and hold investments. So if we look at the return of the SMP 500 and then SPXL are three-time full fund over a month or even a week, it may not be the same because of the volatility.

and the compounding. But on a daily basis, minus expenses and operating fees for the fund, it's going to do that. So traders need to know how to use these particular products. Now, the idea that they cause systematic risk or systemic risk, I should say, in the actual market itself, I think it's a bit of a stretch. As you know, for years, everyone was pointing to ETF's increasing volatility, correlations, they're not going to work in fixed income. They're not going to work in commodities. I think we've seen that through many stressed environments for many, years in different scenarios, the ETF structure has proved to be resilient. But at the end of the day, we really advocate for traders to understand how these works, and particularly around, again,

that daily reset mechanism. Dave, Dave, Nautig, we have them back. We were just talking about the problem with explaining the reset mechanism to investors who seem to get confused about this on a regular basis. You were going to make a point, I think, about the proliferate, if these proliferate, they might pose some kind of broader risk to the market? Do you want to finish your thought on that? It's not so much that I think there's a systemic risk that the exposure is somehow going to put the market itself at risk. I do think there's a lot of opportunity for confusion.

Imagine there being six, seven, eight different ETFs, all pegs say, against Amazon. Now do that for all the securities in the S&P 500, and you've literally got thousands of Amazon and so on adjacent tickers. That's the piece that I think is a little confusing for most investors. I don't worry that these pose a systemic risk. I think that people might not understand them going into them sort of at the retail level. That's what I'm most worried about. Does the Robin Hood investor understand in a world where we've got six or seven of these levered or inverse plays on every major

security in the market? That's where it starts to get a little bit confusing to me. Yeah, you know, Will, you can understand what we're talking about. I'm the guy who has to go on TV and explain what's going on every time the leverage, you know, inverse or voluntary. product blows up and I have to explain this is the daily reset this is and after a while you know Dave and I donag and I have joked for years leverage an in-diverse products are 2% of the volume and they're 98% of the problems when things get weird and you have to explain them I think that's the concern and I often I disagree with Gensler on a lot of things but he does have a point about the potential risk these products have is how do you respond to that?

Well, I think, I mean, the, going back to what is the risk. I mean, there are a number of different risks, as Dave Marza said, they're all really highlighted or disclosed in the prospectors. But clearly, one major risk is that with using leverage, the returns are amplified, and therefore the potential losses can also be amplified. So when you talk about a product needing to close, the reason for that is because the move in the underlying market has been so much or so. big that with the leverage on top of it, the fund loses its exposure or the investor loses its money. But I think that's the really important thing, because with these products, you can't lose more than your initial investment. And that's unlike a lot of forms of leverage, where clearly the big risk is that you can lose more than your initial investment. And so with these

products, when we talk about worst case scenarios, a lot of the time what make the headlines is when a particular fund, you talked about the volatility products have to close, and that's because there's an underlying market move that once you add on the leverage is too big for the product is sustained. But the good news in my mind is that this is a safer way to do leverage than a lot of the traditional ways that investors are already doing in the market, whereby you can lose more than your initial investment. Yeah. So just falling in love with that, Will, this seems. needs to be a product ready made for retail investors. I mean, you mentioned yourself, active investors doing this over in Europe, but I wonder if the tide hasn't passed on this product.

You know, Schwab reported their earnings, and they said retail trading was down. It seemed that way with Robin Hood as well. I'm wondering if the tide has peaked a bit for retail, and these products may not have as much appeal as they would have, say, even a year ago. I think that it's too early to say, whether the trend in retail investing is passed. I think a lot of that would have to be the market environment that we've just been through in Q1. And so clearly that's taken some of the throff out of the sort of rabid appetite

that people had for stocks, particularly in the last quarter when the market was going up parabolic. So I think some of that is just down to the market environment. But I don't think the trend of investing or more investors accessing the market is coming to an end. I think, if anything, you're going to see more people accessing the market, more people wanting to participate in the stock market, and the different forms of, you know, trading or products that are available to them. So for me, I think it's more about the market environment and less about the trend in retail or trading more broadly.

Yeah, Dave, Dave Naughtick, chime in on this, on the retail investor. I'm not saying it's peak retail, although it seems that way a little bit. But we keep trying to make new products attractive to people for short-term investments. I had this problems with thematic tech ETS. I happen to love the idea of a cybersecurity ETF, but you have to admit, if you're Jack Bogle, he's going to be wagging his finger, you're saying, hi, you're just got a shiny new object. I mean, these are speculative vehicles, and that's what they'll be used for. And we've seen with the huge rise in the use of single-stock options by retail investment.

I'm sure that these products are going to be catnip for folks that are really looking to day trade around event risk in particular earnings announcements, inclusions, what's going on in Twitter, all of those things. These are just catnip for those kinds of speculators. But what these aren't are portfolio building block tools. And I think we just need to be really clear about that. Both these gentlemen have been very clear about that. These are traders tools. They should be used for short-term event-specific trading, not for building up a portfolio of exposures. As long as you're a lot of. As long as investors stick to that, as long as I should say traders stick to that, then they won't be surprised here. My concern is that these are very, very sharp tools, and when people reach their hand in the drawer, they're not always looking as carefully as they should. Yeah, I think that's what Gensler is trying to warn about. Dave, maybe you could enlighten us. What products attract the leverage and inverse crowd? The biggest product you've got is the SOXL, which is the semiconductor. This is a leverage three times, right?

That's your biggest product out there. There's over, I think, $3 billion in assets there. Is there a particular type of product and a particular type of investor that uses these more than anybody else? Well, the main type of investor is really that trader. And by that, I mean someone who could monitor their portfolio on a daily basis. If we look at something called the implied holding period, so we calculate how long do folks actually own these funds? It's very, very short. So for the most part, folks are using them appropriately.

They understand the daily reset mechanism. And, you know, if someone is looking for more information, I recommend, you know, taking a look at the material we have on our website to understand that. Now, the products that are being used, particularly this year, it's three camps. And it's probably not unlike what we're seeing with thematics or other. You have a risk on camp. And so we're seeing on a daily basis money move in, particularly on down days, into the semiconductor space. So Soxel has performance-wise struggled, but investors or traders, I should say, have moved into that space, particularly in those down days. Then you have your rotate camp.

And here we're beginning to see money flow into oil and gas. So a ticker is gush. This is a leverage vehicle on the oil and gas space. And then you have a risk off camp. So then there's just folks who are looking at hedge portfolios, particularly with earnings season, So as opposed to maybe selling individual positions that they might have in the tech space or in the financial space, using an inverse ETF to provide that daily hedge for them if they think there's an event risk out there. So really kind of a diverse opportunity set that we're seeing, but really it's primary concentrated with the trading community who are looking to make either that risk on, risk off, or rotate idea. Yeah, you know, the problem I have, Dave Nautic, is that you can do all the disclosure.

want. These guys are all legally protected here because they've done all the disclosure, but that people don't read the disclosures and don't pay attention to it. And that's the problem I have. They don't understand what goes on with these. Because I get the emails. You have to do this too. You have to explain it when this stuff blows up somehow. And then people read to it. Wait, wait, explain that to me again? It gets reset every day? What? Well, this. Explain that. This happens at the... And they can't get their head around this. Yeah, this happens at the face of the coal mine, This is where at the front end of your Schwab account, your Fidelity account, your TD account, many of them will put up a quick note saying, by the way, you're trading something that's got leverage characteristics. Do you really understand what you're doing? I'm a big fan of that kind of positive ad testation for more complex products. That's not exactly what FINRA is asking for in their recent request for comments, but something like that, I think, is inevitably going to come as we have proliferation of more and more complex products. I'm not against the products, but I do think, enhanced disclosure and attestation is probably coming soon.

Dave, Dave Mazzo, can you update on this? When did you file and when does the SEC have to give you a thumbs up or thumbs down? What's the date for this? We had filed for these products back in February. I can't speak to exactly when they may be available or what may happen there. But again, I would say they're structured in the same way as index-based leverage and inverse ETS, even those, to your point, built for daily reset mechanism, the funds are being re-levered or de-levered on a daily basis, and these are intended to operate in a similar fashion.

Right. So, Nordic, isn't it 75 days then? Wouldn't they have to give a response? Maybe I'm wrong on that, but wouldn't they have to get a response? We should expect something soon, but then again, the SEC can always kick that can down the road. So those dates are always suggestions they're never written in stone. And, Will, when did you file? Similar time, I think we all, the three firms that we're talking about filed very soon or very close to each other in that respect.

So very soon. I want to come back to a point just on the suitability thing for a second. It may be just interesting to know how things happen in Europe. And obviously, each market is different. But most of the time it's under a suitability regime. These products have been in the market again for a long, long time. We're talking decade plus whether you've been able to buy leverage. on broad equity indices, on fixed income indices, on individual commodities,

even on cryptocurrencies now. So single stocks are just an extension of that sort of ideology. And most of the time, you know, there are brokers or any access to the market, any gatekeeper, if you will, has their own sort of suitability framework around these kind of products. That doesn't mean to say that you're taking a test or anything, but it does mean that you have to go through some extra questions. and things to evaluate your suitability before you can buy these products.

So I don't want to give the impression that anybody can buy these products or we shouldn't have that impression that anybody can access. That there's a framework already exists. The same in the United States, obviously be different depending on what broker you're talking to. But these are sophisticated products and there is a framework that already exists around access to those. Well, Dave, Naughtick, Will is right.

I mean, we've had leveraged products on the S&P for years, but I think there may be something qualitatively different with a single stock issuance. So you're not going to, it's unlikely you're going to have a two-time leverage ETF that could influence the underlying S&P. But what about a two or three times leveraged NVIDIA? If that ETF got sufficiently large, could it make the underlying stock more volatile, for example? So, sure.

you can imagine a scenario where somehow, you know, 50% of the notional cap weighting of NVIDIA is held by these types of, you know, single leverage or double leverage vehicles that are trading intraday. Yes, I can imagine a world where that could happen. And look, to be fair, there have been moments in time when the volatility levered and inverse funds owned an enormous amount of the available Vega in the options market that they were supposedly tracking. So we have had situations like that before. I would point out none of the products that been filed around particularly small and illiquid companies. By definition and sort of by design, they're going after the big name above the title type companies like Nvidia and Amazon and Alphabet.

So I'm unworthy about it out of the gate, but it's certainly a conversation worth having, right? If these somehow became the default way everybody was trying to get access to these companies, that would be different. So could Gensler approve this? I'll throw this out to anybody. Could Gensler approved this, but with some kind of qualifications that somehow, I'm just trying to figure out Genzel can say yes without completely saying yes. I mean, is the option here basically yes or no? Or is there some conditional way he could approve something? Well, there's not really a way to conditionally approve a product. They could reject it with comments and say, come back to us when you can establish XYZ.

I suspect if they are rejected, they will come with comments about why. I actually think it's more likely that they're just approved, honestly. Yeah, that's a good point. Anybody last word there? Well, you've been a very astute observer of this for many years since you've already got a product out there. You think, I know you can't handicap this, but you've got the last word. I think that under the current environment or under the current law, it's a disclosure-based regime. So it's about does it have the right number of other, the appropriate disclosures, the right amount of disclosures in the perspectives. And on that basis, that's when something will either go effective or not. And it's fairly black and white.

I think if you're talking about something else, a conditional, if you will, Bob, to use your words, I think you're talking about a rule change. And that's a longer process, something that's not beyond the realms of possibility. But I think at the moment, given it's under the 40 Act, we're talking about disclosure. And therefore, it's a question of whether there's adequate disclosure or not. Yeah. This has been a fascinating discussion. And folks, normally on ETF Edge, we have products that you can buy immediately, look at, somebody wants to recommend it.

This is a little more theoretical, but I think it's going to be very, very important. I think there is a good chance to approve it, providing with tons of disclosure pushed forward. So you're going to hear about this in the next few months. And remember, you heard it first here. 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. Today we'll be continuing the conversation with Dave Notic from ETF Trends. And Dave, you just got off a very successful

conference, exchange, the largest ETF conference in the world. You and your associates, Tom Lighting and Matt Hogan. I was there. Successful conference. But I want to get your thoughts on how it went. These conferences are tough to put on. This is for many people when I was there at some of the some of the cocktail parties. It was their first event in two and a half years to get out with. And it was a little awkward socially for some people, I noticed. But your thoughts on the conference as a whole? Yeah, I mean, look, we were all super glad to be able to see people in person again. Yeah, it was a little socially awkward for me. I'll admit it, right? I mean, it was definitely the first time I had been around 2,000 people in a couple of years. And look, we all did the best we could.

and, you know, I think people were, you know, obeyed all the COVID protocols, and hopefully everybody got home safe and happy. But look, the conversation was fantastic. And really, I think what I learned was all of the things we had thought that advisors might be a little concerned about. Inflation, finding income for their clients, trying to figure out what to do with cryptocurrency, where to get alt exposure, to try to diversify. All of those things very much front and center, top of mind for advisors. We had great discussions on all of those topics. And if anything, I think there was even more sort of hunger for information about how to use the ETFs as one of the solutions for all of those problems than I even expected.

Yeah. What quite amazing to me was when I, the RIAs I talked to, the registered independent advisors, it seemed their biggest worry was their bond funds. This whole 60-40 concept seems to be going out the windows. I don't know, I think it was Tom Lighten who said 7030 is the news 6040. And I heard people suggest it was 80-20, it was really closer to where it should be. That seemed to be the big issue because these RIAs have to go home and talk to their people who own their business, their funds, and say, well, what's going on here with these bond funds? That seemed to be the big topic.

Yeah, absolutely. And interestingly, we know we did some live polling in the sessions as we always do, asking folks for their questions. We put up some recent advisor polling we've done on how folks are wrestling with that issue, the sort of the demise of their bond exposure. And sort of shockingly, if you look the first quarter of this year, essentially every dollar that has come out of junk bonds has gone into high-dividend yield ETFs. And that really was a story we heard over and over again. People are looking for income in non-traditional sources.

And compared to bonds, dividend stocks are non-traditional sources. Obviously, that is a very different set of exposures. taking on market risk there. But that slightly off-the-cuff answer about, well, maybe 80-20 is the new 60-40, that's where that 20 percent differential is going. It's going into high-yield stocks, and you're seeing that in the fund flows. Yeah, it's funny. Investco has an interesting product that never got a lot of attention, the low-volatility, high-d-d-d-d-believement-sybh-D, I believe, is the symbol there. And it's suddenly become a rock start. It's at a historic high. The volume's been enormous since January in it. It's basically, you know, the proctor and gambols of the world,

low volatility stocks that pay a dividend, a decent dividend. It looks pretty boring when you look at it on the surface. But you know what? If you're trying to replace your treasury ladder, boring's probably pretty good, you know? Yes. Well, that's the point. We had some other people out who wanted the barbell. They said, you know, have some short-term exposure and even some longer-term exposure. It's the middle you want to be really careful about. There was a lot more discussions about some people, the cash debate was very interesting. There were people who felt that cash is not a bad thing, and other people said, look, Tina is still very much alive.

There is no alternative. How are you going to put money in cash with 8% inflation? I mean, at least CPI inflation right now. That doesn't make a lot of sense either. So it's a really hard game to figure out, and a lot of it, I think, depends upon your time horizon overall. I mean, if you're still going to be sitting in the market for 10 years from now, this may not be a big issue. You could safely be long on the S&P 500 or maybe the equal weight S&P 500 and not worry about it so much. But if we're long term yields are moving up long term,

people pointed out to me, even the people who hate bond funds, you know, those yields will rise eventually in the bond funds too. Yeah, eventually there's going to be a really great entry point to go get into your, you know, your Barclays Ag or your Pimco Total Return or whatever flavor of bond fund you like. The question is, what do you do while you're sidestepping and sort of waiting for the rate cycle to finish so that you reenter at those then achievable higher yields? We saw a lot of interest in inflation hedges, a lot of discussion of crypto as an inflation hedge. I heard a lot of folks talking about the access, a story of inflation ETF, PPI, which launched about two or three months ago. That thing's been pulling in about a million dollars a day ever

since it's launched. And it's a pretty straightforward basket of cyclical stocks and some tips and some commodities. It's not reinventing the wheel. But putting it in a package, people seem to love it. And frankly, I think folks are looking for any port in a storm. Yeah. And yet, the growth crowd, particularly the speculative growth crowd, has not gone away. I had a wonderful interview with Kathy Wood, of course, manages ARC Invest at your conference. And it's been a rough year for Kathy. You know, she's down 45% in 12 months and had a rather nasty morning star down gray, which we talked about, and she responded to. But the extraordinary thing about her fund is that the ARC fund down 45% and yet the shares outstanding are just about where they were

a year ago. Her family, her investors have not abandoned her, even with a 45% decline. That's rather remarkable. Not at all. I mean, they are true believers. And look, I think that's part and parcel of being incredibly transparent. And say what you will about Arc, whether you're a fan or not. They're incredibly transparent about their methodologies, how they think about things, how they trade, what stocks they like. You cannot give them any flaws on that. And when you're that transparent, you kind of know what you're getting into. So it doesn't surprise me that much that a lot of that money has stuck around. Obviously, they had some outflows. Some of that money's always going to be hot. But it doesn't surprise me that a lot of folks are sticking to their knitting

there. Yeah. Any thoughts about where we go from here? I mean, it's a very difficult game to figure out. So the market is saying we seem to be in a late stage economic cycle. So here you have defensive names like consumer staples and health care doing well and commodity stock. like energy and materials doing well and a few interest rate sensitive. Utilities are at new highs. But anything growth related is in terrible shape. Not just tech, but consumer discretionary, communication services, all that stuff is having a tough time of it. And Kathy seemed to acknowledge that even with the revenues of her companies that she covers growing 50% this year, multiple compression is the problem when you have rapidly rising interest rates. Growth stocks just have a problem.

interest rates grow rapidly. Was there any consensus on what people should be doing with their growth stops? No, consensus would be a really strong word. If anything, what I heard was a lot of folks looking for value, a lot of discussions about when the right time to get back into value is going to be. I think the thematic sort of non-profitable text base is going to continue to be interesting to folks, regardless of whether or not they believe we're in a place that is good for growth economically. You know, the so-called shiny object trade is going to remain alive and well. Meanwhile, I heard a lot of folks looking at things like Avantus and dimensional value funds, really trying to figure out when that was going to be the right call for their portfolio.

Look, I'm not a macro economist. I'm not a macro economist, but if I had to make predictions for this year, it would be, hey, we're going to still have this relentless bid that means everything is slowly going to go up into the right. I think we're going to sit with VIX over 20 for most of the year, and that means it's going to be a wild ride. Yeah, yeah. Fix over 20 is, I think, reasonable bet for anything. Dave, congratulations on the conference. I know we had over 2,000 people registered for it. You know, given what happened the last two years to get 2,000 people show up, that's quite a feat. So congratulations on that. Look forward to the next one and being with you, of course.

Everybody, Dave Notting is the Financial Futurist at ETF Trends. And thank you, everyone, my dear listeners, for tuning in and listening. to this particular edition of ETF Edge Podcast. Thank you, everybody. InvescoQQQ believes new innovations create new opportunities. Become an agent of innovation. InvescoQQQ, Invesco Distributors, Inc.