ETF Edge - The tipping-point of “innovation”? 5/19/25

Episode Date: May 19, 2025

On one hand: continue market uncertainty. On the other hand: heightened individual engagement and optimism. Put them together and you have a hungry audience the ETF industry is all-too-happy to cater too. But now, more than ever, the individual really needs to know what they are ordering… and what’s in the dish.     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. Invesco 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 compelling interviews, thoughtful market analysis, and breaking down what it all means for investors.

I'm your host, Dominic Chu. Now, with heightened volatility coupled with heightened individual investor engagement, we've all now seen a rush of new advanced ETF products to market. But now, more than ever, those investors need to do a lot more of their own homework on what's actually out there. Here's my conversation with Simplifies Paisley Nardini and Financial Futurist, Dave Nadeg. Now, let's first set the stage for this conversation. Today, stocks are retreating and yields are spiking on Moody's lowering its credit rating on the United States. But at the same time, we're seeing reports of individual investor optimism returning to levels

that we have not seen since the beginning of this year. Now, let's talk more about some of the specifics around some of the products and strategies that you're currently running Paisley, including managed future strategies, hedged equity strategies, high yield strategies, and those types of things. So Paisley, what exactly is driving the demand for some of these alternatives-based ETF strategies? First off, thank you for having me. Excited to be here with Dave for today's conversation.

Really, the investor adoption and interest in these strategies is just driven by this continued uncertainty. I think what we saw in the first half of this year, which has really continued despite the rally we've seen in equities is uncertainty of future outcomes. And I think where we are even seeing rates back up to today is another reminder as to whether bonds will play that role as ballast in the portfolio. And so some of those strategies you mentioned are really at the forefront of the conversations that we're having with clients, whether it's large institutional allocators or high net worth, thinking about differentiated sources of risk and return, thinking about ways

to lower correlation in the portfolio, and really thinking about ways to kind of diversational diversify away from broad-based equity beta. I don't see a lot of meaningfully positive catalysts in the near term as to why markets should continue to rip higher just despite some of that positive momentum we've seen. So low correlation strategies, strategies that are dynamic, strategies that are flexible, can be long or short, and can really adjust with the market news and the backdrop that we're seeing. And every bit of information that's coming to the markets is moving asset prices. And so being able to be more flexible, we think is really the best way to move forth as you're thinking about building a holistic portfolio. Now, Dave, it brings up another interesting point here. These types of

strategies that are in ETF wrappers, they're not especially new. We've seen the evolution of some of these kind of active models, actively traded type ETFs, stock selection ETFs, even long short equity ETFs, options, kind of override ETFs. But what exactly is it now that is maybe driving a little bit more of that interest in these types of products? Is it simply the volatility that we've seen from a headline perspective, given everything else in the macro economy? Yes, certainly volatility is a big part of it. But honestly, the short answer is, look at today. Just look at what's going on in the market today. People are selling bonds and they're selling equities. A lot of advisors, a of individual investors have kind of been trained that that's not how this is supposed to work,

right? Bonds are supposed to be the thing that zigs when the equity market zags. And what we've started to realize is because of this sort of anything but the USA trade that seems to be going on, whether it's investors in the U.S. or investors outside the U.S., we end up with these situations where we see bonds and equities going the same direction at the same time. That's fine if what you're doing is just trying to maximize your upside risk and you're looking to buy a bunch of risk assets. But that's a problem if you're trying to get real diversification. And strategies like, say, CTA, which is a managed futures product, they're really designed to be counter correlated in a way that you can't expect bonds to be in the face of this kind of chaos that we've seen. So I think we really do have to

give investors some credit. We've gotten a billion dollars in flows into alt strategies so far this year, $2 billion over the last trailing year. Investors are smart. They know they need something better than just another long bond. Okay, Paisley, that begs the question. If there are all of these types of strategies out there, there also has to be some kind of an education element with regard to what these investors are actually buying. You mentioned that the evolution of this has been coming from the institutional side of things and now has worked its way towards retail. I wonder from your perspective as the manager of many of these different types of products, where exactly is the investor demand, whether it's retail or institutional? What types of strategies are you seeing

the most heat, if you will, developing in this market? Yeah, I think you mentioned a really good, important point, which is education. As we think about moving beyond traditional, fundamentally driven stocks and bond selection and portfolios, we're now talking about the use of derivatives, the ability to take leverage through futures positions is one example, the ability to take long and short positions. So as we think about educating our investors to ensure that they're using these appropriately, that is a very salient point and something that simplify is very keen to do through our website and through client engagement. So that's first and foremost. I would say where we've seen a lot of interest is,

and I think this kind of goes back to something we're hearing from clients directly, is not wanting to take active risk, or at least not wanting to be the one behind the decision as to when and how and where they're taking active risk, essentially outsourcing that decision to managers that can take those active decisions for them. And so as it relates to where we're seeing interest in our strategies, it is these more dynamic strategies. Managed Futures is one of those where we're able to scale in and out of bond positions. We're able to scale in and out of commodities when our models are telling us it's advantageous to do so. And so there's a bit of relief then from the allocator's perspective that they're off the hook from making that decision,

essentially outsourcing from an investment decision perspective. So long, short commodity and interest rate futures, another strategy that's been garnering attention just given the backdrop of tariffs, trade negotiations and kind of dislocations of central bank policy globally is in a long short commodity, excuse me, FX strategy. So thinking about currencies, the ability to, take long and short, but do so in a way that is a neutral position to the U.S. dollar. I think that's another kind of defining decision right now that investors are making is whether or not they want to be long or short the dollar. And so the way that we approach FX investing is you don't have to make that decision.

You're really just looking at carry and momentum within currencies broadly. So those are two areas. I think we've seen a lot of interest, just given the backdrop that I shared. Payson, could I follow up really quickly? you mentioned the managed future side of things or the CTA ticket that we saw. I mean, yes, CTA is there for a reason, right? Because it's a commodity trading advisor. That's the acronym that a lot of people in Wall Street kind of are familiar with.

Those are trend following strategies that kind of use computerized models to track momentum, but one way or the other. How much do the retail investors that traffic in these ETFs have to understand about these strategies? And then how much, you mentioned, the outsource. from investment advisors. How much do investment advisors play in terms of a role in themselves educating the people that they are allocating to these particular strategies? Yeah, I think the biggest educational hurdle in CTAs or managed futures is that if you haven't had familiarity or experience investing via futures contracts, there is embedded leverage,

right? You're only posting so much in margin in order to gain that exposure. And so that can be in the upside and the downside over time. I do think when we distill what managed futures are seeking to do, it becomes a little bit more digestible or approachable for a lot of these high net worth advisors, and that many of them are already allocating to long-only commodity strategies. Many of them are already investing in bonds. And so the access that we're giving them two interest rate futures and two commodity futures outside of that leverage component is just the additional ability to take long and short. And I think because of all of the shifts in gyrations that we're seeing in the market, being able to be short a lot of these

markets has been advantageous over the last six to 12 months, just given the dislocation. So very much educational component, but really when we look underneath the hood, I think these become a little bit more approachable for the high net worth advisor. Dave, there are opportunities here, right? And the reason why these products are coming to light is because there is demand that's building out there for it. I wonder if you could take us through a little bit about maybe what type of demand profile there is and whether or not there will be other entrants to this market to offer these types of ETFs because the demand side will grow from investors. Yeah, the challenge here is that there's good ways of doing these kinds of

things and there's bad ways of doing these kinds of things. And I think that's part of the education point. The demand is definitely there. We've seen active just as a class, active versus passive, is now running about 50-50 with passive in terms of all flows. That's across equity, alternatives, bonds, active is really having its day in the sun. Almost every dollar is coming in split between active and passive. In some cases, that's a great thing. It does allow investors this flexibility. But what we've also seen is a lot of complexity, a lot of leverage, and a lot of

fees show up in the ETF industry over the last six to 12 months. Products like CTA, which are clearly designed to kind of be an alternative beta in a portfolio context, those are great. And you can dig into the math and understand what they're doing. But when you're an advisor, an investor, and you're looking at the whole realm of things that are on that menu, a lot of these products are going to be very expensive. A lot of them may be taking more leverage than you really want. So when you start bridging away from sort of the big names we all know in the core beta asset classes,

investors really do have to pay attention. Make sure you know what you're owning, why you own it, and how much you're paying for. All right. Meanwhile, the downside of this pushing of the envelope product-wise is that for every new, strategy offering, there seems to also be a new kind of get rich quick approach, if you will. You know, Dave, there is a lot of ETF strategies that have been out there, ETS that have started off small with hot types of, you know, in the news type strategies. What exactly is your take on this?

How wary do traders and investors have to be about some of these kind of quick to market products that take you through kind of like the push the envelope or frontier type strategy? Yeah, I put these in two categories, black hat products and white hat products. And you know a black hat product is a black hat product when it seems just way too good to be true, or the thing that they're selling you isn't the whole product. I'll give you a couple examples. We've seen a huge run in single stock leveraged ETS. We're up to close to 200 of these products.

They've taken in just enormous assets, I think $12 billion over the last year. These are products that are hyper-volatile. They're the most volatile traded securities in the market right now. They're more volatile than cryptocurrencies because they have all that embedded leverage. For the most part, those are black hat products that unless you're a day trader who really knows what you're doing, you probably shouldn't go anywhere near. The flip side is a lot of single stock income products where people are promising you enormous yields on things like micro strategy or even Apple or Tesla by basically selling options.

That's the process, right? You're selling volatility. to generate an income stream. There's nothing wrong with that as a principle, but when you're paying 1% or more for the privilege and you're exposing yourself to the wild vagaries of what's going on in implied volatility pricing in the options market, there is no free lunch.

So these products live side by side on a lot of these menus. Investors really have to peel off those black hat products and focus on the ones that are providing real portfolio value. All right, Paisley, I'm going to give the last word to you here on this. Your thoughts about the fast evolution of products being brought to market from the ETF standpoint. There are good and bad elements to it. As a manager yourself, how do you view that? Yeah, I would say I'll make one correction to Dave's comment.

There is one free lunch, and that's diversification. But I do think the same door that opened that allowed a firm like Simplify to bring these institutional quality strategies to market is the same one that has opened. the door to a lot of these strategies that Dave just alluded to, that should be taken with a grain of salt. And I think as it relates to risk and thinking about concentration, we are always focused on how to diversify our risk, how to look at various risk premium, how to introduce them into a broader portfolio. And so I would echo those comments and the importance of understanding what you own, working with asset managers to really understand their products. And that's why I always think too, like working through an advisor that has access to this education versus the

individual retail investor is really important. But yes, I would go back to there is no such thing as free lunch when it comes to individual return streams. And so education and kind of formal due diligence I think is always important, especially in these kind of more isoteric parts of the market that investors might not be familiar with. Now it's time to round out the conversation with some thoughtful analysis and perspective to help you budget understand ETFs, with our Markets 102 portion of the podcast. Financial futurist Dave Nadek continues with us now. Dave, it was a fascinating conversation,

but I'd like to kind of take things out a little bit more broadly and ask you a little bit more specifically on some of the trends that we're seeing. Do you feel as though the ETF business, the ETF industry, its products, are coming to market too fast, too slowly, or at just the right pace? Well, it's definitely not too slowly. I'll give you that one. We're facing an absolute tsunami of product launches. That's just the reality of it. We've had a couple hundred products, I think 400 products launched this year already. We're well over 4,000 ETFs. You know, 20 years ago, we were sitting at about 800. So we've had just incredible product proliferation, especially since the passage of the ETF rule, which made it quite easy for people to bring a new strategy to market. And that's allowed a lot of new category. to open up like single stock ETFs we were talking about, like a lot of these sort of over promissory income products. The real issue is it's about to get a lot worse because sometime in the next month or so, we're going to get this approval for share classes of traditional mutual funds trading as

ETFs. That's 53 firms that have filed to do that. And by my count, something like 3,000 products that will launch when those share classes are approved. So we're going to go from 4,000 ETF tickers to about 7,000 ETF tickers this year just kind of by default. So it's hard to say that that's just right or too slow. And obviously, that creates enormous burdens on the individual investor, on the financial advisor to wade through all that stuff. Now, Dave, as a former 40-act guy myself, right, many of the share classes that you're referring to that could work their way into ETF products or different.

ETF tickers are mainly because of the difference when it comes to the fees associated with each of those share classes. The strategies themselves, from say a mutual fund perspective, aren't different or even that markedly different in some of the more significant cases. But the fees that are charged have been based upon some of the minimum levels of investing that go into some of those fund products. So at the end of the day, are these new products really adding that much more complexity, or are they just adding more products to market at different price points for different types of investors? Excellent point. Most of these products that are going to just be share classes of an existing fund are going to be pretty boring. They're going to be, you know,

Putnam's large cap growth fund and their core income fund. A lot of, you know, very traditional asset allocation core type products. A lot of it actively managed, a lot of historically fairly expensive. Now, the good thing about these products coming into the ETF share class will be that we expect most of the fees will be kind of at their lowest institutional level. So for the individual investor, if you genuinely want access to one of these company's products, this will be the very best way to do it. I feel fairly confident in that. To your point, we're not opening up giant new asset classes here. That's really happening at the coal face of ETF launching, the crypto stuff, the private credit stuff, the excess leverage. That's all happening directly in the ETF wrapper.

All right. Now, speaking of because you open the door here, private credit has probably got to have been some of the hottest or the hottest trend in at least investing for at least the Lexus, say, three to five years and maybe even a little bit more beyond that. We have now seen private credit being offered. It's a private equity product and now it's being offered with access to ETF investors. Now, these ETFs aren't necessarily that mature or that large right now. There's not, you know, decades worth of track record, but there's no doubt there's a massive amount of demand for them. I'd like to get your take on your assessment of private credit and whether or not it's a good thing that that private credit product is now much more.

accessible in many ways to retail and high net worth investors. Yeah, let me let me push back a little bit because I don't think there's huge demand for private credit. What there is is huge supply of private credit. If you look at the products that have launched to date, State Street launched their priv product against the SEC's wishes, one of the, the only time that's ever happened in my lifetime. They launched that product. It hasn't had, it's had one create. It trades thousands of dollars a day. It's absolutely fallen off the cliff. So there's been no demand for that product. However, it also hasn't really put a lot of private credit in, even though it's had the opportunity. I think it's sitting at something like 10% private credit and the rest of it's just an expensive bond fund.

So that just may be poor product design. On the private equity side, we've seen a couple of firms, notably ER shares XOVR product to try to use their 15% a liquid bucket that every mutual fund theoretically gets to really aggressively invest in companies like SpaceX and Klarna. There has been demand there. I think private equity has real retail cachet. I do think people want access to SpaceX and to, you know, all the very, you know, OpenAI and all the various other companies they can't get access to. But we haven't seen that really in a full product yet, nor do I think we will.

There are real reasons why it's a bad idea, right? You can't mark these things every day effectively. you can't provide daily liquidity on something if you have to trade it by appointment. So there are real problems there. I think the solutions are in slightly different structures. We saw Capital Group in KKR come out with an interval fund, two interval fund products. That's a much better structure for something that is fundamentally illiquid. So I think we'll see some of these other products open up.

We had tweets from the SEC today saying they want to open up the closed end fund world to get more investors involved in private equity that way. So that's okay. I actually think that's an appropriate response to get people into the less liquid vehicles for the less liquid underlines. I'm kind of a seller on the whole everything should be an ETF narrative. And okay, one more question before we let you go. As we talk about access to private instruments, more illiquid instruments through ETF products. Is there a fear, perhaps, on your side of things, that if things get a little bit crazy, a little bit volatile, that there may not be the stability in these types of products

to be able to support that kind of volatility? Is that a concern for investors that want to go into them? Yes, that's exactly the problem. I mean, you can imagine if, say, one of these products became a $10 billion product, which is not even that big a product these days, that's a big chunk of, say, the two to four year paper in the private credit market. That's a big buyer in that space. If everybody runs for the exit because we have some sort of credit crisis, whatever it is,

the 10-year locks up, whatever it is, we have a credit crisis and everybody wants out. We know what happens in the ETF structure. It will trade to an enormous discount if they're just a lot of sellers and no buyers. The problem is there's no way for a fund like that to close. So if that fund has a natural asset class base of, say, $200 million and beyond that, really, there's nothing left for them to buy. They can't close the fund. You can't shut an ETF because as soon as you do, it will trade like wild crazy pants, like a closed-end fund with a big discount and a big premium swing. So there really is a mismatch problem when you're trying to take illiquid vehicles and put them in millisecond trading vehicles.

Remember, ETFs are now the market. It's where most of the action happens. All right. For sure, crazy risks. Hopefully we don't have to test those things out anytime soon, and the market does react positively if we actually get some kind of test of those types of constructs. All right, Dave Nadeg, thank you so much for taking the time to be with us. We will see you again soon. Thanks for having me, Don. All right. Well, that does it for the ETF Edge podcast. Thank you very much for listening. Join us again next week or just head over to etfedge.cnbc.com.

Vesco QQQR rethink possibility by rethinking access to innovation and the NASDAQ 100. Let's rethink possibility in Vesco Distributors, Inc.