ETF Edge - Thematic ETFs & ETF Market Price

Episode Date: July 20, 2020

CNBC’s Bob Pisani speaks with Chris Hempstead, Head of ETF Institutional Business Development at NY Life and Todd Rosenbluth, Director of ETF and Mutual Fund Research at CFRA. They discussed Thematic ETFs, Corporate Bond ETFs and the IPO Market. In the 'Markets 102' section, Bob discusses the pricing mechanism behind ETFs. Hosted by Simplecast, an AdsWizz company. See pcm.adswizz.com for information about our collection and use of personal data for advertising.

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 bring you interviews, market analysis, and we break down what it all means for investors. I'm your host, Bob Pizzani. Today on the show, we'll break down exactly what's driving the rush to thematic ETFs, and we'll look at some of the year's top performers.

We'll also talk about Ayshares' dominance in the ETF space after BlackRock reported another impressive quarter of inflows. Here's my conversation with Todd Rosenbluth, Senior Director of ETF and Mutual Fund Research at CFRA and Chris Hempstead from Index IQ. Todd, let me start with you. I keep looking at these thematic ETFs. We used to make a joke about this. You know, it started with Bitcoin, then it went to pot ETFs. Tech themes, tech thematic themes, artificial intelligence, social media, cloud computing are all catching on.

They've replaced sort of plain vanilla indexed ETFs as a double. darling. And I guess why not? They capture the zeitgeist, don't they? What is it that's appealing about these thematic ETFs? Well, we're currently in an environment where everyone is working from home for the most part and doing school, perhaps, from home. And so some of these themes fit in very well. You've got cloud computing themes, ETFs like WCLD from Wisdom Tree, and CLOU from Global X. You've got cybersecurity products like CIBR from First Trust, robotics like B.EU like BOR, OTCZ. These are in the more the tech space. But thematic in general, you've seen health care oriented thematic ETFs from ARC or climate change oriented ETFs like ICLN from I shares has gained

popularity. We really think thematic ETFs are here to stay. They're not only a replacement for some of the sector ETFs you talked about, but if you're an old stock jockey, as I used to be as a financial advisor, these ETFs offer the benefits of diversification in a relatively low cost structure in one trade to be able to get 30, 40, 50 names to get your exposure. It's a really good concept. And, Chris, it's a pretty diverse business. I mean, I suppose ESG is a thematic type, but I'm not even talking about that. I broke it down three different ways. GlobalX had a report on this a little while ago. We could talk about fintech as a thematic thing. We can talk about social media. We can talk about the gig economy. We can talk about climate change. We can talk about sustainability.

I guess it breaks things down pretty easily, right? It does, and I think what people need to really grasp with thematic is it's not always about artificial intelligence. It's not always about, you know, electronic vehicles and things like that. Sometimes thematic can also include a way to express an overweight or an underweight in some cases to a particular sector. So we talk about broad-based passive indices like health care or energy or something along those lines. But if you want to overweight oncology, for example, you can find a thematic EPS that

overweights those names. Additionally, you can also look at other strategies like low-vall. We talk about thematic low-vall products. There's an S&P low-v index. There's our high-yield index IQ low-v, which is HYLV. You also have currency hedge products, which, again, some funds are not currency heads, some are fully hedged, and ours is 50% hedge. but that's also a thematic way of expressing your view in a broader index-based world.

Yeah. Yeah, you know, speaking of thematics, Todd, I sort of made a little joke about work from home. I said, when we're going to get work from home, ETF? And of course, we got one, Direxion, and we had Dave Matza on just a few weeks ago talking about that. WFH is the symbol. And you've noted this as well, right on cue, there it came. And we've got almost $60 million in assets in a few weeks. It usually trades over 100,000 shares a day, which is, what, five or six million?

And here's some of the stocks that are in it. It's not bad, considering it's only been around for three weeks. So there's obviously some serious interest in something, which sounds like a sort of invented idea. Let's buy work from home, but it seems to be working. It is. I mean, so we touched on cloud computing and cybersecurity is two of those themes. You get those within this ETF, but you also get other ones. companies like Zoom would fall into a different of those subcategories.

But you mentioned this is just three weeks old. It used to be investors would wait three years before buying an ETF. And then they started going into it earlier once they got a look at the underlying holdings. Three weeks is really impressive. It's a sign that this ETF has certainly resonated with investors. It hopes well for its future. Yeah. Let me move on here because I want to hit on a couple of other topics today.

I mentioned we talked a lot last week, BlackRock, reported. And if you want to watch one stock as a company as an example of what's going on in the ETF space, this is certainly it. We saw the dominance of their number one position overall. They have scale. They're the largest ETF provider out there. They have a very strong brand name in the I shares. They're very diverse. They have passive index. They have active. They are the leader in the ESG space right now. And they've taken that playbook, a page out of the Vanguard playbook, and kept fees as low as possible. Chris, I noted last week that their base rate, you know, sort of an average of what they might charge, was 17 basis points.

That's pretty remarkable when you consider that includes everything, but you can buy their IVV, their S&P 500 for three basis points. I mean, what, 15 years ago, a mutual fund was 100 to 125 basis points. You can buy the S&P 500. Now for three basis points, that's, for you as you don't know, it's $3 for a $10,000 investment. It's pretty remarkable, Chris. It's unbelievable, and it's great. It's great news for you and I and Todd, you know, and everyone else listening. It's a low-cost way to get, again, those core assets allocated to broad-based, you know, core allocations in the portfolio.

But, you know, look, I shares in Vanguard, they fight it out hard. You know, I make the reference a lot of times to Formula One. It's Mercedes versus Ferrari there. You know, you've got the top two, you know, performers there in terms of asset growth. But then there's a pretty big deal, you know, of, of, of, you know, of, other ETF issuers who are fighting for maybe not so much a lion's share of the assets, but fighting more for performance metrics, you know, for a way to diversify away from a broader index like S&P. They do charge a little more for that.

Well, we're sure. Yeah, that's why you see the actual base rate a little bit higher than where their core, where their core asset sits. Well, you're putting up a full screen here that it shows, I mean, everyone's got inflows last quarter over the first quarter, but some of the smaller ones like ARC investment, this is not shown here, but New Veen and Amplify, they had big jumps up. And I know, Chris, you have made this point in the past saying that there's a difference between the managers who get the most assets like Blackrott and Vanguard, and the managers who perform the best in their respective areas. I mean, Kathy Wood has gotten tremendous attention as an active manager in the arc space. She had a huge position in Tesla that

turned out to be correct. That funds attracted a lot of money recently. So I think your point is well taken. While it's nice to see the big guys making, bringing in all this money, there are people doing very well for very specific reasons, Chris. That's right. And I think a lot of it comes down to alpha generation above and beyond the core allocation. So how are managers, advisors, and, you know, managers differentiating their clients' portfolios. They're going to always have a piece of those larger passive index-based products that are so heavily, you know, weighted towards I shares in Vanguard. But then when it comes to upweeting and adding some alpha and adding some manager discretion, they're looking to people like Kathy Wood and Newveen and Index IQ and Amplify for different

ways to differentiate the portfolio and add some alpha. Yeah. Todd, bottom line here is money keeps throwing it, going into those particular funds. But again, we should keep track of what's going on with the smaller ones as well. I don't want to simply say, you know, it's true five percent, excuse me, the top five fund families, particularly I shares and Vanguard, get 90 percent of all the assets under management. But there are other things out there to consider just besides how big they are, right? Right. So you've got 90% going to the overall assets to those top five firms. According to CFRA's research, 82% of the flows have gone into those firms.

So you've got more mid-sized firms, as you guys touched on ARC earlier. J.P. Morgan and Pimco are doing really well within active fixed income. You've got GlobalX with the thematic-oriented ETS. There are certainly other players, and depending upon if you want to specialize in certain themes, you want to look besides the top two firms. There's some great firms that are out there offering compelling products. Yeah. Let me move on here.

I want to talk about bond ETS. How many times have we addressed this in the last two months, but money keeps coming into bond ETS, particularly corporate bond ETFs, guys, and it's not just because the government is buying some corporate bond ETFs. I noted, Todd, last week, Bloomberg noting first-time buyers of BlackRock's I-shares ETFs added 10 billion of inflows in the first half of 2020. That's not all, of course, government money that's coming in here. And they're getting bigger, Todd, and with good reason. Why is money keep going into these funds, despite the fact that we're dealing with essentially

very, very low returns, particularly, of course, on the yields? We noted in a separate piece outside of that one that insurance companies in particular We're increasingly using fixed income ETFs like LQD among the other products. And they were actually buying an early March ahead of the Federal Reserve. It's not that they were market timing. It's just they saw the benefits of liquidity, of price transparency. We saw bond mutual funds have relatively stale net asset values, whereas the ETFs were more real-time in nature. You get diversification benefits.

You get cash management benefits. And that's the institutional side of it. It trickles down towards the traditional retail investor who has tighter spreads, benefits from the scale as the cost keep coming down. Fixed income ETFs are about half of the overall net inflows in 2020, despite being 20% of the overall ETF pie. They continue to punch above their weight, and I think that's really among the major stories of 2020 in the ETF land. I think the key point here, Chris, I want to get your reaction to this point. I think the institutional buyers realize how efficiently the ETF market has been pricing corporate bonds. There used to be some debate about who's right when you get a difference between the prices and the net asset values.

And they would say, oh, well, these things are going to blow up because they're not going to be able to price them because the underlying bonds don't price very accurately or quickly. It turned out it was the ETFs that were right. And don't you think institutional buyers have noticed that fact? I do. I think, look, I think, again, EPS has held up really well in the fixed income space despite, you know, criticisms about transparency on pricing of the underlying bonds. However, you know, like you said, they have held up. And I think that there is, you mentioned yield, while the yields are low and we're seeing these inflows, there is still a need to own, you know, fixed income, whether it's high yield or whether it's investment grade. And people are still searching for yield. Now, right now, you know, there is sort of a, it feels like the market might be on a little bit of a hold in terms of whether spreads are going to continue to compress a little bit to get to those traditional levels in high yield and investment grade or whether or not as we as we ease into this year into the back half of the year the spreads might widen out again with that sort of preset there you might want to start thinking about where you're going to watch this fixed income

asset growth go is it going to move from investment grade to high yield high yield to investment grade or are people going to reduce volatility in those sectors well we know what's going to happen here. If the market keeps going up and the volatility stays down, they'll migrate towards high yield. I mean, that's been the story. Everybody's just desperately going towards higher risk, high yield funds. Let me just move on here and talk about the IPO market because it's doing great. And we had a huge potential IPO announcement today. Jack Ma's Financial, which is the number one FinTech company in the world right now, let's face it. It's a subsidiary, essentially, of Alibaba. They're kicking off their IPO, but not in New York. But not in New York.

And not in London. They're going to do it in Hong Kong and they're going to do it in Shanghai on the tech exchange in Shanghai over there. Guys either wanting to take a crack at this, but I think there are two important stories here. First, it's not New York or London. And I think that's the result of some real geopolitical tensions that exist. And secondly, it's huge. I mean, they're talking about north of $20 billion here. If that is the case, this could be the second or third biggest IPO of all time here. I mean, number one, of course, remains Saudi Aramco at $25 billion. Alibaba's at 21. But if Ancrupe goes over to 22, it could be the second or third biggest in the world. You get the idea here. U.S. visas way down there at $17 billion.

So I guess, Todd, your thoughts on that. And how do you play this? I mean, how would investors getting into international IPOs in an ETF space? So the IPO, ETO, ETF space is relatively limited. IPO, the ticker IPO, is one way of doing it for US exposure. The firm Renaissance also offers an ETF IPOS, that is the international companies that have gone public within the recent period of time. About half of its assets is focused on China.

So it's logical that this is the ETF that's first to get exposed. to it. But then again, this is likely to be added into those broad emerging market ETFs or China-specific ETFs. And you can get IEMG and VWO, the two heavyweights within the emerging market space to get exposure to it at some point. And you'd likely assume it'll be in China ETFs like MCHI and GXC once it makes the past the criteria. But it's very interesting to see that this is not going to be a U.S. listed company. that's what I find most interesting. Yeah, there will be a delay.

Go ahead, Chris. It won't happen right away. I think if anyone has the ability to do it quickly, it's to your point, Renaissance. But the broader indices, you know, look, just like any other big company, you know, that meets the criteria for index inclusion, we expect something of this size and this magnitude would be up for consideration, probably, you know, in the fastest order of time possible to be included. in indices. And then all of those pastive indexes that Todd alluded to, all those, that EPS that track those indices, will be having to add that name if it's allowed. Again, there's been a lot of chatter about what might or might not be allowed going into the second half of this year. Right. So that's my point. The whole IPO thing with China has gotten dragged into all these

geopolitical issues around the trade wars, around coronavirus. And I don't think it's a coincidence that they're not listing in New York or London at all. I think there is obvious political pressure on some of these companies over there to list over here. They may not feel welcome here. There are still companies coming from China, but they're certainly not on the level of financial. I wonder, guys, is the U.S. missing out on something at this point? If we deliberately drove people away, or is this sort of the way the cookie crumbles when you're dealing with the fallout from geopolitical tensions. I think you'll see there'll be an opportunity for U.S. investors to, you know, to find ways and to

find vehicles overseas, you know, to get access if they absolutely need to get access to a security like this. But to your point, you know, look, the geopolitical tensions are definitely going to be an issue, you know, going forward and that's something to keep a very close eye on. Just to jump in quickly, this is the benefit of what ETFs offer for U.S. listed investors to get exposure to harder to access international markets, particularly like China. So even though it won't list here for an individual stock perspective, U.S. ETF investors are the winner again and again and again. I think that's absolutely the case. That's it for this week, guys. Thanks very much for

joining us. We get the best guests here. Now it's time to round out the conversation with some analysis and perspective to help you better understand ETFs. This is our Markets 102 portion of the podcast. Today we'll be chatting about the pricing mechanism behind ETFs. My producer, as always, Kirsten Chang, joins me now. Bob, going back to basics here, another frequently asked question we get all the time from viewers is about pricing and valuations. How is the market price of an ETF determined? So Kirsten, the ETF is really a bundle of a lot of different stocks, and the question is you get one price from this

bundle of different stocks here. So an ETF's market price is really determined by the price at which investors can buy or sell an ETF on an exchange. And the price may deviate from the net asset value or the underlying value of all the shares behind it. It depends on the demand and supply for the ETF at any point in time. So the net asset value, as I said, of the ETF is based on the underlying securities closing prices. Normally, this is not an issue. The price of an ETF is usually

at or very, very close to the rate. to the net asset value. Right, so then explain why the market price of an ETF sometimes is different from the net asset value of an ETF. So sometimes an ETF can trade above or below the net asset value. So if an ETF trades at a price that's exceeding the net asset value, it's said to be trading at a premium. If it trades below, it's said to be trading at a discount.

So as I said, the net asset value and the market price of the ETF should be very very close. If they get far out of whack, the market makers can do an arbitrage. They buy the lower price one and they sell the higher price one, and the redemption mechanism helps keep the market price and the net asset value in line. Sometimes they get out of whack for various reasons. So, for example, there's interesting issues sometimes when the underlying market is closed and the ETF stays open. Well, how do you price it when you don't have the underlying value of the stocks. Or when you have stocks or bonds that are very difficult to trade, the underlying stuff, and they can't price fast enough to price the ETF. How do you know the price of the ETF?

These are very interesting questions. And the answer is, what happens is investors essentially guess and the wisdom of the crowds is pretty darn good. In fact, remarkably good. So a number of months ago, we had Chinese ETFs at the height of the Chinese New Year closed for several days. And yet, ETS in the United States did trade. Well, how did these Chinese ETFs get a price when the underlying Chinese stocks weren't trading at all over in China? Well, as I said, the market estimated, and they got it remarkably correct on that front. And similarly, several months ago, we had bond ETFs, when there was huge, huge demand for bonds, not able to price very fast compared to the ETF. And several times, there were very wide differentiations between the price of the

ETF and the underlying corporate bond ETFs. And again, it turned out market participants were essentially guessing what the correct prices of those underlying bond ETFs should be, even if the market didn't actually have them. I call this the wisdom of the crowds. A lot of people were very skeptical about this initially, and it's turned out to be a pretty good way of pricing it.

In fact, institutional investors have really noticed now that the bond ETF market does price efficiently, even when the underlying prices of the bonds are sort of slow and lagging. And I think this is going to be a major factor in institutions accepting bond ETSs, as legitimate holdings. I think it will help push more bonds

into electronic trading to make them more efficient and price more quickly and efficiently, because bonds used to be traded over the counter on bank trading desks. That's slowly changing, but it's taken a long, long time. And for my money, the sooner they move to electronic and more efficient trading for bonds, the better. That's it for today. I'm Bob Bazani. Thank you for listening. And make sure you tune in next week.

And in the meantime, you can tweet us your questions or topic ideas at ETF Edge, CNBC.