The Derivative - Digging Deep into ETFs with Davie Nadig of ETF Trends

Episode Date: September 9, 2021

How is the ETF sausage made? Who creates the filling? The casing? Who buys it at the store? What other meat is it replacing?  We dig into all these tasty morsels and more with this episode’s guest – the ETF expert Dave Nadig, who has spent his career analyzing ETFs, their asset managers, and how investors fit them into portfolios. We’re talking with Dave about why nobody in Springfield, MA likes Tom Brady, how ETFs went from nothing to a Trillion to $7 Trillion (with a ‘T’), and why exactly they get that super beneficial tax treatment. He covers whether they spell the end for mutual funds, whether they brought on the boom in RIAs, if they’re actually tied to indices anymore?, and how to square passive investment with active allocations to ETFs. Then onto how the SEC punted to Gensler at the CFTC re: Crytpo ETFs (and now he’s at the SEC…wtf), why the future could be ETFs by voting style, and the obligatory Cathie Wood/ARK questions on a pod talking ETFs. Finally, we’re talking what it takes to launch an ETF, who you need on your side in terms of market makers and distributors, and how the ticker has become all important. Don’t miss this informative chat with an insider in the huge world of ETFs. Enjoy. Chapters: 00:00-04:42=Intro 4:43-15:47=Wells Fargo, RIAs vs FAs, and Voltron 15:48-24:45=A Brief History of the ETF: the First Trillion is the Hardest 24:46-40:57=The obligatory ARK/ Cathie Wood questions 40:58-51:11=When do we get Crypto ETFs? Did the Sec Punt? 51:12-01:05:11=How do you do Futures, Leverage, and Taxes in an ETF? 01:05:12-01:16:01=Are there limits on ETF innovation? All Hail the creative Ticker! 01:16:02-01:21:53=The Game Stop Moment 01:21:54-01:26:50=Favorites From the episode: Luke's Entrance but with the Force Theme Follow along with Dave on Twitter @DaveNadig and visit www.etftrends.com for more information Don't forget to subscribe to The Derivative, and follow us on Twitter at @rcmAlts and our host Jeff at @AttainCap2,  or LinkedIn , and Facebook, and sign-up for our blog digest. And visit our sponsor, the CME Group at www.cmegroup.com to learn more about futures and options. Disclaimer: This podcast is provided for informational purposes only and should not be relied upon as legal, business, or tax advice. All opinions expressed by podcast participants are solely their own opinions and do not necessarily reflect the opinions of RCM Alternatives, their affiliates, or companies featured. Due to industry regulations, participants on this podcast are instructed not to make specific trade recommendations, nor reference past or potential profits. And listeners are reminded that managed futures, commodity trading, and other alternative investments are complex and carry a risk of substantial losses. As such, they are not suitable for all investors. For more information, visit www.rcmalternatives.com/disclaimer

Thanks for listening to The Derivative. This podcast is provided for informational purposes only and should not be relied upon as legal, business, investment, or tax advice. All opinions expressed by podcast participants are solely their own opinions and do not necessarily reflect the opinions of RCM Alternatives, their affiliates, or companies featured. Due to industry regulations, participants on this podcast are instructed not to make specific trade recommendations nor reference past or potential profits, and listeners are reminded that managed futures, commodity trading, and other alternative investments are complex and carry a risk

of substantial losses. As such, they are not suitable for all investors. Welcome to The Derivative by RCM Alternatives, where we dive into what makes alternative investments go, analyze the strategies of unique hedge fund managers, and chat with interesting guests from across the investment world. Yeah, I mean, this is sort of the tail wagging the dog problem. And yeah, if you reduce the argument to its natural conclusion, you have a $100 billion fund that's trying to take a 10% position in a $100 million company. Yeah, okay, you can't do it, right? So yeah, there are natural limits on the concentration any fund can

have based on its size and liquidity constraints. 100% true. And that is one of the issues with the ETF structure. Back to the point about, you know, mutual funds aren't going to go away, neither closed-end funds or hedge funds, because there are some things you shouldn't put in an ETF, right? If you want to run a special situations micro-cap fund, you cannot do it in an ETF because you can't close it. You can never say, hey, I've got my $500 million, I'm closing the new business. You just can't do it in an ETF because you create massive dislocations in how the thing will trade. I mean, you technically can, and it has happened, but you'd get a lot of scrutiny and not the good kind.

Okay, we're here with Dave Nadeg, Chief Investment Officer and Director of Research at ETF Trends. And guess what we're going to talk about? ETFs. You know, those little things that bring in trillions of dollars in flows every month, seemingly. Those nifty little securities that let you be long the NASDAQ, short oil drillers, and seemingly everything in between. So welcome, Dave. Well, thanks for having me. I'm a fan of the show. Awesome. Thanks for listening. And where are you in the world these days? So I live in Western Massachusetts, which for some reason I was able to move. This is where

I grew up. And despite having a career in Boston and Chicago and San Francisco over the years, managed to move back here after 9-11 and managed to not leave very much since. So working in a home office I've been in for the last 20 years. Nice. What, uh, what city exactly? I went to school across the border and union college in Schenectady. So I know. So right over the, right over the border. Yeah. Cool. Um,

my favorite Western mass story is Tom Brady broke up with that. Uh, what's her name? Bridget Moynihan. Who's from Springfield, I think. And so they'd show those Patriots fan charts, and there's that little circle, right? They all hate him in Springfield. Yes, there's like a little Piedra Valley dead zone. They all root for the Jets at this point.

Exactly. And I got to ask you about the guitar over your right shoulder. Yeah, that's a humbucker single, single American, American standard Fender Strat and the default guitar, bad rhythm guitarist, which is what I am. Nice. But you enjoy it helps you relax. I do. I do. I enjoy it. My brother's in a band out in Seattle. He does punk surf rock which isn't quite my thing but it takes a lot of practice we do mostly terrible grunge covers from the 90s because we're all a bunch of 55 year old white guys right that's fun um i i was depressed the other day it was like

pearl jam was on like a oldies or a soft rock station i'm like what what's happening yeah yeah you know the aging thing at this point i get called a boomer which that really bothers me because i'm not quite a boomer i'm i'm firmly generation x into your face yes to my face but like you know relax boomer what was the mem a while ago um yeah uh whatever Boomer. Whatever Boomer. Whatever Boomer. So give us a little personal background, how you got to where you're at, ETF Pro, and what you're doing at ETF Trends. Sure. So my ETF career really starts when I joined what was then Wells Fargo, NICO Investment Advisors in 92. And they hired me out of Cerulli Associates, which was a consulting practice Kurt Cerulli and I built in Boston right in 1990,

91. And what I was doing then was really work on the financial advisor market, which at that point was kind of a booming growth market. The whole idea of fee-only advice was a radical new departure from the commission-based days of the 80s. So I did a lot of work there and then went to Wells Fargo and NICO to build out what they called retail, which included mutual funds and then ETFs, as ETFs became a thing in the mid-90s, and worked on the launch of those first, what became the iShares country funds at the time, which some of them are still in existence, trading international markets all over the world that you couldn't trade any other way with any ease. And so worked on those products for a couple of years, was pretty skeptical of them, honestly. I wasn't a big

booster of ETFs at the time. I couldn't figure out how they'd ever work. Obviously, they ended up working. Took a brief detour to be an actively managed fund manager in the late 90s in the tech boom, running an internet fund in 99, 2000, 2001. We can all imagine how that ended. The Janus NetNet fund. What was the big copy? The Munder NetNet fund. They were our biggest competitor. We were called Open Fund was the big copy? Yeah, the Munder NetNet Fund. They were our biggest

competitor. We were called Open Fund was the name of our fund. We were fully transparent, active managers, which now seems like a whole new thing. But back then it was unheard of and it wasn't as well received as we'd hoped. So I took a couple of years off after 2001 and then came back into the industry a few years later as the director of research for what was then Index Universe, which became ETF.com. Built a little data and analytics business there, which we sold to Faxet. Went over with that business to Faxet for a year and a day-ish to bed that down. And then came back to ETF.com as CEO for a couple of years through them being purchased by CBO Global Markets. And then after the CBO Global Markets purchase for a few years, came over to ETF Trends to join Tom Lydon and Tom Hendrickson, who had merged ETF Trends and ETF Database, you can think of that as content and data on the ETF business. They had merged those together as kind of a Voltron behemoth to take on the industry and joined them as director of research about two years ago.

And what, all those sites, like I use them all the time, right? You're like, how do I be, I use short oil drillers before I'm like, what's the short oil ETF? And you Google it and those pop up and you get the list. Like what's the economics behind that? Then you're running the ads of the ETF companies or what's... Yeah. I mean, we are pretty straightforward advertising supportive media, which in the age of tranched crypto contracts seems decidedly old school. But fundamentally, we're in the business of helping financial advisors make good choices for their clients by getting exposure. And that's honestly what I've been doing for about the last 20 years is working with financial

advisors, helping them understand the ETF market. The FA market has really been the growth engine for the ETF industry, honestly, since the very end of the 90s. And as the financial advice market starts adopting product and demanding product, that actually trickles down into the retail market. So I spend a decent amount of time there as well. And then, of course, there's always this push from the institutional market to get more sophisticated product, to get better access to liquidity, to be able to manage risk better. And so it's fun because you get to play in all three of those markets pretty much every day. Awesome. And I'm going to push you on the FA definition because I refer to them as RIAs usually, but are we talking about the same thing? Yeah. I mean, pretty much we're talking about the same thing. So we tend to think of RIAs as independents. Both sort of hang up their own

shingle. They may be platformed at some place like TD or Schwab or something like that. That's sort of the traditional independent market. But at the same time, there's still a huge wire house market. There's still a lot of Wells Fargo advisors out there, a lot of Merrill Lynch advisors out there. And some of those folks are still collecting commissions. Most of them have honestly moved towards some form of fee for service model, usually on a basis point level.

Many of them use model portfolios now that have ETFs bolted into them, even though 10 years ago, they might've still been selling a share front-loaded mutual funds and collecting commissions. So that market continues to evolve to something that I think is honestly just a whole lot more stable, a whole lot better for investors where you just sort of pay for the services you get. And then there's a whole third section of that, which is sort of the regionals, right? The Linscoe Private Ledgers and the Ray J's and the Ed Jones and those kinds of folks. And so maybe you could debunk this, right? In my brain, it's all the RAs are flooding out of wirehouses and becoming because of ETFs, right? And they can set up and they can give their

clients cheap access. They don't have to sell the wire house internal product. But it sounds like you're saying, well, hold on, there's a whole ream of FAs inside of the wire houses that are doing basically the same thing as ours. rags, you'll see this daily cavalcade of six advisors leave XYZ Wirehouse to form their own shop with $2 billion. I mean, you can just print that headline every single day. And you have been able to for about 10 years. But despite that, there's still like 100,000 Wirehouse captive folks out there helping manage people's money. And they are heavy users of ETFs too. 100,000 advisors.

Not just one. Yeah. And they are heavy users of ETFs too. 100,000 advisors, not just one. Yeah, yeah. I mean, depending on how you count, roughly 300,000 folks in the US are in the advice giving business around finance with some level of certification. Some of those folks may be primarily insurance oriented. Some of them may be still boiler rooming stocks out. I'm sure some of those guys still exist somewhere. But in general of that 300,000, it's roughly a third, a third, a third between the wire house market, what we would call a regional market, and then true independents that are absolutely

captains of their own chips. And that market continues to evolve, but the pressure is towards independents, no question. Yeah, for sure. And does that even exist anymore? I don't know the laws of, can the wire house say you have to sell our internal funds? No, there's a lot of rule and regulation now. Reg VI definitely puts a lot of the older issues to bed in terms of, you got to go sell more Apple because we're getting subscription revenue off it. That doesn't really happen very much anymore. I think there's still some shady corners of the insurance market and there's still some folks out there probably pushing UITs and structured products that people probably shouldn't

be buying. But for the most part, I feel like we're in a bit of a golden age for advice. There's so many ways to get good advice, almost regardless of whether you're a $10,000 investor or a $10 million investor. Yeah. And how do you view, it's a little contrary to the whole concept of ETFs though, that you need the advice, right? Like kind of the, in my brain, like, Hey, here's this product. You can just get access to all 500 S&P stocks. You don't need the advisor to help you. You just grab it. But the advisors love it. So how do you square that? Yeah. Well, I push back on that a little bit. I think what the ETFs have done, it's useful to go back to the beginning of ETFs, right? The original ETFs were

not designed as things that an average investor advisor were going to use as their way of getting beta, like getting exposure for their growing wealth over decades. That was not the plan. The plan was the Harvard endowment is sitting on a million dollars in cash every day because they get dividend payments in, or coupons get clipped off the bonds they hold, or rents get paid on property. So there's just constant influx of cash in most big institutional portfolios. And prior to the invention of ETFs, almost the only thing you could do with that was go into the futures market. There was no way to equitize that cash on a daily basis without taking on some level of derivatives risk you may or may not want it to take on. So the ETF just instantly solved that problem. And instead of paying some sort of implied futures contango, instead of paying the widespreads in what were pretty

illiquid derivatives markets back then, you could just, for a 30 basis point spread, which seemed like nothing at the time, you could get in and out of the S&P 20 times a day. And that was a real, real revolution for institutional cash management. So from that, what we built was just this giant toolbox full of tools. But honestly, very, very few of those ETFs were ever launched with the idea that they were solving the advice problem. I mean, a handful, there used to be some target date funds. iShares still has a few sort of risk managed funds that are balanced where you can sort of get a conservative allocation that's got some bonds and got some equities and a little in that. But we're talking about less than 10 basis points of the whole industry is in those kinds of funds. So everything else

is just beta exposure or some kind of tool to make some sort of position in your portfolio. You still need to know what to do. Yeah. Which I talk about on this pod a lot with hedge fund managers, right? They have this other side of the coin of change your stripes or go out of business sometimes, right? And an investor would love for them to just, hey, do this one thing day in, day out. I want to rely on that beta. Even if it's some weird, it's not tied to the stock market, but we'll call it a beta here. But they have a business to run. ETFs kind of let you, I remember talking with a provider once, he's like, oh, we've had the short Japanese yen ETF

for 10 years. It had 3 million in assets. All of a sudden there's a move there. It goes up to 300 billion or 300 million, but it's just sitting on the shelf waiting for that to come in. A hedge fund manager can't do that. They'll go out of business. Right. Right. Exactly. You can't warehouse tools as a hedge fund manager. But this is the flip side of the fact that the ETF industry has become so concentrated. The top three, top five providers have the vast majority of the assets, but you look inside their product line and what you'll find is those really cool tools, right? Yeah, we can sit here and go, gosh, does BlackRock need to have 400 and something ETFs? But then you look and you say,

okay, but if you want Brazil exposure, the fact that they have one that's incredibly liquid and very cheap and has been trading for a decade is kind of helpful as an institution or an individual. You've jumped into the history a little bit. Let's go back even further and just give us the super brief history of the ETF. You mentioned PIMCO before and basically how big of a space is it today? We mentioned BlackRock. So give us. Yeah. So, you know, it started in 93 with the launch of SPY. Actually started a couple of years earlier in Canada with the Toronto version of SPY, which were called TIPS. But SPY was sort of the first one that really caught anybody's attention globally, followed by the WEBS products, World Equity

Benchmark Shares, which are the ones that I worked on in the early 90s. And then that was sort of it for a little while. And then later in the 90s, we got the Qs. And I think that was a big, wide-open idea for a lot of people. But at that time, I was trading them. So I was trading Qs as a way to get intraday tech exposure when I didn't have any better ideas, which was most of the time. And then it sort of languished for a little bit. And then coming out of 2000, 2001, we really saw an explosion in new product ideas and new ways of working with the structure.

We got the first fixed income ETFs. That was a big opening. The early 2000s got us GLD to get gold exposure. It got us the first commodities funds that were trading futures, which are a whole nother different kettle of fish. It got us our first active products. So that decade of 2003 to 2010, I called a golden age in ETF innovation because all sorts of crazy ideas came out. Now, some of them didn't work. Some of those things went into the dustbin, macro shares, which where you'd be trading off exposure from one half of an ETF to another half of an ETF, all sorts of stuff went by the wayside. But what it meant was we kind of went through this period, this trial by fire, survived the global financial crisis quite well. That was a huge hockey stick moment for growth in the ETF industry because so many active managers did so badly, particularly in the credit space in 2008, 2009. And then from there, we've had a pretty steady growth and what I would call a more measured type of innovation since then, largely because there's been a lot more regulatory scrutiny. You know, ETFs lived predominantly through loopholes since 93.

Everything was an exception. You know, you had to fight. I mean, the whole fundamental filing process used to be called exemptive relief. Right. It's not exactly a doesn't roll off the tongue. So none of this was happening by right. It was all happening by SEC fiat, if you will. They would allow this thing to happen that was the ETF until we passed an actual ETF rule a year and a half ago or two years ago, I guess at this point. And that sort of codified what an ETF is today.

So now we live in a very tightly regulated and structured environment. But what that's let us do is really go deep on what we can do. And that's why we're sitting at $7 trillion roughly today. 7T with a T, trillion dollars. Yeah. With 6.9 as of this morning, I think. And break that down. What percent of that is BlackRock and Barclays and iShares? Yeah. So if you go through BlackRock, State Street, SSGA, that's the Spyder products, and Vanguard,

you're roughly 80% of the industry, right? So the top three players really do own it. And if you break it down even more, if you don't look at it by company, but sort of by kind of fund, the vast majority is what I would call cheap beta. Funds that are under 25 basis points and expense ratio indexed and providing for core asset class exposure, right? The Bloomberg aggregate, the GSCI commodities index, the S&P 500, the Russell 1000, those kinds of products, vast majority of the assets. And what was that you mentioned,

kind of that hockey stick moment, or let's say, what was that in 2000 and then 2007, just the total assets up top? Oh, God. I mean, I could pull it up. Off the top of my head, we were knocking on 5 trillion three years ago. We were knocking on the And this has happened, honestly, since 1986, even before we had ETFs. But every time we have a giant market crisis, a huge chunk of the active management community gets flushed. They just absolutely get flushed. They may still survive, but the assets leave. And where do those assets go? Well, initially, they usually go to cash and you can track that. And we always look at the balloon and money supply and margin rates and all that stuff. But then eventually that money needs to find a home again. And every single time it shows up in

whatever the cheapest, most liquid passive vehicle is. And that has just been an inexorable train since the 80s. So global financial crisis, boom, another trillion dollars shows up in ETFs. What we saw in March 20 last year, boom, another trillion dollars shows up in ETFs because they're the natural place to go. If you manage to get out of your underperforming mutual fund without taking an enormous tax hit because you've been sitting on it for 10 years or something like that, boy, why would you go back in in April of 2020? Why would you be taking that as your moment to make a giant bet on a new active manager? It's kind of perverse incentives, right? Like that whole index ETF space, like, hey, if we could lose 40% of our assets in the short term, we'll triple them in the long term with these new

flows. Yeah. Well, I think the funny thing is, I've been kicking around this industry long enough. The joke we make is there are only 400 people in the ETF industry. And it's not true, but it's pretty close, right? I mean, it's a very small world. We all end up working for each other one day or another. There's a bit of a revolving door around the industry where talent sort of moves where it's most valued, as you would expect. But in that group of folks that have seen some things over the last 25 years, every time the market pulls back five or 10%, you don't see anybody crying. Everybody's mobilizing the forces. They're

just like, all right, let's go. We got to get the marketing spend up. We got to figure out how are we going to get retail this time, et cetera, et cetera. People chasing 13F filings to look who was in terrible underperforming hedge funds the whole nine years. All this growth is at the expense of actively traded mutual funds mainly? For the most part, right? I mean, I have some slides and a few decks where I sort of point out that since the global financial crisis, it's been about however many trillion dollars have showed up and flows

into the ETF industry. At this point, it's probably four. And it's been about $2 trillion out on actively managed mutual funds, right? So if there is a balance, that's where you'd pick it from. Now, obviously, you can't tie dollar for dollar, something moving out of something and into something else. But yeah, it's mostly come at the expensive, expensive, underperforming, benchmark-hugging active managers, because those are the active managers that get flushed every time we have a crisis. And I think you had a little nugget in there of benchmark-hugging and underperforming. So are you in the camp of all active mutual funds

will disappear eventually? No, not at all. Neither will active disappear, nor will mutual funds disappear. They both have very important roles to play in the markets. They needed to be shaken up. Active management, we're actually in the middle of a huge active management resurgence, largely on the back of Cathie Wood and the folks at ARK that really sort of put old school stock picking active management back on the map, which if nothing else has been enormously entertaining. But I think it's also really pointing out what active management should be, which is having a very strong investment thesis and then sticking to that regardless of what the headlines look like. That's what you want out of an active manager. You want them to take the hard

bets. And I think we're seeing a lot of that in the ETF industry. And certainly anything interesting in the active management space is either in a hedge fund or in an ETF right now. I don't think anybody's super excited about any recent mutual fund launches. Yeah. Or torpedoes be damned is what you want out of your active management. Yeah. Yeah, exactly. And we work with a few mutual funds who are pairing the beta with an active kind of long ball positive skew piece that can be balanced daily. And that's kind of a more exciting piece of the active space in my mind.

And ETFs have become largely vehicles for active managers, right? And that's a huge component of this. Anybody who's running a ball strategy, probably using some ETF beta under the hood, even if it's just through the options market. So you mentioned, Kathy, what hard to fast has her ascension been of ARK's ascension? And there's lots been written about all the problems with it, too concentrated into illiquid of stocks. Give us your overall view on ARK and what's going on. So, you know, I should caveat this by saying, you know, I've known Kathy for a decently long time. And obviously, I think I should probably caveat this rating. Essentially,

every ETF issuer does business with her firm. So there is some financial involvement, but nobody's paying me to talk about it now. So look, Kathy has been sticking to her knitting on innovation for about 20 years. And some years that's been great. And some years it hasn't been great, both in terms of performance and in terms of how it's received by the market and everything else. What she's doing now, what her team, and I should point out, she is not a stock picker.

She is a team manager and her team is fantastic. Just like as individuals, they're some of the smartest people I've ever talked to. We can totally rational have disagreements about what they do as an investment thesis, but the people, no question, incredibly sharp. And their core thesis of really focusing on transformative technologies with five-year time horizons and doing your own bottom-up research where Wall Street isn't, that's legit. They're doing that work. Now, whether that should be in an actively managed mutual fund or an actively managed ETF tracking X number of stocks with a split on genomics or a split on space or putting it all in one bucket, those are largely marketing access liquidity type discussions. And I think

those are reasonable. I think some people think that things like what they do in ARKK should be only in a hedge fund environment because then they could take private equity placement and then they could really load up on the illiquid stuff. And yeah, there's a version of that kind of strategy. And there are a lot of folks who do that kind of investing out there. Her whole thing was to bring this to the average investor, right? Because historically these kinds of really forward thinking long-term plays were only the province of institutions. They were the only people that actually invested that way. Because they had a performance year that was gangbusters last year, it obviously rose to the

top of everybody's screens. And all these retail investors with new money in their accounts found it at the top of their screens. And they're really good at telling their story. They show all of their work in a way that no issuer I've ever seen does. You can attend a webinar with one of their PMs and they'll go through their analyst sheets and talk about why they're saying this is the growth rate for this individual company. No manager does that openly. It almost borders on non-compliant in my view. When they show their Tesla growth outlook, I'm like, whoa, it's completely hypothetical, right? But so be it. If that's your numbers, that's your number. Yeah. And this issue about whether or not talking your book is nefarious or noble or anything in between.

To be blunt, I have a lot of sympathy with it because like I said, in 1999, I ran a mutual fund where we published our trade blotter in real time. So we were doing that and we were talking our book every day on CNN, CNBC, and we got a lot of crap for it. I mean, Jim Cramer called me a criminal on air because he thought I was trying to run my own stocks. So sure. Okay. That's a reasonable question. That's a nice feather in your cap. Yeah. Well, I'd rather not have it. But the flip side of that is, okay, well then should they not tell investors why they're invested in Tesla? Should they not put out what their targets are? I don't think you get to have

your cake and eat it too on that, right? Either transparency is good or transparency is not good. And I give them credit for being fully transparent about it. You can't argue that you invest in one of their funds and don't know what you're getting. You just can't make that argument. And so let's talk a little on the too big concept, right? Are ARK individually or each, you know, I don't even know the symbols of some of those sub ones that you just said, but are they getting too big, right? If it's a, everything you just said can be perfectly true and they're doing a good job and these are the smartest people in the world and they're picking the right stocks.

But if it's too many assets chasing those stocks, does that eventually become a problem? Yeah. I mean, this is sort of the tail wagging the dog problem. And yeah, if you reduce the argument to its natural conclusion, you have a hundred billion dollar fund that's trying to take a 10% position in a hundred million dollar company. Yeah. Okay. You can't do it. Right. So yeah, there are natural limits on the concentration any fund can have based on its size and liquidity constraints. 100% true. And that is one of the issues with the ETF structure. Back to the point about mutual funds aren't going to go away, neither closed-end funds or hedge funds, because there are some things you shouldn't put in an ETF, right?

If you want to run a special situations micro-cap fund, you cannot do it in an ETF because you can't close it. You can never say, hey, I've got my $500 million, I'm closing the new business. You just can't do it in an ETF because you create massive dislocations in how the thing will trade. I mean, you technically can, and it has happened, but you'd get a lot of scrutiny and not the good kind. So yeah, that is an issue. And to some

extent that limits what something like ARKK could put in the fund because they can't just load it up with microcaps. Now you have to ask yourself, do you think that they're smart enough to understand that and manage that liquidity tightly and have relationships with the street that are good enough that should they want to liquidate something, they can do it without creating giant multi-day market moving events. And the short answer is, yeah, they kind of have shown they can. They dumped Wirecard in a trade, the whole position out of the fund. One of the largest holders of that when Wirecard turned out to be a fraud. They're one of the only institutional holders that was able to extract value out of Wirecard's crash to nothing because they were able to work with the street

and sell it very early. And they, by the way, advertise that trade because that's what they do. So the one case we've had where they wanted to effectively panic exit a security, they did it better than anybody else on the street I've been able to find. Yeah. I would argue they probably caused the crash down by them getting out, right? So if someone else had caused it, it might not work. It belonged at zero. So it's just, it's not like they made it happen and it didn't happen on purpose. But I guess my issue is, right, if they can't set up a toll booth, they can't say, hey, no more money coming in because we have these constraints. So what do they do with that money? Does it become less innovative? Does it become more of a S&P beta? If they have to put that money to work and they can't put it in these

companies, where does it go? Well, yes. If they became a $50 billion Magellan-like behemoth, the ability to make meaningful allocations to smallest securities goes away. There's just no question about that. I don't think that they're near that problem yet. And I suspect that if they genuinely believed that they were getting there, you would see them talk about changing the fund strategy or splitting the portfolio into sub-tranches, which they've done with some of the other segments that they look at. So the people who are really only interested in, say, the electric car industry can just get that exposure as well. So I think it's a manageable problem. Ironically, there are some other much larger passive funds out there that go through

rebalances, which are much more predictable and thus much more exploitable. And we don't talk about them all that often. And those are just genuinely broken market issues. And the Russell reball for a decade was something that people just could deliberately trade against. VIX futures ETPs, 100% tradable. Everybody knows exactly what they're going to do at the end of every single day. Yeah. Let's dig into those because that comes back to, I'm sure, I don't know if you've been on air debating with Mike Green on active versus passive. We've certainly had the discussions, I think only once, maybe once on air, but we've had a discussion privately for sure. Yeah. Right. His theory, if I try and boil it down to is you just have this one hose, right? And the more and more pressure that's coming into that hose, eventually it's going to break or there's going to be downstream problems that you can't fit everything through that one

pipe, which is either the bid-ask spread or the assets they can invest in, right? So I'll take it from art all the way to the whole industry. Like when can it get too big? Is there a point where passive, you know, gets too big for its own good? And what would those problems look like? Yeah. So, I mean, there are a couple different angles to that. So the cleanest one is the price discovery question, right? Which is that if, yes, again, you reduce the argument to its absurd extreme where every single dollar in the world is passively invested and then there is no price discovery. Sure. You're imagining a world where the market disappears and nobody takes risk. Okay. Yes, there is a problem at 99.9999% passive investing. The smartest piece I've seen on this was Andy Lowe at MIT, who his basic run through the math was,

you need to get up to about 90% free riders before price discovery breaks down. And we're maybe 25%. That's probably the best gross estimate you could make. Now, it's not a trackable number. It's not a measurable thing. And therefore, it's not a regulatable thing. So it's a bit of a specious argument. What happens if it never rains for 18 years? I mean, okay, that would suck. We'd have no food, but that's not the real world we live in. So I get a little frustrated with these discussions because imagine the end case. Imagine you banned passive investing. How in the world could you possibly enforce that? If I choose in my portfolio using my Schwab account to hit a button and buy all 500 stocks in the S&P and cap weights,

and then just rebalance that every month? How do you know that I'm doing that? And how do you ban me from doing it? Or if I just buy an S&P future? Well, I'm just saying you'd have to ban all of those instruments too. So if you banned passive investing, all you would do is make it only the province of institutions who could just do it on their own. And there's no way you can ban somebody from that. You can't ban somebody from owning a collection of a certain set of publicly traded securities in a certain weighting. It's crazy. So, you know, you could you could poke at the structures, you could poke at the infrastructure. And that's probably where we will see some action.

I think the more relevant question is about common ownership. And I think that is a legitimate discussion and doesn't have as much to do with passive as it does with just common ownership, right? Giant institutions owning either on their own or on behalf of other investors, enormous blocks of individual companies, and therefore having outsized impact on those companies' activities. That is a legitimate area of discussion. In terms of voting rights or in terms of if they get out, it causes price action? Just in terms of voting rights, right?

I think that's a whole separate thing. Corporate governance in the United States is kind of messed up. It's not great anywhere, but it's not particularly great in the United States. The way we, you know, the sort of complete abdication we've given as individuals, our votes to our asset managers, you know, I understand how we got here. Like, I don't want to see proxy statements for 3000 securities because I own the Russell three. That's terrible. Right. So you got, there's got to be some level of abstraction on that. Where I think we're headed and we're starting to see the crack in that is that people will start choosing their passive manager based on how they say they're going to vote. Now that's really only

hitting at the sort of fringe edge of ESG. We had a great launch a couple of weeks ago, fund called Vote, B-O-T-E, which is basically just an S&P 500 fund with an attitude, right? It's going to get in there and it's going to pick its things it wants to get done in corporate America. And it's going to go make a lot of noise and rally shareholders around predominantly ESG centric themes. But again, it's just an S&P 500 fund. And why they're a little bit different is because not only are they worrying about voting their share, they're lobbying everybody else. So they're working with BlackRock to say, hey, you know what? On this Exxon vote, we've done surveys and this is what people really want. And then they're convincing them. So that's pretty cool. Yeah. And what could the future that

could look like? Hey, here's the S&P maximized profits vote, the S&P maximized social good vote, the S&P maximized environmental good vote. Yeah, exactly. Right. And you could have many tranches. Yeah. Yeah. And I think, you know, we're headed, we're in such an exciting period in time because there's so many incredible financial innovations, which are like one regulatory hitch away from being real. It's like technologically, it would be trivial for Schwab to send me a survey once a month, just asking me 10 questions about what I care about. They don't have to say this Exxon vote. They can just say, given a choice between these three things, hypothetically, and you pick things that are on freaking every proxy solicitation, employee compensation, executive compensation, carbon output, all the stuff that's

hitting everybody, Schwab could just pull me. They could hand that back to the asset managers and say, hey, this is how our audience would like you to vote. That would be cool. That'd be super cool. And technologically, you could do it in 24 hours with one good developer, but there's no regulatory path, for my opinion, to end up in my fund. There's just spaces in between. And everything in crypto is the same way. Really cool things we could do in a heartbeat that we have no regulatory path forward on.

And I think most of these interesting issues in passing management fall into that bucket. I think the S&P 500 CEOs would hate that idea, right? Because I feel like the general public would say that compensation is way too high. Yeah, exactly. But you know what? Isn't that how it's supposed to work, right? If all of the shareholders of IBM don't like the CFO, they should be able to get rid of the CFO, right? Like that's just how that's supposed to work. Right. You're a shareholder. Yeah. But how many people that actually own the Russell 2000 ETF think that they're a shareholder of those 2000 companies? Very few. You're just buying, you know, magic internet coins, like effectively. There's no

difference between the Russell 3000 and Bitcoin in most people's mind. It's just a number that goes up or down. And I think honestly, anything we can do to make people realize that they're actually participating in the economy, I think is good. I think it was Meb Faber at Cambria who runs a bunch of ETFs and as a financial advisor in his own right, somebody was asking him something on, on CNBC about like, you know, how, how can you not be invested in whatever it was, Ethereum or something like that.

It's like, because I'm invested in the global production of the entire planet. And that seems like a pretty good place to start, right? Global equity portfolio. That's what you're doing. Yeah. You know,

that was great. Yeah. I think he's over a billion now too. So yeah,. So kudos to him. He's been working hard. And as we become more of a corporate driven society, it's almost like that needs to get, you know, that, that needs to happen more and more in this society that we're in. Well, we could go down a big, long rabbit hole about corporate statehood, but yeah, I mean, I don't think that's why you brought me on, but I got to know. We'll leave that. There's a good post reform broker. Josh Brown has on the new American gods. I think he called it, you know?

Yeah. Yeah. I mean that, that idea from religion to Apple and Netflix and these things. And then there's the whole issue of regulatory capture and oh my God, I could go on forever. Yeah. Elon Elon Musk just tweeting out whatever he wants. You mentioned crypto in there. Let's talk. How many Bitcoin ETFs are out there? Crypto ETFs waiting to be approved?

50? 16? I mean, it's, you know, what day is it? Because it's probably changed by tomorrow. Right. So Winklevosses were there for 10 years, just waiting, 16. I mean, it's, you know, what, what day is it? Because it's probably changed by tomorrow. So Winklevosses were there for 10 years, just waiting, waiting.

And now there's, so what, what's happening there? Is that going to happen? So we've been back and forth. So originally the Winkle, like to go back to the beginning, and I don't think most people quite get this and this is not from the Winklevoss brothers mouths, but this is just my summation. They came to the street with an idea to put Bitcoin in an ETF in a very GLD like structure, like just take the Bitcoin, put it in a box, fractionalize it, trade it on an exchange. Very straightforward. The reason that they did that as early as they did, which is what, seven years, six years ago now, it was quite a

while ago, was not so much because they were like, this is what, seven years, six years ago now, it was quite a while ago, was not so much because they were like, this is what makes us a bunch of money. It was because they wanted to force the hand of regulators to tell them what the heck Bitcoin was. Oh, really? Okay. And that was, I think, a critical thing, right? And what they actually got out of that were a couple of really pretty key declarations about Bitcoin being property, like how it gets taxed. A lot of what we understand about where Bitcoin and crypto in general sort of lives in the regulatory environment comes from that initial fairly aggressive push to get the SEC and the CFTC to tell them what the heck Bitcoin was from a regulatory standpoint.

And the SEC sort of punted, right? And said, it's a CFTC issue. Exactly. And that was the punt, right? They, at the time, kicked it over to Gary Gensler, now the chairman of the SEC, then the chairman of the CFTC, right? Who basically said, yeah, we're going to treat this as effectively a commodity asset that you can put futures on. And that's as far as we're going to go. And so once they did that, they were able to say, okay, now you have to go through this sort of futures not whole, and we're just going to leave you there for a while. Because once it's in the futures not whole, the 33 Act gives a lot of, the CFTC has a lot of hand in what they say isn't okay, that the SEC has to play a little bit tighter to the rules about, because the CFTC is managing a very different and much smaller market in terms of number of participants. So that was the first push. Then we had a whole bunch of people pile on with different approaches to it, how you store it, how you measure it, what you index it to, how you handle creation redemption, all very under the hood, not that

interesting differentiation. All of them got rejected. SEC told them all to go back to the drawing board until very recently when Gensler basically said, hey, you know what? If you did something in the 40 Act that just used futures, we'd probably say yes. And then ProShares, like a ninja, dropped the filing the next day effectively and then got that fund approved. So there's now a $40, $50 million US listed mutual fund that owns Bitcoin futures. Now, it seems like it should be a fairly trivial bridge from there to an ETF, so much so that I can't quite figure out why ProShares couldn't just convert the mutual fund into an ETF now that it's live. So I think we'll get a set of approvals here sometime before the end of the year. And then we'll have a raft of these Bitcoin futures ETFs, which frankly, not that many people are going to want

because it's not a particularly great way to get exposure to those assets. It'll fill the bucket for some folks, right? It's probably a little better than GBTC, which is an OTC listed trust that trades at big premiums and discounts. So probably a little tighter tracking than GBTC has on average, but not really the tool anybody wants. Well, I think the argument from the crypto community was this will let institutions who can't invest in it, invest in it because it's a security, you know, it's a stock. And there's truth to that, right? I think that, look, are we going to get a billion dollars into Bitcoin futures ETFs? Absolutely. So it will be

successful. I don't know who's going to be at the front of the list. If I had to pick one today, it's going to be Valkyrie because their filing's the cleanest, but more likely the SEC comes back, tells everybody, this is what you need to look like. Everybody scrambles and pays their lawyers a lot of money and they refile in a way that the SEC has told them to. And then they do a day one approval for everybody. And then it's whoever has the biggest marketing budget wins. Yeah. And so none of all of those filings now are going to use the futures? Yeah. Currently all of the extant filings use futures in the US because the SEC has told everybody else to pull their physical, physical, their, their, their, you know, and what it was physical, physical, you know, their, their in specie, you know, version of

the Bitcoin filings. But that's the only one that anybody wants, right? Really all anybody wants is just a straight up creation redemption GLD like Bitcoin fund. Yeah. And our sponsor CME group, thank you. Right. They, it can't can't get hacked. It's on an index of prices. So you're not going to lose your exposure. Yeah. On the future side. Yeah. So like I said, will a billion dollars show up in these funds? Of course it will, because there's enough use cases for it just as a tool, much less as anybody saying, this is how I'm getting my Bitcoin exposure, just as a Delta One tool, just being able to manage that exposure versus the futures, versus the underlying, creates an arbitrage circle that the market will jump into and there'll be

a billion dollars in it just for people managing that arbitrage circle. Yeah. Just the Chicago prop firms, right? Yeah. So there will be plenty of money in those funds. People will short them. That's another thing that's useful here. It all makes me a little sad, to be honest, because the really interesting stuff is all

being done on the crypto side of the balance sheet, right? The stuff that's happening outside of US jurisdiction is so much more interesting than the idea of baking CME futures into a fund. Yeah. It's Ben Hunt's Bitcoin jazz hands, right? Of like Wall Street's just co-opted it and trademarked it basically and said, hey, you're getting Bitcoin, look over here. But meanwhile, you've got, gosh, you've got guys like Barnbridge building effectively tranched crypto securities that are like CDOs that run through automated securities contracts that just completely disintermediate the entire financial services industry in one contract. And that stuff's going to take over the world. But the problem is it has no regulatory home.

Does that kill ETFs eventually, right? If you can just buy- Yeah, I wrote a piece this spring effectively saying the only reason the ETF should exist at this point is because of the regulatory framework. If you look at what the index co-op is doing on the crypto side, where they're basically creating smart contracts that spit out a portfolio token when you present a portfolio of coins in a certain, that is the ETF creation redemption mechanism. That is exactly what it is, the way it works, how it uses portfolio composition files, how it handles everything. It is automated ETF, top to bottom. The only thing that we don't have is a token you can submit to that that says Tesla or S&P or IBM.

And once you do, which those tokens exist, they trade on FTX, but if you could trade them more broadly, then anybody in the world could stand up an ETF with air quotes around it in 20 minutes by just modifying an ERC-20 contract. It's child's play in terms of how obvious it seems. The two big issues, I was just having a conversation with Adam Butler from Resolve Asset Management last night about this. The two big issues are one, there's no legal way to do any of this. There is no regulatory framework that allows any of this to happen. The second one is there's a huge timing mismatch, right? Because everything in crypto is instantaneously settled. Nothing in securities is instantaneously settled. So if you created an ETF using all of these like Tesla tokens

and IBM tokens and ran it through one of these sort of index co-op type smart contracts, who's warehousing the settlement risk? Because when you buy more of the one thing, the Tesla, you don't actually own it for a number of days. Whereas in crypto, that thing hits your wallet and it's yours for better or for worse. And that timing gap in settlement is the hugest problem. I'll add a third problem. There's $7 trillion worth of people disinterested in seeing this happen. I disagree with that too. The most interesting stuff going on in the asset management industry is happening in these little crypto tiger teams. I mean, WisdomTree filed for a Solano listed

40 act registered mutual fund. That's bananas. The only way you'll be able to buy it is through blockchain. Now, I don't know whether that's going to make anybody any money, but it's not like, like if wisdom trees, a top 10 issuer, they should be interested in protecting their business. They're not, they're building a whole new digital assets business and trying to wedge the 40 act into it to create mutual funds. So I think there's the ETF, I think, a little bit further ahead than people think in terms of how they're trying to get through this stuff. The huge problem is warehousing, the settlement risk, and regulation.

You need a group like Apple or Tesla who says, we're going to direct list via some blockchain, right? And then it would instantly settle via the blockchain and cut out. But then you have NYSE and everyone else. Yeah, but that way you'd break 50 securities laws at the moment by doing it that way. I mean, look at the Uber path, right? Who is it that just got a $2 billion SEC investigation yesterday?

Not Bitfinex. One of the early guys put in an ICO on their exchange. I should know this. It was yesterday's news. But my point is, this was what ICOs were supposed to do. And the SEC basically said, oh, look, unregistered securities. Congratulations, you're going to jail. Like, welcome to Danbury minimum.

So we've mentioned futures a few times. Let's talk, if we can, come back. The creation, redemption, the structure of ETFs, how much, how is future, how are futures used inside of ETFs? That seems to be only growing. We seem to be getting more and more complex in the ETF world.

So speak if you can for a minute on just how you've seen futures used and how they continue to be used. Yeah. So for a long time, futures were not used. And this is the PIMCO story, such as there is. So when PIMCO launched BOND, which was their clone of the PIMCO Total Return Mutual Fund, which at the time was the biggest mutual fund in the world. This was 15 or 10 years ago, something like that, 10 years ago. They tried to launch it as a pure clone and they couldn't. And the reason they couldn't was because they couldn't get the SEC to approve allowing them to use things like interest rate futures, right? Just simple

stuff that they used in their bond portfolio to just manage risk around the edges, get a little exposure here, add a little convexity there, just like really pretty straightforward stuff from a futures trading position. And de minimis amounts of the fund. It's not like this was 25% of the fund. It was a percent or two, right? It was equitizing cash, things like that. And when they launched as a fully active, fully transparent ETF, the SEC said no derivatives, period, top to bottom. And this was part of a set, I mean, and the dates don't matter, but from about 2000 through about 2015, the SEC has gone back and forth on how ETFs can or can't use derivatives multiple times. And this is back to your, there were just exceptions.

There wasn't one rule. It was just this issue had a better lawyer and got it through. This one didn't. Yeah. And there still exists a huge mismatch in what individual firms are allowed to do based on when and how they got approval. So if you launch a fund now, thankfully, you've got a new set of laws, the 6011 rules for ETFs, but there's still people who have grandfathered stuff for another

seven months or something like that, where they get to do stuff nobody else gets to do. And derivatives were one of these things where there was a real haves and have nots. In particular, you ended up with situations where the leveraged and inverse guys, direction and pro shares, could do a bunch of stuff, launch a bunch of product. Most of those are just regular old 40 act funds that just sit on a whole bunch of cash and swap positions. And they were totally allowed to do that. Nobody else was, nobody else could get permission. So they went back to the well and they sort of rewrote those rules. And now it's relatively straightforward to use futures in one of two ways in an ETF. The most common way now and the way all of these Bitcoin products are being filed is through what's called the Cayman Islands hack. And what that just means is-

Yeah, Cayman blockers. Yeah. So you just end up sticking, you have a million dollars from your investors, you take most of that and you just leave it sitting in cash on your balance sheet. You buy some repo, minimum risk, collateral. You take 25% of it and you send it down to a subsidiary in the Caymans, which then levers that up, usually just using the inherent leverage in the futures contracts to get you notionally 100% of the exposure you wanted in the first place. And what that lets you do is run a very concentrated portfolio in the Cayman Islands

because what you're showing on your books is a whole pile of cash. And from an IRS perspective, that gets you out of jail on the tax front very easily. So you end up with notionally 100% of the futures exposure you wanted, a little bit of cash, which isn't actually generating any revenue at this point. But in the old days, that used to be yield too. And so you get effectively your notional Delta one exposure to the futures contracts you were looking at. And you don't get a K1 partnership tax form at the end of the year, which you would if you did it the other way, which is you just list a commodities pool to trade. That's what something like USO, which people use to trade front month oil futures, that's just a listed commodity pool. And so that's regulated by the CFTC. It's not a

40 act fund. You get taxed on a 60, 40 long, short basis. You get marked to market every year and you get a K1 form. So it's a huge pain in the ass from a tax perspective. And that's because they're holding the futures directly. Yeah. They're just holding futures, right? They are a commodities pool. And those funds work great. It's just they give you this weird tax treatment, which for some investors is beneficial. If you're a short-term holder, you get some long-term treatment. That's a good thing. And all of our listeners basically have that tax treatment. So go easy on them. Yeah. So, I mean, that's the problem for most people trying to play in the commodities or future space with ETFs is some of those funds throw you these K1 forms and that's a pain in the ass. Some of them don't.

The so-called no K1 funds all use this Cayman Islands hack to get around. And if I'm an ETF normal retail guy, I have no idea probably even what a K1 is, right? I just want to click it and get my 1099B from E-Trade or whatever. About six, seven years ago, I used to get the regular email from financial advisors who were saying, so I bought all this commodities exposure because it's 2010, 2011, we're in the middle of that commodities run. People are like, go, go,, this 2010, 2011, we're in the middle of that commodities run. People are like, go, go, go. And then they're sitting there in, you know, April of the next year and they still haven't gotten their K1 forms from their clients. And they have 100 clients that can't file their taxes and they're all grumpy about it because they didn't realize that's what K1s are. Right. Everybody files an extension if you're waiting for a K1.

That's just how that game is played. And what are your thoughts we did a post god must be like 10 years ago now but it was the ung i think was the natural gas and i can't remember there was the inverse and the positive yeah and they were both down 95 life today right so people are like what what is happening here um shouldn't one go up and that's just as a result of, as you said, contango and backwardation and the role- Well, and daily rebalancing, the inverse leverage stuff. I think we've passed- Talk if you could about that and how that works in the VIX and all that of why these aren't,

investors shouldn't think of them as buying old, right? Yeah. I mean, the good news is for the most part, I think the retail phase of heavy use of leveraged and inverse funds seems to be over. They were never designed for retail investors. Levered and inverse products were always designed as trading vehicles, predominantly for hedge funds or institutions that trade a lot. But the problem is if you look at any things like Nugget, which is the double to 2X gold miners ETF or something like that, the way they get that 2X exposure is by resetting it every single day. So every morning at 9.30, when the market opens, you're going to get 2X the return when four o'clock rolls around.

So if it's up 1%, you're going to be up 2%. But the problem is that means every single night you have to rebalance that portfolio. It also means that you're pro cyclical, whether you're long or short. What I mean by that is like, if you're in nugget and gold miners go up, you have to buy more. You have to notionally get more exposure tomorrow to keep your 2x leverage. So you've got to go negotiate a swap contract to get more levered. If you were in the inverse of that, which I think is dust, the exact same thing happens, right? Your position just got shrunk, which means you now need to unload, which means that you are unloading your short means you're a natural buyer. So everybody

has to go in and buy at the close if they're rebalancing these leverage and inverse products. So in markets where the leverage and inverse products become a big part of the market, that's a huge issue. And where that's shown up is in VIX. There are windows of time in which the daily rebalance of what are now a fairly small number of those volatility ETPs, they basically absorb all of the available vega you can buy in the market. Now, it hasn't happened in a while, and it's certainly not every day, but there are these windows of time. And I have a spreadsheet I occasionally post on Twitter that sort of shows when it's a big deal, where you can look and say, okay, well, let's see, the VIX futures complex is traded, I'm making up numbers here, a billion dollars notional through 330. And then all of a sudden, it's got 10 billion notional to put on, because that's the rebalance from the complex. And it's usually not that scaled, but a lot of these weird end of day things we see during times of significant crisis can actually be explained by the rebalance of the

leverage and inverse ETPs. Right. I think what we called volmageddon, right, of the Feb 18 was that effect going on into the close. And then actual options traders were seeing their spreads blow out and it just started to cascade. Well, and this is sort of gets into the long ball stuff and the Chris Didials and Chem Carsons and Mike Greens of the world and those folks that you've had on. This is just one more thing that is adding this weird pro-cyclicality to all of our markets, right? Which is part of the long ball thesis is we are mismeasuring the real tail risk here because everything feels really nice and happy and central tendency and VIX is printing 15 as I'm writing this,

except boy does it go from 15 to 25 in a heartbeat, right? So we can't count on those measurements at all. And that's really what we're talking about. It's just another pro-cyclical factor that as prices move, prices move. I love it. And I'm going to come back because you had a nice piece on that about the GameStop, which sort of ties in there. But we mentioned the tax. So just quickly talk about the tax loophole. Is it a loophole or the benefit of ETFs? Oh, so back to the beginning on ETFs. Yeah. So yeah, one of the reasons ETFs caught advisors' attention in the 2000s and why they became the growth engine was

because the vast majority of ETFs have never made a capital gains distribution. And the reason that they do that is they rely on, I mean, I won't get too deep in the weeds, but there's a principle called general utilities, which comes back from the 20s and was sort of codified by the Supreme Court in the 70s or late 60s, which basically says if a company hands out an asset to its shareholders, it is not a taxable event for the company. It is a taxable event for the shareholders. So that's on them, like whether they're taxable or not, or how they do it. That principle was put in place to, I mean, originally because a company happened to be sitting on an enormous amount of stock and somebody wanted to buy it from them and to avoid getting double taxed on both the corporation's position and then the

dividend that they would have had to pay out to their shareholders. They basically gave all their shareholders the stock and let them sell it to the buyer. That was general utilities. That's exactly what happens in an ETF every day. When the ETF needs to unload stock, they hand the stock out to an authorized participant. It's not a taxable event for the fund because since 1920s, it hasn't been. And then those individual shareholders have to deal with it. In this case, those individual shareholders with air quotes are authorized participants. So it's Goldman Sachs and BNY and GTS and all those guys, Jane Street, all of whom get taxed as dealers. So it doesn't matter to them what their basis is. They're getting taxed on that stuff as inventory, not as actual buying and selling for capital gains. So what that lets an ETF...

Sorry, what? They're flipping it a thousand times a day anyway. Yeah, exactly. So it would be a nightmare if they actually had to track basis lots. They don't. That's just not how being a market maker works. So what that means for an average investor is when you go ahead and buy and sell an ETF, your tax experience is uniquely your own. You know what your cost basis is when you bought it. You'll get some dividends over time, maybe. You'll know what your tax basis is when you sell it. You pay your taxes then. As opposed to a mutual fund,

where in a mutual fund, because of the buying and selling and rebalancing inside the mutual fund, and even more importantly, because of selling to meet big redemptions, the fund actually has to end up booking that because they sell the securities to generate cash. And at that point, there's no dodge available to them anymore. If a fund sells something, they're going to own tax on it. So that's why mutual fund investors get this tax distribution every year, whether they did a thing or not, they get a capital gains distribution from most mutual funds that they have to pay taxes on in current years. So ETFs sort of act as this accidental tax deferral, which is enormously valuable for anybody investing taxable money. And do you see that ever either changing or the law changing for the mutual funds?

It seems like an uneven playing field that they should make even in some way. Mutual funds could do this. Technically now in the regulations that we're working under, there really isn't a difference between an ETF and a mutual fund in any meaningful way, except for how it's distributed, like the actual end point of how it gets to an investor. Otherwise they're just mutual funds. So mutual funds could do this. And in fact, they are allowed to do this and do occasionally do it. Vanguard's done this a few times. Large investors can cash out of a mutual fund and get the in-kind securities. Happens in bond funds.

Sometimes you'll get a big institutional, go into a big, less liquid mutual fund, and then use that to get a bunch of securities out of that fund through a redemption. So it can happen, but it can't happen on the individual in and out basis because the way an individual gets new shares of Fidelity Magellan, the mutual fund, is they give them cash and then they have to go buy securities. And when they get out, they get cash back. But it seems like there should be some innovation there of like, okay, we're not going to give you cash. We're going to treat it the same as the ETF world. Yeah. Ultimately, I think it's just all going to end up on the ETF side of the balance sheet, right? With the

exception of 401ks, because you need fractional shares to do 401ks. And that turns out to be hard. Let's talk real quick about, are we becoming too complex? Is there any limit to like what we could do with these ETFs, right? Like the, you mentioned the inverse, the triple inverse, it seems like the LPL and those kinds of groups like put limits on that basically, right? Of like, Hey, you got to sign these extra disclosures. So has that throttled down that innovation? Or you think the innovation's alive and well? Well, what's happened is those types of folks have to now be gatekeepers, right? And so if you're an advisor who uses LPL, chances are you can't trade triple leverage to anything.

You may not even be able to trade commodities, ETFs, right? You're going to have to work underneath a list that they're going to tell you is approved. That's not a bad system, right? The whole mutual fund industry has worked that way for decades and it's worked pretty okay. Now it puts a lot of pressure and a lot of responsibility on the hands of those gatekeepers, which the industry hates, right? Because they don't want all these gatekeepers telling advisors they can't buy their products. But that's sort of the world that we've come to. Now, the bad part of that is there's a lot of pay to play that goes on.

I was just about to say that. We'll put you on the platform once you're at 100 million and we make X off you. Yeah, exactly. So there's a difference between saying we want to see this much liquidity in your product, or we don't think this is exposure we want our advisors getting. Those are pretty reasonable things. We need to have you pay $100,000 to sponsor our conference every year, and then we'll put your funds on our platform. Obviously, that is very different and a little bit less above board. There is a decent amount of that that happens, and that is an issue. And I'd love

to see that get reined in a little bit. Right. I think the best products should be what win. And we, you mentioned dig and dust. Like to me, the best innovation is in the naming conventions, which like, Oh, the ticker battles. They never, ticker battles is awesome. Like just quickly, how does that work? How do you apply for one? Are there, is it like domains? Like every four letter word, I'm sure is probably already taken or close to it. It doesn't quite work like that. So if you're an issuer, you have to go to the person at the exchange that you're working with, your listing agent, and you ask them to reserve a ticker for you. And there's a system that the exchanges all

work into. I think technically it's run through NASDAQ like the tape is, but it doesn't really matter. There is a system all the exchanges use to reserve tickers. And you have a certain amount of time to use it. It might be six months. It might be a little longer now. Oh, really? But they roll off, right? You can't squat on it forever.

It's not like a domain where you can just feed it 10 bucks a year and you get to own it forever. There's a bit of a user to lose quality to it. They should just make that a crypto market where they trade. Yeah, because there's no question if you can get weed as the ticker for your pot fund, you're in better shape than if it's PTX or something like that. Yeah, a guy I know had bought Bloomberg2020.com in like 2017 or something. And the campaign came to him and was like, hey, we need this. So I think he sold it for 75 grand or something. Nice. Yeah. Yeah. I don't think you can do that with tickers.

That would happen with like millions, if not billions of dollars would be. Well, yeah. Given what URL sell for that have anything ETF in the title right now, good luck trying to get one of them. But yeah, the ticker system is definitely real. And a lot of that is the rise of retail. We have a lot more retail traders in the ETF market than we ever have before. And so having, particularly if you're going to do something them know, having Buzz as your ticker for your social media ETF is a whole lot better than, you know, SCL. Yeah. And then speaking of starting an ETF, so you get the name, you talked through this a little

bit of like, I've gone down this path a little bit. We were trying to do a managed futures one in the past. The market maker is sort of heavily involved here, right? Or correct me if I'm wrong. Yeah, it depends on the kind of ETF you're trying to launch. But the critical component, there's a lot of plumbing. The plumbing is relatively straightforward. Depending on how you do it, it's somewhere between $150 and infinite amount of money

to sort of just get a custodian and all that stuff and get a trust set up and get the board set up and get stuff filed with FINRA and all that jazz. It's a pretty boilerplate process at this point, since we changed the rules a couple of years ago. Where it gets much trickier is trying to actually be successful. And that's where things like seed money and who your market makers are and who your authorized participants are, who's distributing for you, how you're going to market. That's actually what determines almost all of your success. There are a lot of great products out there that have opened, languished, and closed because nobody could figure out how to sell them or who to sell them to.

Or they had plumbing problems. They didn't work with a market maker. They couldn't keep their spreads tight. They couldn't get creation redemption done well. So those are really critical issues. But i would honestly say distribution is the biggest one if you don't know who's going to buy the product you shouldn't launch it yeah um and in the old old days did it have to be tied to an index yeah pre-2000 challenging me on dates pre-early 2000s when we had the first the bond filing yeah there were only the passive etfs that's all that existed and then people started like their trading strategy became an index even though it wasn't like yeah and you saw a lot of firms um like i think alpha architect

west gray's group like i think they went back and forth i think i think meb did it too at cambria where they like had stuff filed as an index and then they came back to active, but then they went back to index because they wanted to be able to do custom baskets, which allows authorized participants to not be perfect in their creation redemption, which you couldn't do in the active funds for a while. Now it's sort of come back because of the ETF rule, it makes everything easier. So there's been a lot of flip-flopping on whether you take your intellectual property and roll it into an index or just launch a fund. Pros and cons to both sides. I think most managers believe it's a lot easier to run those things active no matter how quantitative they are,

because it's just less paperwork. Yeah. Yeah. Yeah. And then talk a little bit about that bid-ask spread and that's now a required listing on the website, like the average spread, I believe. Yeah. So one of the things that came out of the 6011, the ETF rule was a bunch of standardized disclosures, which is all great around trading premiums and discounts, average spreads, portfolio holdings over time. There's a bunch of new material that really has to be on any traditional 40 act registered ETF. I make that distinction because for instance, if you launch a futures fund, it's not going to have anything to do with that. If it's a commodities pool, right? So this is only the stuff that's going down the middle of

the 40 act. And yeah, and that stuff's pretty straightforward. The honest truth is ETFs are trading so well now, I haven't had to write like an ETF trading story in two years. And I used to write them all the time. Like it was such an easy throwaway story. You find some ETF that printed badly. You go tease it out of the Bloomberg, run the tape, show what happened. It's like, ah, here's a guy who put in a giant fat finger limit order in the middle of a ramp. He got hosed. You don't see that very much anymore.

You don't see big, erroneous trades with the big X on them on the tape. It just really hasn't happened. It didn't happen really at all in March 2020, which was shocking. And what did happen in March 2020, right? There was some, the bond ETFs especially, or the high yield dislocated from the index. Yeah, but that's what's supposed to happen. That was cool because the whole point of the ETF is it's supposed to be the liquidity relief valve for the underlying. You trade the ETF before you trade the underlying. That's the whole point. I want exposure to Germany, but I don't want to open an account

over there. I buy the ETF, it buys Germany for me. So you're buying on purpose for that dislocation to the underlying market. Where people sometimes get hung up is on highly liquid markets that can go very illiquid, like bonds, particularly high yield immunies. When you get that switch in liquidity, you get a natural disconnect between what you think the underlying market should be doing and what the ETF is doing. And that's a big distinction because when we had those quote unquote dislocations in March 23rd, I think it was, of 2020, the dislocation wasn't that the ETF did something weird. It's that the underlying market stopped trading entirely. So you went from trace eligible high yield bonds that I would watch on my screen trading 50 times a day to trading three times a

week. And so at that point, how do you say what that thing is worth? If it traded at par yesterday and 10 down today, and then doesn't trade for eight days, do you assume that it's still sitting 10 down? You assume it went back up because something... So that's the problem is you end up with net asset values that are completely bogus because the underlying hasn't traded, but the ETF trades every second. So that's where you see the disconnect because the ETF becomes the warehouse for all price discovery when liquidity hits. And some people are putting that up there as like, this proves the ETFs are going to ruin the whole market, right? And any credence to that? Or no, it's still- No, it's 100% the opposite. Imagine a world where March 23rd, whatever day it was in 2020, the world's melting. The Fed hasn't made any

backstop announcements. Everybody's unloading corporate credit. So all the triple Cs go first, any bid gets hit. And now everybody's sitting on the junkiest part of their portfolio, knowing it's at risk, assuming they're not going to get backstopped and there's no ETFs in existence. What happens? Those things trade to zero. Literally, they start trading at pennies on the dollar because there's managers out there that need to get these things off their books before the risk manager walks in the door. Right?

Like just real talk, human beings here. So we've seen that happen. This is what happened to some extent in 2008, in the worst trading days. People were just unloading anything they could, and that's what drives things to crazy dumb discounts. Within ETF, you have a relief valve. You have a highly liquid single security as opposed to all those individual bonds that can absorb all of that panic. And so people who want to take risk by buying at the bottom have one trade that they know they can get executed to take that risk.

People who want to unload that risk at any price, they can unload that risk at any price, but you don't break the whole market. You allow those who are seeking and providing liquidity to reset the price. And that's how markets are supposed to work. Yeah. Well, same as a futures market in that way, I guess. So I want to finish up with, talk a little bit about your post when that GameStop thing was happening and

i thought you had a really good post on how it was you know it's it's not the same as in the past when there were either boiler rooms or chat rooms or you know just enthusiasm this is algorithmic driven enthusiasm so just summarize if you could that post and we'll dig into it a little bit yeah so you know i think the the challenge of the GameStop moment, and I think that's really what it was because it hasn't really ended, but it sort of kicked something off was that it pulled together multiple forces into a single event. The one that almost everybody got focused on was gamma and that totally legitimately a part of it, right. That the options dealers were trying to figure out how to hedge their gamma and a bunch of guys on the internet had figured out

how to put them in a tight spot and that moved the price. So that is 100% a thing that happened. I actually think it's only about 20% of what happened because at the same time, what you ended up with was a whole lot of individual investors who now had access that they had not previously had, whether it was through Robinhood or whatever, sitting at home, some of them with extra money that they hadn't had before, but mostly just bored. And I think there's a cultural component to that too. Scott

Galloway did a lot of great work talking about the challenge of specifically young men. I know gender is a tough thing to get into here, but I think there was some truth to that, that you took a whole lot of young men and you locked them in a room and told them they needed to figure out something to do. And a lot of them ended up on Reddit. Yeah. So that was a piece of it as well. But I think the other piece people miss is a whole lot of people had just made an awful lot of money in crypto in 2019 going into 2020. And that money did not sit on the crypto side of the balance sheet. And that's part of why crypto goes up and down so much, right? Because people take their winnings and they move it to the other parts of the world. And the other parts of

the world include things like GameStop stock. So I still believe that a lot of the activity we saw in GameStop and continue to see in meme stocks today is driven by people who are fundamentally crypto traders. That's where they started. That's where they made their money. And so when people look at even things like what's going on in the NFT market right now, and they're like, how in the world can people spend $2 million on a pixel and then shocked that it goes down to a million dollars the next day? And isn't somebody, no, people aren't crying in their soup because that money all started in crypto. People assume that things are going to be insane and volatile and driven by meme, driven by intent rather than by fundamentals. And that's what we've seen, right? That trading by

intent and valuation by intent is everything that's driving those stocks, right? That's why, I mean, I keep them up on my screen just because it's boring not to. Like, that's why, who's on top today? A GME is down, you know, 3% today. Like tomorrow it'll be up 10%. Like, this is not anybody trading these stocks on fundamentals. Lily Frank is on Twitter, had a good quote of the,

regret per dollar is very low, right? Like they have no regrets because it's free money, basically. Right. It's house money. I mean, I got a rack of behavioral economist books on the back of my wall here that would tell me, oh, it's irrational, blah, blah, blah. It's not house money is a fallacy and all that. It's not. This is how people are actually reacting to the world that's been handed to them. And in a lot of cases, I know a bunch of folks that are heavily in this space, trading crypto, trading DeFi, trading meme stocks. It's not that they don't understand that a million dollars has a million dollars worth of economic value.

It's that they made enough money over the last three years that they feel like they've got their basics covered and they're willing to take enormous exogenous risk with the part that's not. That's the old, uh, trader trick. What's the best way to make a million dollars? Start with 10. Yeah, exactly. The, um, but in tying it back, your post a little bit was that this is algorithmically driven, right? Of the more people look at GameStop, the more of the algorithm is going to serve up stuff about GameStop. That's the other part. And, and and and and this is something that i honestly if people want to get up to speed on this what they really should do is just spend on way too much time on tick tock for a day like just one day just and and for you know particularly you know guys in my generation uh you know my socioeconomic bracket bracket we're not sitting around on tick tock day. Yet, if you go look at what's

happening, not just there, but on Instagram and on Twitter to some extent and on Reddit, and even on Google News Search, what you see is a result of what everybody else is talking about and the result of an algorithm that's trying to decide what you've been interested in before. So if you're a crypto trader and you've been trading a lot of wacky stuff on the side, and you've been liking a lot of posts about this guy's DeFi project, and then all those people who are doing that migrate to talking about GameStop because there's a technical hack, the gamma piece, then all of a sudden, all you're going to see is that. Even though it may be a terrible investment, even though something much more interesting and much more valuable is happening somewhere else, because you're already part of

an ecosystem of self-reinforcement, you've limited your funnel. You've limited the access to information you're going to get. So it creates this environment where hurting isn't just a thing that happens once in a while. It's actually the driving force for a lot of this stuff. I keep a little chart on my Bloomberg where I try to keep track of the amount of market cap moving between meme stocks and crypto. And it's never perfect, but boy, there are definitely days when you can say, huh, 50 billion came out of Ethereum, 50 billion showed up in AMC. I wonder what happened. And you can track it within minutes. it definitely happens yeah i love it

so we do some quick fire favorites here favorite uh guitar player oh boy uh that's really incredibly difficult i'm gonna going to, I, this is boring, but I'm going to say Jimi Hendrix. I'm not a huge, I don't like pop it on to listen, but I love people who break things. From his, from his skillset. Yeah. Well just, just, he reinvented how he got a guitar. I was expecting that or Prince, but that's good. Yeah. Favorite. You mentioned your books behind you,

their favorite investment book. And then we'll do favorite non-investment book. And I'll include behavioral economics and investment category. Yeah. Oh, boy. Favorite. I mean, I'm going to be boring here again. I'm going to start with Ben Graham because that's probably what kicked me off right that's i think probably easiest one um but i probably then back up to misbehavior of markets mandelbrot yeah that'd probably be it love it just again because he's taking status quo and figuring out all the ways it's broken and that's kind of been my whole career i was uh getting into the n a little bit, looking at those. And there was a couple of Mandelbrot images that were catching my eye.

Yeah. I actually tried to buy one in my wallet. It was got too complex for the time of night. And I'm like, I'll do this tomorrow. So whatever I was looking at, it's probably up. It's probably up a thousand percent. Exactly. Now it costs as much as a car.

Yeah. I missed it. Favorite non- percent since then. Exactly. Now it costs as much as a car. Yeah. I missed it. Favorite non-investment book? House of Leaves by Daniel Lusky. All right. Don't know. Which again, it's a multi-threaded narrative. You have to buy it in print because it's color-coded.

So you can't really read it on a Kindle. And it's four or five stories told together through an interweaving narrative. It's bonkers. Big related. Love it. Favorite ETF ticker or tickers. Oh boy. It's so hard to pick a favorite.

We could say funniest. PBJ. I've always thought PBJ was a great one because it's food and beverage. And it was one of the first tickers I remember seeing somebody trying to be clever with. Right. Now you have to be, right? Right now it's weed and buzz and dust and nugget and, you know, all that kind of stuff. So there are good ones out there, you know, and a lot of them are thematic. Right. So a lot of the thematic funds that have launched have fun ticker jets. You know, jets is such a great ticker. How can you not like jets? But I always have a soft spot for PBJ. My buddy's a doctor and he was getting caught up in all the stock trading. Like we were just saying in March, 2020, just kept texting to everybody.

Jets, jets, jets. Like during the rally, he would just text jets. J E T S jets, jets, jets. And lastly, all our guests get the favorite star Wars character. Oh, I'm going to have to go with Luke. i mean i was you know i i'm i'm old i was born in the mid 60s so you know luke was luke was teenage uh in teenage hero worship for me i mean i think i was 14 when i saw star wars something like that um were you a mandalorian watcher oh god huge huge so that last episode where he cut the cgi version of luke that was pretty cool there's a cgi i think he'd think they rotoscoped him for it i think he actually did the acting for

it really nice yeah um and there's a i'll send it to you maybe we'll put it in the show notes there someone put different music to that the uh i can't remember the uh one of the themes from the earlier movies to him coming through there and knocking down all those guys. It's awesome. Oh my God. So great. I will send that. You've just spoiled the end of the Mandalorian for your, I know. Sorry. Spoiler alert. I mean, come on. If you haven't watched it by now, at this point, I think the statute of limitations is over on the Mandalorian. Exactly. Awesome. Well, thanks so much. It's been fun.

Oh, it's been great. I really appreciate the opportunity to be here. Yeah. I'll look you up next time we're in upstate New York and shoot over the border and grab a coffee for sure. Definitely. All right. Thanks so much. All right. Cheers.

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