Speaker 1: Hello, and welcome to Trillions presents the E t F Story.
Speaker 1: I'm Joel Webber and I'm the editor of Bloomberg Business Week.
Speaker 1: In this episode, we're going to focus on a critical
Speaker 1: part of the e t S rise, which Eric baltun
Speaker 1: Iss likens to something out of early Silicon Valley. It
Speaker 1: almost seems like webs and spy at this time. We're
Speaker 1: like the PC or the mouse went back when Xerox
Speaker 1: had it, where some people just recognize its potential, even
Speaker 1: of the people who actually own it at the time
Speaker 1: don't see it. This is Dave Noddi. He's the managing
Speaker 1: director of e t F dot Com. The comparison to
Speaker 1: what happened with the pala Alto Research Center, the Park
Speaker 1: Labs having the the gooey for what became the mac
Speaker 1: uh and that sort of that idea, whether it's stolen
Speaker 1: or borrowed or whatever, it's very apt for the e
Speaker 1: t F for number of reasons. It's it's apt because
Speaker 1: you can argue about the intellectual property and is it
Speaker 1: theft or is it you know, people just recognizing greatness
Speaker 1: and building on it. But it's also relevant because it
Speaker 1: was that big a phase shift in how people thought
Speaker 1: about investing naught. It has been around E t F
Speaker 1: pretty much since the beginning, and he says that, yes,
Speaker 1: the Market Break Report is largely credited as the genesis
Speaker 1: of the E t F, as that's where Nate Most
Speaker 1: and Steve Bloom got their idea for spot success has
Speaker 1: a thousand fathers. So everybody tries to claim on a
Speaker 1: given day that they were the father of the E
Speaker 1: t F. It's really whatever unnamed person probably slid that
Speaker 1: into the report. But I will say this that once
Speaker 1: that idea was planted in that you know, sec report,
Speaker 1: the idea was in the air. Bob Tole is president
Speaker 1: of his own E t F consulting company, but was
Speaker 1: with Morgan Stanley in the nineteen eighties, and he says
Speaker 1: nothing is right about there being something in the air
Speaker 1: after the seven Market Break Report was published. He says
Speaker 1: people were trying to come up with something like a
Speaker 1: collective investment, but that treated like a stock. Meanwhile, Leland
Speaker 1: O'Brien and Ruberstein are really trying to redeem themselves in
Speaker 1: the financial community, and they start working on a product
Speaker 1: called super shares up in Canada, the Canadian Stock Exchanges,
Speaker 1: working on a thing called tips. All of these became
Speaker 1: the precursors to both securities. Remember John O'Brien from episode one, who,
Speaker 1: along with a team at Leland O'Brien Rubinstein, created portfolio insurance,
Speaker 1: but most people in Wall Street didn't understand what that was.
Speaker 1: Some big asset managers did, some big focal dealers did,
Speaker 1: and they realized when the market went down, portfolio insurance
Speaker 1: required selling stock and buying bonds. As Toll says, O'Brien
Speaker 1: and his firm were working to redeem themselves because their
Speaker 1: portfolio insurance was largely credited to stock market crash. O'Brien
Speaker 1: says that what they were working on was the first TTF. Yeah, well,
Speaker 1: I think we were the creator of the t F A.
Speaker 1: It wasn't called any TF back then. He says. They
Speaker 1: were communicating with folks at the am X at the time,
Speaker 1: and we have a handshake agreement they would not copy
Speaker 1: our products and they would benefit from the trading of it.
Speaker 1: O'Brien says the AMEX didn't hold up their end of
Speaker 1: the deal, so they undercut us, you know, maybe not
Speaker 1: so intentionally, but maybe intentionally, and came out with the
Speaker 1: spies exactly one month and one day after the super
Speaker 1: Trust began trading on November five, and when I called
Speaker 1: him up, they said, well, the handshake agreement is good
Speaker 1: for a month. Meanwhile, up in Canada, a spy is
Speaker 1: waiting for SEC approval. A team from the Toronto Stock
Speaker 1: Exchange managed to get their version of a market basket
Speaker 1: product approved within a year. It was called the Toronto
Speaker 1: Index Participation shares or tips and attract the Toronto Stock
Speaker 1: Exchange Index. And this was an e t F launched. Now,
Speaker 1: if you go around to conferences like I do, there's
Speaker 1: a general view amongst the analysts that Canada came out
Speaker 1: with the first TTF. However, when I talked with people
Speaker 1: from that time, even from Canada, and they admitted that
Speaker 1: what happened was the Toronto Stock Exchange had come down
Speaker 1: and met with AMEX and just I guess they just
Speaker 1: you know, we're friends, buddies. They took the spy idea
Speaker 1: and basically red sketched it up there. And the Canadian
Speaker 1: regulatory body is much more liberal than the US. We've
Speaker 1: seen that time and time again. Since then, they were
Speaker 1: in and out of approval process within a year. Dave
Speaker 1: Nodding says, he's not proving to all those details about
Speaker 1: how TIPS came about, but one thing was for sure, Yeah,
Speaker 1: the am X was driving it. And whether or not,
Speaker 1: you know, Nate showed the idea to somebody over a
Speaker 1: T s X or Toronto at that time, um, and
Speaker 1: they stole the idea, launched it there. To some extent.
Speaker 1: It's a little bit of I don't know who really cares.
Speaker 1: I mean exposed in retrospect. You can make a good,
Speaker 1: you know, thriller movie out of it. Somebody running the
Speaker 1: briefcase across the tracks kind of thing. We spoke with
Speaker 1: Peter Haynes, who began his career on the Toronto Stock
Speaker 1: Exchange as an intern. I came back were a full
Speaker 1: time in eighty nine and Tips from launching nineties saw
Speaker 1: as part of the launch team for TIPS, so I
Speaker 1: do have that on my resume. TIPS Toronto Index Participation
Speaker 1: Units is what they were called. The symbol was t
Speaker 1: I P listed on the Toronto Stock Exchange on March nine,
Speaker 1: and probably the most interesting factoid of all is that
Speaker 1: there was zero feet. Haynes says there was no management
Speaker 1: expense ratio or mirror at the time, and that the
Speaker 1: exchange ran as a way to give retail investors access
Speaker 1: to the market with just one trading vehicle. The hundred
Speaker 1: and fifty million dollars that were seated at the original
Speaker 1: launch of TIPS all one million institutional investors, so that
Speaker 1: was a bit of a surprise in the shock. Haynes
Speaker 1: says that yes, there were conversations with Nate Most and
Speaker 1: Steven Bloom at the time, but that the most significant
Speaker 1: influence on their product was not the AMMYX the Philadelphia
Speaker 1: Exchange as they were attempting to launch something called SIPs
Speaker 1: cash Index Participation securities and they struggled to get that
Speaker 1: product through the sec And this was in the late
Speaker 1: eighties early nineties that they were trying this, and our
Speaker 1: management at the time had spent some time with the
Speaker 1: Philly guys and said, hey, let's try this in Canada.
Speaker 1: And where we were lucky and I think forward thinking
Speaker 1: in terms of our regulators was the time from the
Speaker 1: time the obviously was approached to the time was approved
Speaker 1: was I believe less than six months. So it was really,
Speaker 1: at the end of the day, a lucky thing that
Speaker 1: the Toronto Exchange happened to be the first market in
Speaker 1: the world to launch an e t F. But you know,
Speaker 1: sometimes it's better to be lucky than good. Reggie Brown
Speaker 1: of Cantor Fitzgerald, whose nickname Mr ETF, was working at
Speaker 1: the Philadelphia Stock Exchange when the Philix developed Certificate Index
Speaker 1: Participation Shares or SIPs, and I remember uniquely that they
Speaker 1: were born from the seven Crash and some gurus at
Speaker 1: the Philipstocer Exchange came with an idea based on a report,
Speaker 1: and I do remember they traded briefly on the phile X,
Speaker 1: and in my role on the industry, I always recall, Hey,
Speaker 1: by the way, the Philix had SIPs and unfortunately it
Speaker 1: was overlooked, not well recognized, and they were designed based
Speaker 1: on the report that came out from the government said
Speaker 1: there needed to be a vehicle in order to help
Speaker 1: offset sell in bounce orders in the marketplace, and the
Speaker 1: phil X was ahead of their time, but unfortunately they
Speaker 1: went away. Brown says there was a legal issue with
Speaker 1: McGrath hill, who owned a license name of SP five
Speaker 1: under a standard and colors and McGraw hill sued and
Speaker 1: successfully got in a junction around trademark issues around SIPs
Speaker 1: and it stopped trading because of that. So the reality
Speaker 1: is these other products did come to market before Spy.
Speaker 1: Here's Eric again. So to sum this up, even though
Speaker 1: you may hear that Canada came out with the first TTF,
Speaker 1: that is true, but the idea was in the US.
Speaker 1: I think that's important. So it's a good footnote to
Speaker 1: the story. In the end, the fact that Spy is
Speaker 1: the biggest et F on the planet almost by twofold
Speaker 1: says all you need to know. And the TIPS product
Speaker 1: has been bought and merged and doesn't even have that
Speaker 1: ticker anymore, and that kind of also matters to the story.
Speaker 1: So the fact that Spy outlasted them, outlived them, outgrew them,
Speaker 1: and is the most trade to security four times over
Speaker 1: on the planet as to its so legacy. But some
Speaker 1: have tried to take away from it by saying, well,
Speaker 1: actually it wasn't first, and so I would say, well,
Speaker 1: it depends on how you define it. And I don't
Speaker 1: blame Toronod for doing it. It It was a heads up play.
Speaker 1: But the fact that just because they had to wait
Speaker 1: four years, you can't really blame them for that. They
Speaker 1: would have been out in one if they could. They
Speaker 1: have been at if they could have, But why didn't
Speaker 1: these products that were birth from similar circumstances at the
Speaker 1: exact same time gained the same success well, as Bob
Speaker 1: Tole says, there are a few reasons. Well, first of all,
Speaker 1: you had the most renowned index in the United States,
Speaker 1: next to the dal Jones Industrial thirty right being the
Speaker 1: benchmark for it. It was a full replication, so there
Speaker 1: was no question on the back of the SEC that
Speaker 1: somebody was managing this asset. And you had the publications
Speaker 1: that they required daily of information to provide a level
Speaker 1: of transparency that was nowhere available in the mutual fund industry,
Speaker 1: information including the composition the assets, the holdings, and what
Speaker 1: the waitings were. Also, these similar products hadn't undergone the
Speaker 1: same level of scrutiny with the U. S. Government as
Speaker 1: Spy had because Spy, remember was filed under the forty Act.
Speaker 1: A move toll Fields was worth the weight. Oh absolutely, honestly,
Speaker 1: I do. You could have had a structured note, but
Speaker 1: then you realize you're taking balance sheet risk. At that time,
Speaker 1: especially after the eight seven crash, nobody wanted balance sheet risk. Okay,
Speaker 1: then you say, okay, I'm gonna buy a mutual fund. Well,
Speaker 1: that was what everybody thought was froll to begin with.
Speaker 1: So now you have to have a new structure, so
Speaker 1: you have your choices. Right, you can have a closed
Speaker 1: end fund which has premiument discounts. Right, you could have
Speaker 1: a traditional mutual fund, or you could have this new
Speaker 1: animal called at this time an index share. And the
Speaker 1: index share was really I mean, it was an epiphany.
Speaker 1: Dave Not says, a lot of Spy success can be
Speaker 1: attributed to its no frill structure. If you actually look
Speaker 1: at the structure of Spy, it was phenomenally simple. A
Speaker 1: lot of the index participation, securities models and things really
Speaker 1: were almost like versions of structured notes, right. They were complex,
Speaker 1: they had counterparties that people weren't used to dealing with.
Speaker 1: And I think that the genius of the Spy model
Speaker 1: and then later the sort of more traditional for the
Speaker 1: act versions that came after it, where they took really
Speaker 1: simple existing structures and they used those to create what
Speaker 1: they needed to create. Um, you know, they used the
Speaker 1: U I T structure to you know, embed the index
Speaker 1: into the product. That I think was a really critical
Speaker 1: part of getting that approved. But you know, they used
Speaker 1: that structure that existed already that lawyers were comfortable with
Speaker 1: that everybody was comfortable with, and they said, oh great,
Speaker 1: that's our investment vehicle. And then they took sort of
Speaker 1: a traditional prime brokerage model of moving large baskets of
Speaker 1: securities in and out, and they said, hey, we're just
Speaker 1: going to take what was then the default prime brokerage
Speaker 1: trading model. We're going to use that to do these
Speaker 1: creation redemption baskets. So what they did was take all
Speaker 1: the pieces that already worked and changed as little as
Speaker 1: possible to make something new happen. And now spices footprint
Speaker 1: is enormous as the largest ETF with two dred and
Speaker 1: seventy billion in assets. For a comparison, the second largest
Speaker 1: et F has one billion dollars less than assets than SPY.
Speaker 1: It's really stood the test of time. Here's not again.
Speaker 1: But but in the end, all of these things come
Speaker 1: down to execution. And I think that's actually been the
Speaker 1: story of ets for twenty five years, is it's always
Speaker 1: down to execution. Next time on trains presents how the
Speaker 1: e t F really started to gain steam. It wasn't
Speaker 1: until I was sitting on a trading desk and all
Speaker 1: of a sudden, I could like hit a button and
Speaker 1: get a million dollar exposure to the cues. I was
Speaker 1: all in. Thanks for listening to Trillions Presents until next time.
Speaker 1: You can find us on the Bloomberg Terminal, Bloomberg dot com,
Speaker 1: Apple Podcasts, and where else you want to listen. Trillions
Speaker 1: Presents is produced by Jordan Bell, with production help from
Speaker 1: Magnus Hendrickson. Francesco Levy is the head of Bloomberg Podcasts.