WEBVTT - The ETF Story 4: The Competition 0:00:04.360 --> 0:00:07.680 Hello, and welcome to Trillions presents the E t F Story. 0:00:07.840 --> 0:00:10.720 I'm Joel Webber and I'm the editor of Bloomberg Business Week. 0:00:11.160 --> 0:00:13.240 In this episode, we're going to focus on a critical 0:00:13.320 --> 0:00:16.439 part of the e t S rise, which Eric baltun 0:00:16.520 --> 0:00:19.279 Iss likens to something out of early Silicon Valley. It 0:00:19.320 --> 0:00:22.520 almost seems like webs and spy at this time. We're 0:00:22.600 --> 0:00:26.040 like the PC or the mouse went back when Xerox 0:00:26.120 --> 0:00:31.720 had it, where some people just recognize its potential, even 0:00:31.720 --> 0:00:34.560 of the people who actually own it at the time 0:00:35.200 --> 0:00:41.959 don't see it. This is Dave Noddi. He's the managing 0:00:42.000 --> 0:00:45.680 director of e t F dot Com. The comparison to 0:00:45.720 --> 0:00:48.160 what happened with the pala Alto Research Center, the Park 0:00:48.240 --> 0:00:51.640 Labs having the the gooey for what became the mac 0:00:52.000 --> 0:00:54.680 uh and that sort of that idea, whether it's stolen 0:00:54.800 --> 0:00:58.000 or borrowed or whatever, it's very apt for the e 0:00:58.080 --> 0:01:00.960 t F for number of reasons. It's it's apt because 0:01:01.040 --> 0:01:03.280 you can argue about the intellectual property and is it 0:01:03.400 --> 0:01:06.880 theft or is it you know, people just recognizing greatness 0:01:06.880 --> 0:01:09.160 and building on it. But it's also relevant because it 0:01:09.200 --> 0:01:11.959 was that big a phase shift in how people thought 0:01:11.959 --> 0:01:15.160 about investing naught. It has been around E t F 0:01:15.280 --> 0:01:18.919 pretty much since the beginning, and he says that, yes, 0:01:18.120 --> 0:01:22.679 the Market Break Report is largely credited as the genesis 0:01:22.720 --> 0:01:25.520 of the E t F, as that's where Nate Most 0:01:25.560 --> 0:01:28.840 and Steve Bloom got their idea for spot success has 0:01:28.840 --> 0:01:31.280 a thousand fathers. So everybody tries to claim on a 0:01:31.319 --> 0:01:33.000 given day that they were the father of the E 0:01:33.040 --> 0:01:36.680 t F. It's really whatever unnamed person probably slid that 0:01:36.720 --> 0:01:40.560 into the report. But I will say this that once 0:01:40.640 --> 0:01:44.000 that idea was planted in that you know, sec report, 0:01:44.520 --> 0:01:48.760 the idea was in the air. Bob Tole is president 0:01:48.800 --> 0:01:51.600 of his own E t F consulting company, but was 0:01:51.640 --> 0:01:54.520 with Morgan Stanley in the nineteen eighties, and he says 0:01:54.600 --> 0:01:57.800 nothing is right about there being something in the air 0:01:58.040 --> 0:02:01.680 after the seven Market Break Report was published. He says 0:02:01.720 --> 0:02:03.400 people were trying to come up with something like a 0:02:03.480 --> 0:02:07.600 collective investment, but that treated like a stock. Meanwhile, Leland 0:02:07.640 --> 0:02:11.560 O'Brien and Ruberstein are really trying to redeem themselves in 0:02:11.600 --> 0:02:14.639 the financial community, and they start working on a product 0:02:14.680 --> 0:02:19.560 called super shares up in Canada, the Canadian Stock Exchanges, 0:02:19.639 --> 0:02:22.959 working on a thing called tips. All of these became 0:02:23.000 --> 0:02:28.040 the precursors to both securities. Remember John O'Brien from episode one, who, 0:02:28.080 --> 0:02:32.760 along with a team at Leland O'Brien Rubinstein, created portfolio insurance, 0:02:33.080 --> 0:02:37.280 but most people in Wall Street didn't understand what that was. 0:02:38.320 --> 0:02:42.720 Some big asset managers did, some big focal dealers did, 0:02:43.120 --> 0:02:46.400 and they realized when the market went down, portfolio insurance 0:02:47.480 --> 0:02:52.520 required selling stock and buying bonds. As Toll says, O'Brien 0:02:52.600 --> 0:02:56.079 and his firm were working to redeem themselves because their 0:02:56.080 --> 0:03:02.320 portfolio insurance was largely credited to stock market crash. O'Brien 0:03:02.360 --> 0:03:06.079 says that what they were working on was the first TTF. Yeah, well, 0:03:06.080 --> 0:03:08.320 I think we were the creator of the t F A. 0:03:08.639 --> 0:03:11.520 It wasn't called any TF back then. He says. They 0:03:11.520 --> 0:03:13.839 were communicating with folks at the am X at the time, 0:03:14.040 --> 0:03:19.320 and we have a handshake agreement they would not copy 0:03:19.480 --> 0:03:24.160 our products and they would benefit from the trading of it. 0:03:25.240 --> 0:03:27.720 O'Brien says the AMEX didn't hold up their end of 0:03:27.800 --> 0:03:31.400 the deal, so they undercut us, you know, maybe not 0:03:31.840 --> 0:03:35.840 so intentionally, but maybe intentionally, and came out with the 0:03:35.840 --> 0:03:41.680 spies exactly one month and one day after the super 0:03:41.720 --> 0:03:49.720 Trust began trading on November five, and when I called 0:03:49.800 --> 0:03:52.840 him up, they said, well, the handshake agreement is good 0:03:52.840 --> 0:03:58.280 for a month. Meanwhile, up in Canada, a spy is 0:03:58.280 --> 0:04:01.760 waiting for SEC approval. A team from the Toronto Stock 0:04:01.840 --> 0:04:05.240 Exchange managed to get their version of a market basket 0:04:05.240 --> 0:04:08.400 product approved within a year. It was called the Toronto 0:04:08.640 --> 0:04:13.120 Index Participation shares or tips and attract the Toronto Stock 0:04:13.120 --> 0:04:17.280 Exchange Index. And this was an e t F launched. Now, 0:04:17.880 --> 0:04:20.600 if you go around to conferences like I do, there's 0:04:20.600 --> 0:04:23.400 a general view amongst the analysts that Canada came out 0:04:23.400 --> 0:04:26.440 with the first TTF. However, when I talked with people 0:04:26.960 --> 0:04:30.560 from that time, even from Canada, and they admitted that 0:04:30.600 --> 0:04:33.040 what happened was the Toronto Stock Exchange had come down 0:04:33.160 --> 0:04:35.680 and met with AMEX and just I guess they just 0:04:35.880 --> 0:04:39.919 you know, we're friends, buddies. They took the spy idea 0:04:40.320 --> 0:04:44.279 and basically red sketched it up there. And the Canadian 0:04:44.480 --> 0:04:47.320 regulatory body is much more liberal than the US. We've 0:04:47.360 --> 0:04:49.400 seen that time and time again. Since then, they were 0:04:49.400 --> 0:04:57.360 in and out of approval process within a year. Dave 0:04:57.440 --> 0:04:59.800 Nodding says, he's not proving to all those details about 0:04:59.800 --> 0:05:03.200 how TIPS came about, but one thing was for sure, Yeah, 0:05:03.240 --> 0:05:05.480 the am X was driving it. And whether or not, 0:05:06.040 --> 0:05:08.880 you know, Nate showed the idea to somebody over a 0:05:08.960 --> 0:05:12.040 T s X or Toronto at that time, um, and 0:05:12.120 --> 0:05:14.880 they stole the idea, launched it there. To some extent. 0:05:15.000 --> 0:05:18.239 It's a little bit of I don't know who really cares. 0:05:18.240 --> 0:05:20.159 I mean exposed in retrospect. You can make a good, 0:05:20.680 --> 0:05:22.960 you know, thriller movie out of it. Somebody running the 0:05:22.960 --> 0:05:26.360 briefcase across the tracks kind of thing. We spoke with 0:05:26.400 --> 0:05:29.200 Peter Haynes, who began his career on the Toronto Stock 0:05:29.240 --> 0:05:32.720 Exchange as an intern. I came back were a full 0:05:32.760 --> 0:05:34.600 time in eighty nine and Tips from launching nineties saw 0:05:34.640 --> 0:05:37.440 as part of the launch team for TIPS, so I 0:05:37.480 --> 0:05:41.719 do have that on my resume. TIPS Toronto Index Participation 0:05:41.800 --> 0:05:44.400 Units is what they were called. The symbol was t 0:05:44.560 --> 0:05:47.520 I P listed on the Toronto Stock Exchange on March nine, 0:05:48.600 --> 0:05:51.960 and probably the most interesting factoid of all is that 0:05:52.000 --> 0:05:55.160 there was zero feet. Haynes says there was no management 0:05:55.240 --> 0:05:59.000 expense ratio or mirror at the time, and that the 0:05:59.040 --> 0:06:02.400 exchange ran as a way to give retail investors access 0:06:02.440 --> 0:06:05.279 to the market with just one trading vehicle. The hundred 0:06:05.279 --> 0:06:08.200 and fifty million dollars that were seated at the original 0:06:08.240 --> 0:06:12.400 launch of TIPS all one million institutional investors, so that 0:06:12.480 --> 0:06:15.440 was a bit of a surprise in the shock. Haynes 0:06:15.480 --> 0:06:18.279 says that yes, there were conversations with Nate Most and 0:06:18.360 --> 0:06:21.880 Steven Bloom at the time, but that the most significant 0:06:21.920 --> 0:06:25.000 influence on their product was not the AMMYX the Philadelphia 0:06:25.000 --> 0:06:29.360 Exchange as they were attempting to launch something called SIPs 0:06:29.440 --> 0:06:33.360 cash Index Participation securities and they struggled to get that 0:06:33.400 --> 0:06:36.279 product through the sec And this was in the late 0:06:36.279 --> 0:06:39.680 eighties early nineties that they were trying this, and our 0:06:39.720 --> 0:06:42.680 management at the time had spent some time with the 0:06:42.680 --> 0:06:45.240 Philly guys and said, hey, let's try this in Canada. 0:06:45.760 --> 0:06:49.479 And where we were lucky and I think forward thinking 0:06:49.480 --> 0:06:53.120 in terms of our regulators was the time from the 0:06:53.160 --> 0:06:56.279 time the obviously was approached to the time was approved 0:06:56.440 --> 0:07:00.200 was I believe less than six months. So it was really, 0:07:00.200 --> 0:07:02.719 at the end of the day, a lucky thing that 0:07:02.760 --> 0:07:05.039 the Toronto Exchange happened to be the first market in 0:07:05.080 --> 0:07:09.039 the world to launch an e t F. But you know, 0:07:09.080 --> 0:07:12.280 sometimes it's better to be lucky than good. Reggie Brown 0:07:12.320 --> 0:07:16.280 of Cantor Fitzgerald, whose nickname Mr ETF, was working at 0:07:16.280 --> 0:07:21.080 the Philadelphia Stock Exchange when the Philix developed Certificate Index 0:07:21.160 --> 0:07:26.400 Participation Shares or SIPs, and I remember uniquely that they 0:07:26.400 --> 0:07:30.600 were born from the seven Crash and some gurus at 0:07:30.600 --> 0:07:34.000 the Philipstocer Exchange came with an idea based on a report, 0:07:34.280 --> 0:07:38.600 and I do remember they traded briefly on the phile X, 0:07:39.400 --> 0:07:43.920 and in my role on the industry, I always recall, Hey, 0:07:43.960 --> 0:07:49.120 by the way, the Philix had SIPs and unfortunately it 0:07:49.200 --> 0:07:54.400 was overlooked, not well recognized, and they were designed based 0:07:54.520 --> 0:07:57.240 on the report that came out from the government said 0:07:57.560 --> 0:08:00.480 there needed to be a vehicle in order to help 0:08:00.640 --> 0:08:05.400 offset sell in bounce orders in the marketplace, and the 0:08:05.440 --> 0:08:08.880 phil X was ahead of their time, but unfortunately they 0:08:08.920 --> 0:08:12.120 went away. Brown says there was a legal issue with 0:08:12.200 --> 0:08:15.240 McGrath hill, who owned a license name of SP five 0:08:15.320 --> 0:08:19.320 under a standard and colors and McGraw hill sued and 0:08:19.360 --> 0:08:23.920 successfully got in a junction around trademark issues around SIPs 0:08:24.960 --> 0:08:27.920 and it stopped trading because of that. So the reality 0:08:28.040 --> 0:08:31.200 is these other products did come to market before Spy. 0:08:31.520 --> 0:08:34.560 Here's Eric again. So to sum this up, even though 0:08:34.559 --> 0:08:36.840 you may hear that Canada came out with the first TTF, 0:08:36.840 --> 0:08:39.320 that is true, but the idea was in the US. 0:08:39.760 --> 0:08:43.240 I think that's important. So it's a good footnote to 0:08:43.280 --> 0:08:46.079 the story. In the end, the fact that Spy is 0:08:46.120 --> 0:08:48.960 the biggest et F on the planet almost by twofold 0:08:49.559 --> 0:08:51.600 says all you need to know. And the TIPS product 0:08:52.040 --> 0:08:54.000 has been bought and merged and doesn't even have that 0:08:54.040 --> 0:08:57.600 ticker anymore, and that kind of also matters to the story. 0:08:57.720 --> 0:09:01.280 So the fact that Spy outlasted them, outlived them, outgrew them, 0:09:01.280 --> 0:09:03.320 and is the most trade to security four times over 0:09:03.840 --> 0:09:07.319 on the planet as to its so legacy. But some 0:09:07.360 --> 0:09:09.120 have tried to take away from it by saying, well, 0:09:09.160 --> 0:09:12.000 actually it wasn't first, and so I would say, well, 0:09:12.240 --> 0:09:14.080 it depends on how you define it. And I don't 0:09:14.080 --> 0:09:16.640 blame Toronod for doing it. It It was a heads up play. 0:09:16.679 --> 0:09:18.520 But the fact that just because they had to wait 0:09:18.559 --> 0:09:20.920 four years, you can't really blame them for that. They 0:09:20.920 --> 0:09:22.280 would have been out in one if they could. They 0:09:22.280 --> 0:09:26.560 have been at if they could have, But why didn't 0:09:26.600 --> 0:09:29.840 these products that were birth from similar circumstances at the 0:09:29.880 --> 0:09:33.320 exact same time gained the same success well, as Bob 0:09:33.320 --> 0:09:36.320 Tole says, there are a few reasons. Well, first of all, 0:09:36.360 --> 0:09:39.320 you had the most renowned index in the United States, 0:09:39.360 --> 0:09:42.120 next to the dal Jones Industrial thirty right being the 0:09:42.160 --> 0:09:46.240 benchmark for it. It was a full replication, so there 0:09:46.320 --> 0:09:49.360 was no question on the back of the SEC that 0:09:49.480 --> 0:09:55.040 somebody was managing this asset. And you had the publications 0:09:55.080 --> 0:09:58.800 that they required daily of information to provide a level 0:09:58.800 --> 0:10:02.480 of transparency that was nowhere available in the mutual fund industry, 0:10:02.920 --> 0:10:06.600 information including the composition the assets, the holdings, and what 0:10:06.640 --> 0:10:10.160 the waitings were. Also, these similar products hadn't undergone the 0:10:10.200 --> 0:10:13.040 same level of scrutiny with the U. S. Government as 0:10:13.040 --> 0:10:16.800 Spy had because Spy, remember was filed under the forty Act. 0:10:17.080 --> 0:10:20.920 A move toll Fields was worth the weight. Oh absolutely, honestly, 0:10:21.080 --> 0:10:23.160 I do. You could have had a structured note, but 0:10:23.240 --> 0:10:26.360 then you realize you're taking balance sheet risk. At that time, 0:10:26.440 --> 0:10:30.160 especially after the eight seven crash, nobody wanted balance sheet risk. Okay, 0:10:30.240 --> 0:10:32.640 then you say, okay, I'm gonna buy a mutual fund. Well, 0:10:32.640 --> 0:10:34.480 that was what everybody thought was froll to begin with. 0:10:34.600 --> 0:10:37.360 So now you have to have a new structure, so 0:10:37.559 --> 0:10:39.360 you have your choices. Right, you can have a closed 0:10:39.440 --> 0:10:43.480 end fund which has premiument discounts. Right, you could have 0:10:43.520 --> 0:10:45.719 a traditional mutual fund, or you could have this new 0:10:45.760 --> 0:10:49.200 animal called at this time an index share. And the 0:10:49.240 --> 0:10:54.520 index share was really I mean, it was an epiphany. 0:10:56.720 --> 0:10:59.000 Dave Not says, a lot of Spy success can be 0:10:59.040 --> 0:11:02.199 attributed to its no frill structure. If you actually look 0:11:02.240 --> 0:11:06.880 at the structure of Spy, it was phenomenally simple. A 0:11:06.920 --> 0:11:10.360 lot of the index participation, securities models and things really 0:11:10.400 --> 0:11:14.600 were almost like versions of structured notes, right. They were complex, 0:11:14.679 --> 0:11:17.240 they had counterparties that people weren't used to dealing with. 0:11:17.600 --> 0:11:20.440 And I think that the genius of the Spy model 0:11:20.559 --> 0:11:23.280 and then later the sort of more traditional for the 0:11:23.360 --> 0:11:26.320 act versions that came after it, where they took really 0:11:26.520 --> 0:11:31.760 simple existing structures and they used those to create what 0:11:31.880 --> 0:11:34.480 they needed to create. Um, you know, they used the 0:11:34.600 --> 0:11:38.200 U I T structure to you know, embed the index 0:11:38.360 --> 0:11:40.800 into the product. That I think was a really critical 0:11:40.800 --> 0:11:43.160 part of getting that approved. But you know, they used 0:11:43.200 --> 0:11:47.000 that structure that existed already that lawyers were comfortable with 0:11:47.080 --> 0:11:49.640 that everybody was comfortable with, and they said, oh great, 0:11:49.679 --> 0:11:51.719 that's our investment vehicle. And then they took sort of 0:11:51.760 --> 0:11:54.880 a traditional prime brokerage model of moving large baskets of 0:11:54.880 --> 0:11:56.839 securities in and out, and they said, hey, we're just 0:11:56.880 --> 0:11:59.280 going to take what was then the default prime brokerage 0:11:59.280 --> 0:12:01.800 trading model. We're going to use that to do these 0:12:01.840 --> 0:12:05.079 creation redemption baskets. So what they did was take all 0:12:05.080 --> 0:12:07.600 the pieces that already worked and changed as little as 0:12:07.640 --> 0:12:15.079 possible to make something new happen. And now spices footprint 0:12:15.160 --> 0:12:18.079 is enormous as the largest ETF with two dred and 0:12:18.120 --> 0:12:21.680 seventy billion in assets. For a comparison, the second largest 0:12:21.679 --> 0:12:25.280 et F has one billion dollars less than assets than SPY. 0:12:25.480 --> 0:12:28.360 It's really stood the test of time. Here's not again. 0:12:28.600 --> 0:12:31.880 But but in the end, all of these things come 0:12:31.920 --> 0:12:34.360 down to execution. And I think that's actually been the 0:12:34.440 --> 0:12:37.440 story of ets for twenty five years, is it's always 0:12:37.480 --> 0:12:50.360 down to execution. Next time on trains presents how the 0:12:50.480 --> 0:12:53.200 e t F really started to gain steam. It wasn't 0:12:53.280 --> 0:12:55.480 until I was sitting on a trading desk and all 0:12:55.480 --> 0:12:57.480 of a sudden, I could like hit a button and 0:12:57.559 --> 0:13:00.400 get a million dollar exposure to the cues. I was 0:13:00.440 --> 0:13:07.040 all in. Thanks for listening to Trillions Presents until next time. 0:13:07.200 --> 0:13:10.079 You can find us on the Bloomberg Terminal, Bloomberg dot com, 0:13:10.280 --> 0:13:13.640 Apple Podcasts, and where else you want to listen. Trillions 0:13:13.640 --> 0:13:17.319 Presents is produced by Jordan Bell, with production help from 0:13:17.360 --> 0:13:21.880 Magnus Hendrickson. Francesco Levy is the head of Bloomberg Podcasts.