1 00:00:06,080 --> 00:00:10,400 Speaker 1: Hello, and welcome to another edition of the Odd Lots podcast. 2 00:00:10,600 --> 00:00:15,120 Speaker 1: I'm Joseph Wisenthal, Managing Editor Bloomberg Markets, and I'm Tracy Alloway, 3 00:00:15,200 --> 00:00:18,880 Speaker 1: Executive editor of Bloomberg Markets. So, Tracy, today we're going 4 00:00:18,960 --> 00:00:21,560 Speaker 1: to be it's like a special episode. We're talking to 5 00:00:21,600 --> 00:00:24,720 Speaker 1: one of our colleagues here, special edition of Odd Lot 6 00:00:25,120 --> 00:00:27,800 Speaker 1: We're gonna be talking about one of the most important 7 00:00:28,240 --> 00:00:31,560 Speaker 1: financial innovations of the modern era. Wouldn't you say? I 8 00:00:31,560 --> 00:00:34,280 Speaker 1: would definitely say so. Isn't it something like a three 9 00:00:34,560 --> 00:00:38,519 Speaker 1: trillion dollar industry? Is that right? And that industry is 10 00:00:38,800 --> 00:00:41,400 Speaker 1: the e T F And I think almost everybody at 11 00:00:41,400 --> 00:00:43,519 Speaker 1: this point who is aware of markets knows what e 12 00:00:43,600 --> 00:00:48,000 Speaker 1: t s are. Their exchange treated funds. You can use 13 00:00:48,080 --> 00:00:51,120 Speaker 1: them to make a bet on the STP as a whole. 14 00:00:51,640 --> 00:00:54,360 Speaker 1: You can use them to make a bet on gold, 15 00:00:54,480 --> 00:00:57,000 Speaker 1: and you can use them to do crazy stuff like 16 00:00:57,360 --> 00:01:01,120 Speaker 1: make a three x levered bet on junior gold. Miners 17 00:01:01,400 --> 00:01:04,160 Speaker 1: do that all the time. But it's like a basket 18 00:01:04,240 --> 00:01:07,240 Speaker 1: of things, right, and it trades like a single stock 19 00:01:07,400 --> 00:01:10,200 Speaker 1: on an exchange exactly right. And these e t f 20 00:01:10,280 --> 00:01:13,320 Speaker 1: s have been hoovering up assets, as you said, trillions 21 00:01:13,319 --> 00:01:17,959 Speaker 1: of dollars away from traditional funds, from traditional money managers, 22 00:01:18,280 --> 00:01:20,800 Speaker 1: and it doesn't look like they're slowing down anytime soon. 23 00:01:21,440 --> 00:01:24,360 Speaker 1: And not only that, they continue to innovate. So there 24 00:01:24,360 --> 00:01:26,000 Speaker 1: are more and more new kinds of e t F 25 00:01:26,080 --> 00:01:30,040 Speaker 1: s all the time. From what humble beginnings did the 26 00:01:30,040 --> 00:01:31,760 Speaker 1: e t F market come to us? This is the 27 00:01:31,760 --> 00:01:35,399 Speaker 1: fascinating thing. We're going to discuss with our colleague Eric Balcunas. 28 00:01:35,440 --> 00:01:38,440 Speaker 1: He has a new article out in Bloomberg Markets magazine 29 00:01:38,760 --> 00:01:40,920 Speaker 1: called the e t F Files, and that's based on 30 00:01:40,959 --> 00:01:44,720 Speaker 1: a new book that he's publishing. And so it turns out, Eric, 31 00:01:44,760 --> 00:01:47,160 Speaker 1: thanks for joining us, thank you for having me. So 32 00:01:47,240 --> 00:01:50,560 Speaker 1: the e t F, this monster innovation that's changing how 33 00:01:50,600 --> 00:01:53,640 Speaker 1: people invest, came out in a weird way. It came 34 00:01:53,640 --> 00:01:57,160 Speaker 1: out thanks to basically a memo, right yeah, memo, will 35 00:01:57,160 --> 00:01:59,640 Speaker 1: be putting it mildly at eight hundred and forty page 36 00:01:59,720 --> 00:02:03,360 Speaker 1: governed report is really where the seed for the e 37 00:02:03,440 --> 00:02:06,520 Speaker 1: t F was found. So what happened was in the 38 00:02:06,840 --> 00:02:11,119 Speaker 1: seven crash called Black Monday, right the worst, the worst 39 00:02:11,120 --> 00:02:15,639 Speaker 1: stock market crash in history. There was SEC spent four 40 00:02:15,680 --> 00:02:18,320 Speaker 1: months writing a report about what happened. They were trying 41 00:02:18,360 --> 00:02:20,760 Speaker 1: to figure out what really not the macro events that 42 00:02:20,840 --> 00:02:23,840 Speaker 1: caused selling, but what exacerbated the sell off that it 43 00:02:23,880 --> 00:02:27,360 Speaker 1: was so brutal, and Key tell us what did happen? 44 00:02:27,440 --> 00:02:31,120 Speaker 1: Because we can't pass up an opportunity to talk portfolio insurance. 45 00:02:31,160 --> 00:02:34,320 Speaker 1: I'm sorry. Sure. So what they found was, when the 46 00:02:34,400 --> 00:02:38,079 Speaker 1: dark clouds were going over the market, institutions had all 47 00:02:38,080 --> 00:02:41,640 Speaker 1: started using something called portfolio insurance, which essentially was a 48 00:02:41,680 --> 00:02:46,639 Speaker 1: strategy that involved shorting futures right based on indices as 49 00:02:46,639 --> 00:02:49,720 Speaker 1: soon as the stocks they held started hitting a certain level. 50 00:02:50,400 --> 00:02:52,960 Speaker 1: So essentially what happened was on that day there were 51 00:02:53,000 --> 00:02:55,560 Speaker 1: just weren't that many buyers for the people trying to 52 00:02:55,600 --> 00:02:58,760 Speaker 1: sell insurance. Then on top of that, you had program 53 00:02:58,840 --> 00:03:02,440 Speaker 1: traders who were arbitrage in the futures to the individual stocks, 54 00:03:02,720 --> 00:03:06,519 Speaker 1: which involved buying the futures and then selling all five 55 00:03:06,600 --> 00:03:08,359 Speaker 1: hundred or how many of our hundred stocks at the 56 00:03:08,400 --> 00:03:11,880 Speaker 1: same time, right, So what happened was those program traders 57 00:03:11,880 --> 00:03:15,320 Speaker 1: stepped in and they were putting all the cell orders 58 00:03:15,360 --> 00:03:18,520 Speaker 1: on the individual stocks. That caused more panic and all 59 00:03:18,800 --> 00:03:20,720 Speaker 1: all of a sudden, Really what you had was all 60 00:03:20,720 --> 00:03:23,960 Speaker 1: these forces looking to sell individual stocks all at the 61 00:03:24,000 --> 00:03:26,320 Speaker 1: same time and that's when you had the crash. And 62 00:03:26,360 --> 00:03:29,760 Speaker 1: how much was the crash that day the crash it 63 00:03:29,880 --> 00:03:33,320 Speaker 1: was a five D eight point drop in one day. 64 00:03:34,160 --> 00:03:37,040 Speaker 1: I mean, we've had like some flash crashes in recent years, 65 00:03:37,560 --> 00:03:40,040 Speaker 1: but that really puts it into perspective. It also reminds it. 66 00:03:40,280 --> 00:03:43,160 Speaker 1: You know, we've blamed high frequency trading and all kinds 67 00:03:43,160 --> 00:03:45,839 Speaker 1: of stuff on modern flash crashes, but you can get 68 00:03:45,880 --> 00:03:49,120 Speaker 1: some extraordinary moves. It seems about just about any area, 69 00:03:49,560 --> 00:03:53,680 Speaker 1: that's right. Yeah, Okay, So the SEC put out after 70 00:03:53,840 --> 00:03:57,680 Speaker 1: several months of studying that crash in they wrote an 71 00:03:57,720 --> 00:04:01,160 Speaker 1: eight hundred and forty page memo. And what was in 72 00:04:01,360 --> 00:04:05,200 Speaker 1: that memo that led to the e t F Sure 73 00:04:05,280 --> 00:04:08,440 Speaker 1: on chapter three, right deep into the into the actual 74 00:04:08,480 --> 00:04:11,640 Speaker 1: white paper memo, there was something where they talked about 75 00:04:11,880 --> 00:04:14,800 Speaker 1: if an alternative approach were to be examined, so they 76 00:04:14,920 --> 00:04:17,760 Speaker 1: used that language, and what they're basically saying was the 77 00:04:17,880 --> 00:04:21,080 Speaker 1: SEC was thinking that the futures market volatility and sell 78 00:04:21,120 --> 00:04:24,800 Speaker 1: off had transmitted to individual stocks. So they thought, you know, 79 00:04:25,279 --> 00:04:27,719 Speaker 1: if there was only a way to do basket trading, 80 00:04:27,760 --> 00:04:29,880 Speaker 1: so you didn't hit sell on five stocks at once, 81 00:04:30,240 --> 00:04:32,640 Speaker 1: but you hit sell on a basket and you had 82 00:04:32,839 --> 00:04:35,960 Speaker 1: market makers and specialists who were able to trade those baskets. 83 00:04:36,279 --> 00:04:38,960 Speaker 1: It might have provided a buffer in between the futures 84 00:04:39,000 --> 00:04:42,400 Speaker 1: market in Chicago, which the SEC doesn't have any regulation over, 85 00:04:42,839 --> 00:04:45,200 Speaker 1: and the individual stocks in New York, which they do. 86 00:04:45,800 --> 00:04:47,320 Speaker 1: So they just put it in there is maybe a 87 00:04:47,360 --> 00:04:50,680 Speaker 1: possible alternative approach. However, they did use the word product. 88 00:04:51,120 --> 00:04:53,000 Speaker 1: And then the two guys at the m X, who 89 00:04:53,000 --> 00:04:55,680 Speaker 1: were hungry for some more volume because that exchange was 90 00:04:55,760 --> 00:04:58,520 Speaker 1: really in third place at the time, read this and 91 00:04:58,560 --> 00:05:00,479 Speaker 1: really looked at it as a product propos Well from 92 00:05:00,520 --> 00:05:03,520 Speaker 1: the SEC. I mean, it's kind of a creative approach, 93 00:05:03,680 --> 00:05:08,000 Speaker 1: right to read an CEC paper on this huge negative 94 00:05:08,040 --> 00:05:11,200 Speaker 1: event in markets and think I have a product idea 95 00:05:11,240 --> 00:05:14,400 Speaker 1: out of that. Yeah, I mean the SEC does use 96 00:05:14,440 --> 00:05:17,080 Speaker 1: the word product and they say alternative approach. Remember they 97 00:05:17,120 --> 00:05:19,760 Speaker 1: worked at am X, right, So exchanges were really into 98 00:05:19,760 --> 00:05:22,960 Speaker 1: this report. Because I asked Stephen Bloom, who was one 99 00:05:23,000 --> 00:05:25,280 Speaker 1: of the two guys who read it, they said they 100 00:05:25,279 --> 00:05:28,120 Speaker 1: were riveted by every page. I thought, who would read 101 00:05:28,120 --> 00:05:31,159 Speaker 1: an eight d forty page government report, But they did, 102 00:05:31,240 --> 00:05:33,800 Speaker 1: and they you know, they got rewarded for reading every 103 00:05:33,800 --> 00:05:37,279 Speaker 1: word like that, So they were really excited. One of 104 00:05:37,279 --> 00:05:39,400 Speaker 1: the quotes that we found from him was that he 105 00:05:39,400 --> 00:05:41,680 Speaker 1: said he walked into his boss's office and said, here's 106 00:05:41,680 --> 00:05:44,240 Speaker 1: an opening. We can drive a truck through this exchange. 107 00:05:44,240 --> 00:05:47,839 Speaker 1: In particular, MX was hurting, so they were really looking 108 00:05:47,880 --> 00:05:49,840 Speaker 1: for something. So they had their eyes wide open when 109 00:05:49,839 --> 00:05:51,720 Speaker 1: the report hit. I just want to pause and say, 110 00:05:51,800 --> 00:05:55,120 Speaker 1: I love that point that he who hears you, who 111 00:05:55,120 --> 00:05:58,440 Speaker 1: reads an eight hundred and forty page government white paper 112 00:05:58,800 --> 00:06:02,200 Speaker 1: and really notices all the details, there's a reward to 113 00:06:02,279 --> 00:06:04,760 Speaker 1: that they deserve to make money. Yeah, exactly, I think. 114 00:06:04,760 --> 00:06:08,760 Speaker 1: So Eric tell us about the product that they eventually 115 00:06:08,800 --> 00:06:11,560 Speaker 1: came up with. What were the actual beginnings, right, So 116 00:06:11,600 --> 00:06:14,360 Speaker 1: they thought, okay, well let's get a basket trading product. Right. 117 00:06:14,400 --> 00:06:17,480 Speaker 1: Their first idea was to go to Jack Bogel at 118 00:06:17,520 --> 00:06:20,080 Speaker 1: Vanguard and see if they could trade an SMP index 119 00:06:20,120 --> 00:06:24,159 Speaker 1: fund for from Vanguard. Jack Bogel met with Nate Most, 120 00:06:24,279 --> 00:06:26,279 Speaker 1: who Nate Most and Steve Bloom with the two guys 121 00:06:26,839 --> 00:06:29,400 Speaker 1: and basically said thank you, but no thank you. And 122 00:06:29,720 --> 00:06:32,600 Speaker 1: when I interviewed Jack Bogel, he said, Nate Most walked 123 00:06:32,640 --> 00:06:35,080 Speaker 1: into my office. I looked at his proposal. I said, 124 00:06:35,560 --> 00:06:37,880 Speaker 1: I'm not interested anyway, but I will give you three 125 00:06:37,920 --> 00:06:40,720 Speaker 1: criticisms flaws that I think your product has that if 126 00:06:40,720 --> 00:06:43,200 Speaker 1: you fix them, might be better. So that's what Bogel claims. 127 00:06:43,240 --> 00:06:45,839 Speaker 1: So basically he said no, thank you, because Jack Bogel 128 00:06:45,880 --> 00:06:48,120 Speaker 1: wants nothing to do with trading anywhere near his funds. 129 00:06:48,120 --> 00:06:49,960 Speaker 1: You know, he's anti trading, and this would be a 130 00:06:49,960 --> 00:06:52,279 Speaker 1: product that would trade. So that was really where the 131 00:06:52,279 --> 00:06:55,280 Speaker 1: difference lies. So Nate Most said that that meeting got 132 00:06:55,360 --> 00:06:58,120 Speaker 1: him thinking about a way where you could trade a 133 00:06:58,160 --> 00:07:00,599 Speaker 1: fund but not drive up cast us and the fund 134 00:07:00,600 --> 00:07:02,520 Speaker 1: from people coming in and out of it. That was 135 00:07:02,560 --> 00:07:05,400 Speaker 1: the big problem. And this is where the I think 136 00:07:05,440 --> 00:07:07,960 Speaker 1: the value from Nate Most than the AMEX came in 137 00:07:08,000 --> 00:07:09,320 Speaker 1: to make the e t F more than what the 138 00:07:09,360 --> 00:07:11,760 Speaker 1: SEC called for. And that is that Nate Most was 139 00:07:11,800 --> 00:07:13,200 Speaker 1: seventy four years old and he used to be a 140 00:07:13,200 --> 00:07:15,280 Speaker 1: commodities trader, and he used to be president of the 141 00:07:15,320 --> 00:07:18,720 Speaker 1: Pacific Commodities Exchange, and he basically looked at the paradigm 142 00:07:18,760 --> 00:07:21,960 Speaker 1: of the commodities warehouse receipt, which is where you know, 143 00:07:22,040 --> 00:07:24,640 Speaker 1: palm oil or coco. You don't want to move the 144 00:07:24,680 --> 00:07:26,360 Speaker 1: merchandise back and forth. So what you do is you 145 00:07:26,360 --> 00:07:28,760 Speaker 1: store it in a warehouse, you get a receipt, then 146 00:07:28,760 --> 00:07:30,320 Speaker 1: you trade the receipt. That way you don't have to 147 00:07:30,320 --> 00:07:33,000 Speaker 1: move anything, and then he saves costs, and that saves costs. 148 00:07:33,000 --> 00:07:35,120 Speaker 1: Then you could gather up the receipts at any time, 149 00:07:35,160 --> 00:07:37,880 Speaker 1: go to the warehouse and get your commodities back. So 150 00:07:38,000 --> 00:07:40,680 Speaker 1: that that paradigm was then applied to the sort of 151 00:07:40,720 --> 00:07:44,320 Speaker 1: the SEC's general idea, and that really was the sort 152 00:07:44,360 --> 00:07:46,920 Speaker 1: of foundation of the et start. So let's just break 153 00:07:46,960 --> 00:07:49,560 Speaker 1: down what we've learned, because I think this is really fascinating. 154 00:07:49,640 --> 00:07:53,120 Speaker 1: And for those who don't know, Jack Vogel famous for 155 00:07:53,240 --> 00:07:57,400 Speaker 1: his belief in indexing not trading, the key to winning 156 00:07:57,400 --> 00:08:00,360 Speaker 1: and investments is low costs, and so theoretic at least 157 00:08:00,400 --> 00:08:04,080 Speaker 1: something like an SMP index fund could have appealed to him. 158 00:08:04,120 --> 00:08:06,800 Speaker 1: When he saw this product, he said, hey, this is 159 00:08:06,800 --> 00:08:09,440 Speaker 1: a trading vehicle. He's not into vehicles that make it 160 00:08:09,520 --> 00:08:11,480 Speaker 1: easy to get in and out of the market and 161 00:08:11,600 --> 00:08:15,520 Speaker 1: be there's too much costs involved in the internal running 162 00:08:15,560 --> 00:08:18,800 Speaker 1: of the fund. But when they solved that problem, it 163 00:08:18,840 --> 00:08:21,120 Speaker 1: still didn't really solve the fact that it's a trading vehicle. 164 00:08:21,400 --> 00:08:25,600 Speaker 1: But it did become a low cost product that people 165 00:08:25,680 --> 00:08:28,680 Speaker 1: can use to make a directional bet on the market 166 00:08:28,920 --> 00:08:30,720 Speaker 1: in a way that we didn't have before. Yeah. And 167 00:08:30,720 --> 00:08:33,439 Speaker 1: I think what it did was the meeting with Bogel, 168 00:08:33,440 --> 00:08:34,840 Speaker 1: even though it was never going to happen with him 169 00:08:34,840 --> 00:08:38,080 Speaker 1: because he was anti trading, the meeting pushed them to 170 00:08:38,200 --> 00:08:40,760 Speaker 1: think of something different. And that's where bringing this commodities 171 00:08:40,800 --> 00:08:44,000 Speaker 1: paradigm is why et f s can trade upwards of 172 00:08:44,160 --> 00:08:46,920 Speaker 1: eighteen trillion dollars a year. They trade all day long, 173 00:08:47,000 --> 00:08:49,360 Speaker 1: right uh. And if you look at like sp Y 174 00:08:49,400 --> 00:08:52,000 Speaker 1: for example, trades about billion dollars a day. That's the 175 00:08:52,040 --> 00:08:54,319 Speaker 1: big sp five, that's the big SMP. That's the one 176 00:08:54,360 --> 00:08:57,240 Speaker 1: that they first designed, these two guys. But yet someone 177 00:08:57,280 --> 00:08:59,880 Speaker 1: like my aunt Joyce could go into the SMP Spy 178 00:09:00,040 --> 00:09:02,720 Speaker 1: for ten years and that trading every day does not 179 00:09:02,920 --> 00:09:06,080 Speaker 1: bother or drive up costs for her long term investment. 180 00:09:06,559 --> 00:09:10,240 Speaker 1: And that is where the model really was something special. 181 00:09:10,280 --> 00:09:12,920 Speaker 1: And when you talk to the guy who was one 182 00:09:12,960 --> 00:09:15,760 Speaker 1: of the lawyers who wrote the market break report, the 183 00:09:15,840 --> 00:09:18,280 Speaker 1: SEC document, he said when he saw the proposal come 184 00:09:18,320 --> 00:09:21,440 Speaker 1: in from am X with this design, he was blown away. 185 00:09:21,480 --> 00:09:23,679 Speaker 1: It was way more than he thought when they were 186 00:09:23,720 --> 00:09:26,520 Speaker 1: writing it. So he thought this product would had much 187 00:09:26,559 --> 00:09:28,880 Speaker 1: more utility than even they thought when they said we 188 00:09:28,920 --> 00:09:31,240 Speaker 1: need something for a basket trading product. So hold on 189 00:09:31,240 --> 00:09:34,640 Speaker 1: one second. They borrowed the commodities warehouse idea with the 190 00:09:34,679 --> 00:09:38,720 Speaker 1: sort of trading receipts, but you still need a virtual 191 00:09:38,920 --> 00:09:42,160 Speaker 1: warehouse for the shares, right, how did that come about? Right? 192 00:09:42,200 --> 00:09:44,600 Speaker 1: So there, right, there's no warehouse, right, So instead of 193 00:09:44,760 --> 00:09:47,680 Speaker 1: a warehouse is called a custodian. So State Street was 194 00:09:47,679 --> 00:09:49,480 Speaker 1: one of the first obvious places they went, and so 195 00:09:49,559 --> 00:09:53,160 Speaker 1: that's became the custodian for the stock. So the custodian 196 00:09:53,320 --> 00:09:56,320 Speaker 1: is the virtual warehouse that and today every et F 197 00:09:56,400 --> 00:09:59,559 Speaker 1: needs a custodian to store those stocks or bonds or 198 00:09:59,600 --> 00:10:02,400 Speaker 1: whatever holding. And that is what makes the e t 199 00:10:02,559 --> 00:10:04,679 Speaker 1: F slightly different than a derivative. Some people say E 200 00:10:04,720 --> 00:10:07,240 Speaker 1: t s are a type of derivative. The fact is 201 00:10:07,320 --> 00:10:10,040 Speaker 1: that these stocks that are in the spy or any 202 00:10:10,080 --> 00:10:12,959 Speaker 1: E t F our literal picture, and they're literally stored 203 00:10:13,000 --> 00:10:15,560 Speaker 1: in a warehouse just happens to be a custodian's electronic 204 00:10:16,040 --> 00:10:18,920 Speaker 1: But the fact is those are receipts for those physical 205 00:10:18,960 --> 00:10:21,520 Speaker 1: they're physically backed and that that's what makes some difference 206 00:10:21,559 --> 00:10:23,880 Speaker 1: in like a futures contract and tell us how those 207 00:10:23,880 --> 00:10:27,560 Speaker 1: stocks actually get in the virtual warehouse, if you will, 208 00:10:27,600 --> 00:10:30,760 Speaker 1: because that's a process that's really important for e t S, 209 00:10:30,880 --> 00:10:33,560 Speaker 1: right sure, It's called the creation redemption process. And this 210 00:10:33,600 --> 00:10:36,079 Speaker 1: is where I sometimes teach courses on e t S 211 00:10:36,120 --> 00:10:38,600 Speaker 1: where the students get really like confused and bored. I'll 212 00:10:38,640 --> 00:10:41,520 Speaker 1: be honest. That's why are our listeners are not going 213 00:10:41,559 --> 00:10:45,160 Speaker 1: to give our Our listeners are very sophisticated, wonky people, 214 00:10:45,200 --> 00:10:46,640 Speaker 1: and this is the part they're going to be most 215 00:10:46,640 --> 00:10:50,320 Speaker 1: excited about. So well, and that's why I went into 216 00:10:50,360 --> 00:10:52,080 Speaker 1: the story of how the first t t F came about, 217 00:10:52,080 --> 00:10:54,920 Speaker 1: because when I tell the story, people get it more. Right, 218 00:10:54,920 --> 00:10:57,920 Speaker 1: when I explain the commodities visual, they understand it. So 219 00:10:58,280 --> 00:11:01,640 Speaker 1: the way creation redemption works is an authorized participant, which 220 00:11:01,679 --> 00:11:04,679 Speaker 1: is a gigantic bank connected to the system with you know, 221 00:11:04,760 --> 00:11:07,960 Speaker 1: a lot of money. Basically they are Every et F 222 00:11:08,000 --> 00:11:11,160 Speaker 1: has several aps that are assigned to it. When a 223 00:11:11,160 --> 00:11:14,600 Speaker 1: new creation is done, the AP will hand in the basket, 224 00:11:14,640 --> 00:11:17,760 Speaker 1: which is say five s in the SMP into the 225 00:11:17,840 --> 00:11:20,720 Speaker 1: state into the issure state Street and in return they 226 00:11:20,720 --> 00:11:23,600 Speaker 1: get fifty shares of spy and that would be like 227 00:11:23,640 --> 00:11:26,160 Speaker 1: the receipts. Then they sell those on the exchange, and 228 00:11:26,200 --> 00:11:28,439 Speaker 1: that's where those receipts will trade. And then if there's 229 00:11:28,440 --> 00:11:31,640 Speaker 1: a redemption, the same thing will happen. They'll take spy shares, 230 00:11:32,080 --> 00:11:35,080 Speaker 1: hand them into State Street and get their five stocks back. 231 00:11:35,280 --> 00:11:37,440 Speaker 1: And then that is sort of the creation redempture process, 232 00:11:37,480 --> 00:11:40,559 Speaker 1: which I sort of equate to the flux capacitor from 233 00:11:40,559 --> 00:11:43,079 Speaker 1: Back to the Future. You know it's in that movie. 234 00:11:43,080 --> 00:11:46,040 Speaker 1: It's how time travel works. What I just described is 235 00:11:46,080 --> 00:11:49,240 Speaker 1: how the e t F has been so resilient in 236 00:11:49,360 --> 00:11:53,080 Speaker 1: several market stress events. And I think, you know, people 237 00:11:53,120 --> 00:11:54,760 Speaker 1: are waiting for them to blow up, but that what 238 00:11:54,840 --> 00:11:56,760 Speaker 1: I just described does make them, I think a little 239 00:11:56,800 --> 00:11:59,319 Speaker 1: more resilient than people think who are sort of just 240 00:11:59,400 --> 00:12:02,319 Speaker 1: learning about them. So what actually motivates the a p 241 00:12:02,559 --> 00:12:06,480 Speaker 1: s to bring their shares and things to this warehouse 242 00:12:06,520 --> 00:12:09,000 Speaker 1: and get the sort of the E t F share 243 00:12:09,000 --> 00:12:11,880 Speaker 1: in return? Right, the AP gets a small cut from 244 00:12:11,880 --> 00:12:13,640 Speaker 1: a spread when they deal with the market makers, and 245 00:12:13,679 --> 00:12:16,679 Speaker 1: they also are able to do arbitrage, and arbitrage sounds 246 00:12:16,679 --> 00:12:19,320 Speaker 1: like a bad dirty word, but it's actually really effective 247 00:12:19,360 --> 00:12:22,559 Speaker 1: for e t s because if the basket, if the stocks, 248 00:12:22,720 --> 00:12:24,599 Speaker 1: if the e t F price starts to go a 249 00:12:24,640 --> 00:12:28,560 Speaker 1: little higher than the value of the stocks, the AP 250 00:12:28,720 --> 00:12:30,840 Speaker 1: can arbitrage by handing in the e t F shares 251 00:12:31,000 --> 00:12:33,280 Speaker 1: and buying the underlyings or vice versa. So they can 252 00:12:33,320 --> 00:12:36,520 Speaker 1: always arbitrage the e t F versus the basket by 253 00:12:36,559 --> 00:12:39,720 Speaker 1: using the creative redemption process. That in effect is a 254 00:12:39,840 --> 00:12:43,280 Speaker 1: natural economic motive for them to keep the price close 255 00:12:43,320 --> 00:12:45,640 Speaker 1: to the n A V. And that's a huge difference 256 00:12:45,679 --> 00:12:48,120 Speaker 1: on e t F compared to close end funds, which 257 00:12:48,160 --> 00:12:50,559 Speaker 1: don't have that ability to create and redeem new shares 258 00:12:50,559 --> 00:12:54,160 Speaker 1: any time, because clothes and funds are limited shares outstanding, 259 00:12:54,160 --> 00:12:57,480 Speaker 1: so that there's always massive premiums or discounts. That is 260 00:12:57,520 --> 00:13:00,160 Speaker 1: one sort of way the E t F evolved. These 261 00:13:00,200 --> 00:13:03,240 Speaker 1: then fun to you know, improve that model, because if 262 00:13:03,240 --> 00:13:06,360 Speaker 1: I'm an authorized participant and I see a huge difference 263 00:13:06,440 --> 00:13:08,760 Speaker 1: between the underlying shares and the share of the E 264 00:13:08,840 --> 00:13:10,960 Speaker 1: t F, I'm gonna want to come in and take 265 00:13:10,960 --> 00:13:13,240 Speaker 1: advantage of that and try to arbitrage it. Out right, 266 00:13:13,320 --> 00:13:15,880 Speaker 1: it's free money, it's a risk free profit for that 267 00:13:16,040 --> 00:13:18,600 Speaker 1: APay right, and that you know, again everybody wins. Again, 268 00:13:18,600 --> 00:13:21,600 Speaker 1: that economic incentive is crucial, and that is the secret 269 00:13:21,640 --> 00:13:24,600 Speaker 1: sauce that keeps everything going and makes the regular retail 270 00:13:24,640 --> 00:13:26,600 Speaker 1: investors get a price that's really close to the fair 271 00:13:26,679 --> 00:13:28,800 Speaker 1: value of those of the basket of stocks. All right, 272 00:13:28,880 --> 00:13:31,440 Speaker 1: let's go back to the stories. So now we understand 273 00:13:31,480 --> 00:13:35,479 Speaker 1: we have this the SPY which still trading, the gigantic 274 00:13:36,040 --> 00:13:40,360 Speaker 1: SPI index fund. They launch it, how does how did 275 00:13:40,360 --> 00:13:44,000 Speaker 1: it go? How did they do it attracting people do 276 00:13:44,200 --> 00:13:47,600 Speaker 1: trade it? And how did that work out? Right? So well, 277 00:13:47,640 --> 00:13:50,199 Speaker 1: first I had to wait four years to get SEC approval. 278 00:13:50,280 --> 00:13:51,880 Speaker 1: SEC did not know what to do with this. They 279 00:13:51,920 --> 00:13:55,320 Speaker 1: were even though they suggested the reason it took four years. 280 00:13:55,640 --> 00:13:59,000 Speaker 1: It had to go through which is the strictest of regulations. 281 00:13:59,400 --> 00:14:04,040 Speaker 1: So finally got approval under the that's what regulates mutual funds. 282 00:14:04,320 --> 00:14:06,160 Speaker 1: So when it came out in ninety three, it had 283 00:14:06,200 --> 00:14:08,120 Speaker 1: a good first day. They had a lot of hype. 284 00:14:08,120 --> 00:14:10,320 Speaker 1: They had a large spider hanging from the ceiling and 285 00:14:10,720 --> 00:14:14,240 Speaker 1: the trade a million shares, but a spider because because 286 00:14:14,480 --> 00:14:20,680 Speaker 1: they're called the Standard and Poors Depository receipts with acronym spider. 287 00:14:20,840 --> 00:14:23,960 Speaker 1: And back to the commodity warehouse receipts. Depository receipts is 288 00:14:23,960 --> 00:14:26,240 Speaker 1: even in the name of Spider, which kind of connects 289 00:14:26,240 --> 00:14:29,560 Speaker 1: to the commodities warehouse receipts. But they traded a million shares, 290 00:14:29,600 --> 00:14:32,480 Speaker 1: but then it dwindled down. But even more, ETFs don't 291 00:14:32,520 --> 00:14:35,320 Speaker 1: offer brokers any commission to sell them. It's why people 292 00:14:35,400 --> 00:14:37,320 Speaker 1: like them, it's why they're so low cost. But it 293 00:14:37,360 --> 00:14:40,200 Speaker 1: also inhibited some of the early sales growth. So what 294 00:14:40,280 --> 00:14:42,600 Speaker 1: happened it was some true believers who really thought, wow, 295 00:14:42,640 --> 00:14:44,760 Speaker 1: this is a great product. They were doing guerilla marketing. 296 00:14:45,240 --> 00:14:47,520 Speaker 1: When it really came back after like two years, they 297 00:14:47,520 --> 00:14:50,000 Speaker 1: were almost thinking of closing it. It It traded eighteen thousand 298 00:14:50,000 --> 00:14:53,960 Speaker 1: shares one day about five months after launching, which is 299 00:14:54,280 --> 00:14:57,560 Speaker 1: that's that's like less than the Global X Solar Energy 300 00:14:57,600 --> 00:15:00,240 Speaker 1: e t F trades today, So it was not trading all. 301 00:15:00,400 --> 00:15:02,800 Speaker 1: So you had people who were just out there figuring 302 00:15:02,800 --> 00:15:05,800 Speaker 1: out ways to sell it, and some institutions caught on. 303 00:15:05,880 --> 00:15:09,880 Speaker 1: But really what happened was the nineties kicked in was 304 00:15:09,960 --> 00:15:12,640 Speaker 1: like an epic year for the market, so just buying 305 00:15:12,680 --> 00:15:15,400 Speaker 1: the SMP became a big deal, and then that really 306 00:15:15,440 --> 00:15:18,040 Speaker 1: was the supreme catalyst and it never looked back at 307 00:15:18,040 --> 00:15:22,240 Speaker 1: doubled assets every year after. How important was the rise 308 00:15:22,600 --> 00:15:26,520 Speaker 1: of sort of discount retail brokerages online brokerages in the 309 00:15:26,560 --> 00:15:29,080 Speaker 1: mid nineties, you know, in terms of you mentioned that 310 00:15:29,120 --> 00:15:31,560 Speaker 1: there was no brokerage commission on these things. But once 311 00:15:31,640 --> 00:15:35,280 Speaker 1: people got into this idea during the nineties market boom 312 00:15:35,320 --> 00:15:39,200 Speaker 1: of investing for themselves and trading, did that help their rise? Yeah? 313 00:15:39,240 --> 00:15:41,840 Speaker 1: It did, believe it or not. Though institutions were some 314 00:15:41,880 --> 00:15:44,640 Speaker 1: of the first early buyers, like pensions, And there's even 315 00:15:44,680 --> 00:15:47,800 Speaker 1: a story about a rich Seattle investors in the mid 316 00:15:47,880 --> 00:15:50,600 Speaker 1: nineties and the guy was like, he's very, very wealthy 317 00:15:50,640 --> 00:15:52,720 Speaker 1: from Seattle. You guys could probably guess who it is 318 00:15:53,480 --> 00:15:56,520 Speaker 1: like to use spy because they could buy options on 319 00:15:56,560 --> 00:16:00,160 Speaker 1: it to protect their position. So the first adopted as 320 00:16:00,160 --> 00:16:02,840 Speaker 1: were big institutions. Because some of the institutions like using 321 00:16:02,840 --> 00:16:06,160 Speaker 1: in play who is the investor? I think it's Bill Gates, 322 00:16:06,160 --> 00:16:08,440 Speaker 1: but he wouldn't tell me. I'm just thinking what they 323 00:16:08,440 --> 00:16:10,280 Speaker 1: think that he got he was into them for his 324 00:16:10,360 --> 00:16:13,200 Speaker 1: personal investments. Yes, interesting, yeah, but we don't know that. 325 00:16:13,520 --> 00:16:16,880 Speaker 1: We don't know. That's the second. Very wealthy is why 326 00:16:16,920 --> 00:16:19,200 Speaker 1: I thought and from Seattle. Maybe Paul Allen, I don't 327 00:16:19,200 --> 00:16:21,240 Speaker 1: know one of those guys, probably Steve Jobs isn't that 328 00:16:21,320 --> 00:16:24,840 Speaker 1: rich yet, but I don't think that's right. He was 329 00:16:24,920 --> 00:16:28,920 Speaker 1: from California. Well, okay, wait, so we've told the story. 330 00:16:29,080 --> 00:16:31,440 Speaker 1: We're now at this point where you know, the s 331 00:16:31,480 --> 00:16:34,520 Speaker 1: p Y e t F is trading like twenty five 332 00:16:34,560 --> 00:16:38,000 Speaker 1: billion worth of shares a day. But beyond just the 333 00:16:38,040 --> 00:16:41,280 Speaker 1: story of that particular e t F, we've also had 334 00:16:41,320 --> 00:16:44,200 Speaker 1: the entire industry kind of grow around it. We have 335 00:16:44,280 --> 00:16:46,640 Speaker 1: all these new kinds of e t F. Tell us 336 00:16:46,640 --> 00:16:50,520 Speaker 1: about what's changed since the early days when you look 337 00:16:50,560 --> 00:16:52,840 Speaker 1: at it. You know, in the SEC commissioner who was 338 00:16:52,880 --> 00:16:55,720 Speaker 1: around in the late eighties who I interviewed, he said, well, 339 00:16:55,720 --> 00:16:59,880 Speaker 1: we didn't envision anything non stock baskets. We thought just 340 00:17:00,080 --> 00:17:03,320 Speaker 1: some stock baskets would really help with the stock market volatility. 341 00:17:03,360 --> 00:17:06,720 Speaker 1: But now you've got fixed income ETFs. You've got gold 342 00:17:06,840 --> 00:17:08,680 Speaker 1: g l D was a game changer. That was the 343 00:17:08,720 --> 00:17:10,720 Speaker 1: first commodities et F. Now you've got a hundred and 344 00:17:10,720 --> 00:17:14,520 Speaker 1: fifty commodities ETFs. Fixed income. As you know, we've discussed 345 00:17:14,520 --> 00:17:17,520 Speaker 1: this several times. It's a hot topic because bonds don't 346 00:17:17,560 --> 00:17:20,639 Speaker 1: trade like stocks. So now you're taking something antiquated and 347 00:17:20,760 --> 00:17:23,000 Speaker 1: over the counter and putting it in a stock like vehicle, 348 00:17:23,000 --> 00:17:26,040 Speaker 1: and that's created some concerns. And then you've gotten things 349 00:17:26,080 --> 00:17:29,320 Speaker 1: like leverage ets which whold total return swaps, or oil 350 00:17:29,400 --> 00:17:32,280 Speaker 1: futures that hold you know, literally hold futures contracts, and 351 00:17:32,520 --> 00:17:34,359 Speaker 1: now you're basically buying an et F that is like 352 00:17:34,359 --> 00:17:38,480 Speaker 1: your personal oil futures trader. So they've expanded into every 353 00:17:38,560 --> 00:17:41,840 Speaker 1: asset class and what I call standardization, just like a 354 00:17:41,960 --> 00:17:44,679 Speaker 1: ubs port or a gas bump is standardized, you know 355 00:17:44,800 --> 00:17:47,880 Speaker 1: that need for consumers. The e t F has basically 356 00:17:47,920 --> 00:17:50,440 Speaker 1: made everything trade like a stock, which means you can 357 00:17:50,440 --> 00:17:53,240 Speaker 1: see the pricing, you can buy it easily, and it's 358 00:17:53,240 --> 00:17:56,439 Speaker 1: taxed like everything else. So that kind of standardization, I 359 00:17:56,480 --> 00:17:59,080 Speaker 1: think is one of the big reasons people like using 360 00:17:59,119 --> 00:18:01,959 Speaker 1: them and for a long time, or you know, when 361 00:18:02,000 --> 00:18:03,359 Speaker 1: I think of e t F, so I think of 362 00:18:03,440 --> 00:18:07,480 Speaker 1: something really simple like SMP gold, but something sort of 363 00:18:07,600 --> 00:18:12,040 Speaker 1: underlying is passive. But increasingly the composition changes and they're 364 00:18:12,119 --> 00:18:13,960 Speaker 1: active e t f s and their e t F 365 00:18:14,080 --> 00:18:17,760 Speaker 1: based on formulas where the where the stocks are changing. Right, Yeah, 366 00:18:17,840 --> 00:18:21,200 Speaker 1: that's a whole thing called smart beta also slightly controversial, 367 00:18:21,240 --> 00:18:24,320 Speaker 1: but basically the early products were just you know, their 368 00:18:24,359 --> 00:18:27,320 Speaker 1: market cap weighted beta one they call you know whatever. 369 00:18:27,359 --> 00:18:30,920 Speaker 1: That very simple understand So some people came along and said, hey, look, 370 00:18:31,119 --> 00:18:35,240 Speaker 1: academics have studied what factors active managers rely on to 371 00:18:35,280 --> 00:18:38,679 Speaker 1: get alpha, such as tilting to small caps, tilting to value, 372 00:18:38,680 --> 00:18:42,439 Speaker 1: tilting to volatility momentum, and they've taken these tilts and 373 00:18:42,480 --> 00:18:45,520 Speaker 1: they've put them into rule based passive products. And so 374 00:18:45,800 --> 00:18:48,880 Speaker 1: smart beta is sort of fills the void that existed 375 00:18:48,920 --> 00:18:51,840 Speaker 1: between pure active and pure passive, and that's a four 376 00:18:51,920 --> 00:18:54,240 Speaker 1: hundred billion dollars section of the e t F world, 377 00:18:54,640 --> 00:18:56,359 Speaker 1: and that is where you're getting a lot of the 378 00:18:56,359 --> 00:18:59,640 Speaker 1: new players like Goldman, Sachs and JP Morgan. They think 379 00:18:59,680 --> 00:19:02,359 Speaker 1: smart BATA is the future because there's ten trillion dollars 380 00:19:02,359 --> 00:19:04,560 Speaker 1: in active mutual funds right now and a lot of 381 00:19:04,560 --> 00:19:06,240 Speaker 1: that money is going to go away because the mutual 382 00:19:06,280 --> 00:19:09,120 Speaker 1: fund structure. So they think that a smart beta will 383 00:19:09,160 --> 00:19:10,960 Speaker 1: be a place where a lot of the new assets 384 00:19:11,000 --> 00:19:13,640 Speaker 1: will go from the money that's coming over from pure 385 00:19:13,640 --> 00:19:15,359 Speaker 1: active because they want to try to beat the market, 386 00:19:15,440 --> 00:19:17,240 Speaker 1: but they don't want to pay the fees and they 387 00:19:17,240 --> 00:19:19,320 Speaker 1: want something that's easy to trade, and they don't want 388 00:19:19,320 --> 00:19:21,800 Speaker 1: to capital gains taxes either. So smart beta e t 389 00:19:22,000 --> 00:19:24,680 Speaker 1: f s are in some people's eyes, a real interesting 390 00:19:24,800 --> 00:19:27,080 Speaker 1: arm of the e t F expansion. Well, can we 391 00:19:27,119 --> 00:19:30,440 Speaker 1: talk more about how the sort of active fund management 392 00:19:30,520 --> 00:19:34,200 Speaker 1: or mutual fund industry feels about e t F s. 393 00:19:34,320 --> 00:19:39,120 Speaker 1: Uh I gather not so positive necessarily probably not. I mean, 394 00:19:39,119 --> 00:19:41,120 Speaker 1: if you're an active mutual fund, you've got to make 395 00:19:41,119 --> 00:19:44,040 Speaker 1: a decision do I ride the gravy train? Because if 396 00:19:44,040 --> 00:19:45,520 Speaker 1: you look at the fees, like you know, I look 397 00:19:45,520 --> 00:19:48,439 Speaker 1: at my mom's statements sometimes and I'm just I'm stunned 398 00:19:48,440 --> 00:19:50,600 Speaker 1: at how much she pays and the load she already 399 00:19:50,600 --> 00:19:54,040 Speaker 1: paid for mutual fund in a Class A share. So 400 00:19:54,080 --> 00:19:57,040 Speaker 1: they're making so much more money than e t f 401 00:19:57,080 --> 00:19:59,160 Speaker 1: s even though ETFs are growing, so it's a gravy train. 402 00:19:59,240 --> 00:20:03,000 Speaker 1: Still they have to ask themselves, do I cannibalize myself 403 00:20:03,040 --> 00:20:04,919 Speaker 1: to survive in the future. Do I just ride this 404 00:20:05,000 --> 00:20:08,359 Speaker 1: until it's over? And you can see some are struggling 405 00:20:08,359 --> 00:20:10,680 Speaker 1: with that question. PIMCO is a good example of one 406 00:20:10,680 --> 00:20:13,040 Speaker 1: that said, look, we've got to get involved. So they 407 00:20:13,080 --> 00:20:15,960 Speaker 1: came in with active etf they've been somewhat successful, and 408 00:20:16,000 --> 00:20:18,960 Speaker 1: then other companies have come in with smart beta versions 409 00:20:19,000 --> 00:20:21,679 Speaker 1: of their active products. So a lot of these firms 410 00:20:21,680 --> 00:20:23,320 Speaker 1: are trying to figure that out. For sure, it's a 411 00:20:23,320 --> 00:20:26,880 Speaker 1: big it's a big deal intellectually, I wonder so you 412 00:20:26,880 --> 00:20:31,040 Speaker 1: you mentioned these different factors that people have discovered leads 413 00:20:31,080 --> 00:20:35,120 Speaker 1: to outperformance, like momentum factors, so stocks that exhibit strong 414 00:20:35,160 --> 00:20:39,360 Speaker 1: momentum tend to outperform, or sometimes people say value stocks 415 00:20:39,480 --> 00:20:44,160 Speaker 1: or stocks with strong balance shoes, whatever it is. But well, 416 00:20:44,200 --> 00:20:47,760 Speaker 1: these factors, like once it becomes so cheap to play 417 00:20:47,800 --> 00:20:51,680 Speaker 1: these strategies, do they cease to be useful? Like are 418 00:20:51,760 --> 00:20:54,600 Speaker 1: people who for a long time have been investing these 419 00:20:54,640 --> 00:20:57,639 Speaker 1: in these strategies worried that now that everyone can just 420 00:20:57,640 --> 00:21:00,280 Speaker 1: press a button and instantly get momentum and that of 421 00:21:00,320 --> 00:21:04,800 Speaker 1: having to say find it themselves will ruin the strategy itself. Sure, 422 00:21:04,920 --> 00:21:08,200 Speaker 1: I think that is largely based on the herd mentality 423 00:21:08,200 --> 00:21:12,040 Speaker 1: as well. You know, momentum. Everybody can make money by 424 00:21:12,080 --> 00:21:14,880 Speaker 1: all piling into momentum stuff that's rights work. I see 425 00:21:14,920 --> 00:21:16,960 Speaker 1: it happened with low voltility all the time. Low ball 426 00:21:17,040 --> 00:21:19,000 Speaker 1: has a big ear and then it has a bad 427 00:21:19,080 --> 00:21:20,520 Speaker 1: year and then it has a big year in a 428 00:21:20,520 --> 00:21:22,560 Speaker 1: bad year, and it kind of swings like a pendulum. 429 00:21:23,040 --> 00:21:25,879 Speaker 1: And you actually know how ETFs trying to solve that problem, 430 00:21:25,880 --> 00:21:28,360 Speaker 1: which is called multi factory t f s where they 431 00:21:28,440 --> 00:21:31,639 Speaker 1: switch from the different factors based on market signals. So 432 00:21:32,280 --> 00:21:34,280 Speaker 1: they got all, this is another strand on the smart 433 00:21:34,359 --> 00:21:37,919 Speaker 1: beta evolution line. And so yeah, people are concerned with 434 00:21:37,960 --> 00:21:40,959 Speaker 1: which factor by using when, and but then generally like 435 00:21:41,000 --> 00:21:44,720 Speaker 1: a dividend, DTF dividend is a factor that is something 436 00:21:44,760 --> 00:21:46,840 Speaker 1: that just general retail investors like, they're not trying to 437 00:21:46,840 --> 00:21:50,600 Speaker 1: time anything, they just want dividend. Little less vultility wouldn't 438 00:21:50,600 --> 00:21:52,879 Speaker 1: scrifice a little upside. So some of these factors can 439 00:21:52,920 --> 00:21:55,040 Speaker 1: actually be used in the long term, not just trying 440 00:21:55,040 --> 00:21:57,320 Speaker 1: to play it and beat the market. Let's go back 441 00:21:57,320 --> 00:21:59,560 Speaker 1: to the very beginning of our story, because we had 442 00:21:59,600 --> 00:22:03,480 Speaker 1: the sc SEE put out this report that somehow years 443 00:22:03,520 --> 00:22:07,879 Speaker 1: down the line managed to spawn a huge, huge industry. 444 00:22:08,480 --> 00:22:10,760 Speaker 1: And nowadays we see the SEC talking about e t 445 00:22:10,920 --> 00:22:14,399 Speaker 1: f s in a slightly different light. Right, you've touched 446 00:22:14,400 --> 00:22:18,080 Speaker 1: on it before. We've seen worries and concerns about e 447 00:22:18,160 --> 00:22:20,840 Speaker 1: t f s. Uh, the liquid wrapper that might not 448 00:22:20,920 --> 00:22:23,479 Speaker 1: be suitable for all sorts of assets. Yeah. The the 449 00:22:23,600 --> 00:22:26,560 Speaker 1: SEC has two main areas of focus where they literally 450 00:22:26,560 --> 00:22:29,760 Speaker 1: have written rule proposals. I think that's the most important thing. 451 00:22:30,200 --> 00:22:33,359 Speaker 1: One is on liquidity, right, so they've written some strict 452 00:22:33,400 --> 00:22:34,760 Speaker 1: rules that e t s will have to be able 453 00:22:34,760 --> 00:22:37,359 Speaker 1: to sell off a certain amount of assets that within 454 00:22:37,480 --> 00:22:40,639 Speaker 1: fifteen days. That would affect how you'll bond. ETFs might 455 00:22:40,680 --> 00:22:43,679 Speaker 1: have affected some emerging market funds. Uh, there's gonna be 456 00:22:43,720 --> 00:22:46,920 Speaker 1: some negotiations. Black Rock is lobbying them relentlessly, I'm sure, 457 00:22:47,240 --> 00:22:49,400 Speaker 1: and so the final rule might not be as hardcore 458 00:22:49,440 --> 00:22:52,000 Speaker 1: as the proposal. But that's one and then the other 459 00:22:52,040 --> 00:22:54,560 Speaker 1: one is derivatives. They have a rule that would essentially 460 00:22:54,560 --> 00:22:57,520 Speaker 1: limit the amount of leverage to one fifty, which would 461 00:22:57,560 --> 00:23:01,120 Speaker 1: really at some leverage gts have a way to work 462 00:23:01,119 --> 00:23:03,320 Speaker 1: around it, but largely that would inhibit a lot of 463 00:23:03,359 --> 00:23:05,480 Speaker 1: three times, especially and maybe some of the two times. 464 00:23:06,000 --> 00:23:08,720 Speaker 1: And then beyond that are e t F where they 465 00:23:08,800 --> 00:23:12,040 Speaker 1: move three x the underlying automatically, so you could buy 466 00:23:12,160 --> 00:23:15,159 Speaker 1: a three x financial stocks one and if the banks 467 00:23:15,280 --> 00:23:17,639 Speaker 1: rise one percent in a day, theoretically the e t 468 00:23:17,800 --> 00:23:20,560 Speaker 1: F rises three percent that day. That's right. Every day 469 00:23:20,640 --> 00:23:22,560 Speaker 1: that the three times doesn't work over the long term, 470 00:23:22,560 --> 00:23:24,280 Speaker 1: but per day that that's what they promised. But the 471 00:23:24,320 --> 00:23:27,120 Speaker 1: other two areas that they have looked at was one 472 00:23:27,200 --> 00:23:30,679 Speaker 1: is August last year, which ironically was called Black Monday. 473 00:23:30,720 --> 00:23:33,480 Speaker 1: To right, it was referring to that as Black Monday, 474 00:23:33,600 --> 00:23:35,840 Speaker 1: and uh e t f s were all involved in that, 475 00:23:35,960 --> 00:23:38,119 Speaker 1: and that's why this whole Black Monday to Black Monday. 476 00:23:38,160 --> 00:23:40,359 Speaker 1: It's kind of ironic, h that the e t F 477 00:23:40,480 --> 00:23:42,399 Speaker 1: was designed to kind of counter one Black Monday, and 478 00:23:42,400 --> 00:23:44,320 Speaker 1: there they are in the next one, right, because people 479 00:23:44,359 --> 00:23:46,520 Speaker 1: are concerned about the ability of e t f s 480 00:23:46,560 --> 00:23:50,640 Speaker 1: to actually function and track their underlying stocks and assets 481 00:23:50,720 --> 00:23:54,320 Speaker 1: in an environment of intense volatility. August, though, can be 482 00:23:54,320 --> 00:23:56,919 Speaker 1: explained pretty easily. I've looked into it. It's really about 483 00:23:56,960 --> 00:24:00,480 Speaker 1: the halting that the exchange has so on Black Monday, basically, 484 00:24:00,680 --> 00:24:04,159 Speaker 1: market makers came in, stocks were halted, and if a 485 00:24:04,200 --> 00:24:07,359 Speaker 1: market maker can't figure out the real time value and 486 00:24:07,400 --> 00:24:10,080 Speaker 1: it needs all the stocks prices to figure that value out, 487 00:24:10,480 --> 00:24:12,000 Speaker 1: it has to widen it spread on the e t 488 00:24:12,119 --> 00:24:13,960 Speaker 1: F because it doesn't know where you are. The aps 489 00:24:14,000 --> 00:24:16,960 Speaker 1: in as well, just just in order to protect themselves 490 00:24:16,960 --> 00:24:19,359 Speaker 1: from risks. So a market maker needs to know the 491 00:24:19,400 --> 00:24:22,200 Speaker 1: actual real time, inter day net asset value of the stocks. 492 00:24:22,200 --> 00:24:24,200 Speaker 1: And if all the stocks aren't having pricing because are halted, 493 00:24:24,720 --> 00:24:26,520 Speaker 1: that's a chain reaction that makes it harder for e 494 00:24:26,600 --> 00:24:28,560 Speaker 1: t F to trade. So if you look at Nastact 495 00:24:28,560 --> 00:24:30,440 Speaker 1: that day, e t F traded fine because they didn't 496 00:24:30,480 --> 00:24:33,200 Speaker 1: have the same halting rules that Nicey did, and Bondy 497 00:24:33,280 --> 00:24:35,720 Speaker 1: TF traded fine that day because they weren't halted. So, 498 00:24:36,080 --> 00:24:39,080 Speaker 1: in essence, August was a little bit of a complicated issue, 499 00:24:39,119 --> 00:24:41,480 Speaker 1: but certainly a concern. And then the other fourth area 500 00:24:41,480 --> 00:24:44,400 Speaker 1: that SEC is concerned with is just complex products. We've 501 00:24:44,400 --> 00:24:46,639 Speaker 1: described a little bit today, multi factor e t f s. 502 00:24:46,720 --> 00:24:48,640 Speaker 1: They even brought up the millennial e t F which 503 00:24:48,640 --> 00:24:52,720 Speaker 1: we uh, which you and I know about, that's designed 504 00:24:52,720 --> 00:24:56,480 Speaker 1: to track stocks that theoretically millennials, as they get older 505 00:24:56,480 --> 00:24:59,040 Speaker 1: and spend more money, will do well. Eric, I guess 506 00:24:59,119 --> 00:25:02,200 Speaker 1: the big question and I have, and maybe Joe has 507 00:25:02,240 --> 00:25:04,760 Speaker 1: after listening to all of this, is do you think 508 00:25:04,760 --> 00:25:07,760 Speaker 1: e t f s have been a net positive for 509 00:25:07,920 --> 00:25:11,520 Speaker 1: investors or a net negative? Well, I'm a net positive. 510 00:25:11,520 --> 00:25:14,240 Speaker 1: I've studied hedge funds, mutual funds and clothed and funds. 511 00:25:14,280 --> 00:25:17,280 Speaker 1: I've been in fund data for fifteen years, and when 512 00:25:17,280 --> 00:25:20,000 Speaker 1: I was assigned ETFs in two thousand and six, I 513 00:25:20,119 --> 00:25:22,320 Speaker 1: quickly started to, you know, sniff around them, like, wow, 514 00:25:22,320 --> 00:25:25,040 Speaker 1: these things are really useful. They're they're fully funded and 515 00:25:25,040 --> 00:25:27,199 Speaker 1: approved by the SEC N of the nine gives them 516 00:25:27,240 --> 00:25:29,800 Speaker 1: some security. So I do think their net positive. I 517 00:25:29,840 --> 00:25:31,760 Speaker 1: think I don't think any of the things that I 518 00:25:31,800 --> 00:25:34,160 Speaker 1: just mentioned or the SEC is looking at, is really 519 00:25:34,200 --> 00:25:36,359 Speaker 1: the thing I would be concerned with. I think a 520 00:25:36,359 --> 00:25:39,000 Speaker 1: lot of that is um them reacting to media. Uh, 521 00:25:39,080 --> 00:25:41,199 Speaker 1: there's some concerns there, But the big concern for me 522 00:25:41,720 --> 00:25:43,840 Speaker 1: is I would feel the same way as Bogel does. 523 00:25:44,359 --> 00:25:46,680 Speaker 1: They trade eighteen trillion dollars a year, but they only 524 00:25:46,680 --> 00:25:50,680 Speaker 1: have two trillion assets. That's n turnover. Put that in perspective. 525 00:25:50,680 --> 00:25:53,160 Speaker 1: Stocks only turn over two d and fifty percent a year, 526 00:25:53,440 --> 00:25:55,239 Speaker 1: so E t f s trade three times more. So 527 00:25:55,640 --> 00:25:57,560 Speaker 1: when you trade, all you do is work over money 528 00:25:57,600 --> 00:26:00,119 Speaker 1: to Wall Street. So I think that for investors, if 529 00:26:00,119 --> 00:26:02,880 Speaker 1: they get hooked on trading too much, I think that's 530 00:26:02,880 --> 00:26:05,080 Speaker 1: probably a losing scenario. So that would be my That 531 00:26:05,080 --> 00:26:08,680 Speaker 1: would be maybe the net negative. Structurally, you'd say their 532 00:26:08,720 --> 00:26:11,679 Speaker 1: sound and they are low cost vehicles. But if the 533 00:26:11,720 --> 00:26:14,640 Speaker 1: net result is it people get hooked on trading them, 534 00:26:14,760 --> 00:26:17,160 Speaker 1: that undermines their benefit, is what you're saying, and that 535 00:26:17,160 --> 00:26:19,479 Speaker 1: that's their choice. I just think if a retail investor 536 00:26:19,560 --> 00:26:22,160 Speaker 1: starts trading, like we just talked about millennials loving the 537 00:26:22,200 --> 00:26:24,680 Speaker 1: three x crude oil e T n H, then yeah, 538 00:26:24,720 --> 00:26:26,359 Speaker 1: I think people could get hurt and that would leave 539 00:26:26,400 --> 00:26:29,000 Speaker 1: a bad experience for that customer. We are like so 540 00:26:29,119 --> 00:26:34,080 Speaker 1: into that. Thank you very much. Eric bolcons fascinating discussion. 541 00:26:34,119 --> 00:26:37,280 Speaker 1: Thank you so, Joe. We just learned a whole lot 542 00:26:37,320 --> 00:26:39,119 Speaker 1: about the origins of e t f s. Would you 543 00:26:39,160 --> 00:26:42,200 Speaker 1: think I thought it's fascinating. I mean it, guess when 544 00:26:42,240 --> 00:26:45,120 Speaker 1: it comes to financial products, you just sort of take 545 00:26:45,160 --> 00:26:48,159 Speaker 1: them for granted that they exist sometimes and you forget 546 00:26:48,160 --> 00:26:51,760 Speaker 1: that someone had to invent them, someone had to design 547 00:26:51,800 --> 00:26:55,399 Speaker 1: the mutual funds, someone had to design various structures of 548 00:26:55,400 --> 00:26:57,560 Speaker 1: bonds that exist, and of course et f s are 549 00:26:57,600 --> 00:27:00,239 Speaker 1: no exception. And I love that it was discus ord 550 00:27:00,320 --> 00:27:04,560 Speaker 1: in this gigantic SEC memo that was by mind numbing 551 00:27:04,600 --> 00:27:07,480 Speaker 1: to the vast majority of the population. I really like 552 00:27:07,560 --> 00:27:10,880 Speaker 1: the idea of the whole thing kind of coming full circle. 553 00:27:11,400 --> 00:27:14,840 Speaker 1: We had them spring from this SEC memo, and now 554 00:27:14,880 --> 00:27:17,240 Speaker 1: we see the SEC kind of worried that maybe the 555 00:27:17,240 --> 00:27:21,160 Speaker 1: structure has been applied to things that aren't appropriate for it, right, 556 00:27:21,240 --> 00:27:23,639 Speaker 1: like the idea in the beginning, Okay, we're gonna make 557 00:27:23,680 --> 00:27:26,439 Speaker 1: this incredibly simple product. It's going to be good for 558 00:27:26,520 --> 00:27:29,800 Speaker 1: market stability, very low fees. And now you have these 559 00:27:29,800 --> 00:27:35,480 Speaker 1: incredibly increasingly complex mutual funds, actively manage mutual funds, triple 560 00:27:35,560 --> 00:27:39,240 Speaker 1: lever mutual funds, mutual funds where the underlying assets aren't 561 00:27:39,240 --> 00:27:41,399 Speaker 1: particularly liquid, and now you have all these people like, 562 00:27:41,440 --> 00:27:44,760 Speaker 1: oh what, what, where's this going? E t s for 563 00:27:44,960 --> 00:27:48,080 Speaker 1: every single need you could possibly imagine, And it seems 564 00:27:48,200 --> 00:27:50,480 Speaker 1: like the evolution of E t f s is not 565 00:27:50,640 --> 00:27:53,560 Speaker 1: slowing down anytime soon. So well, I have to check 566 00:27:53,600 --> 00:27:55,400 Speaker 1: back in on this story in ten years and see 567 00:27:55,400 --> 00:27:58,040 Speaker 1: where it is. Yeah, we will, And in the meantime, 568 00:27:58,160 --> 00:28:00,720 Speaker 1: our listeners can go and read the full article over 569 00:28:00,760 --> 00:28:03,840 Speaker 1: in Bloomberg Markets Magazine or on Bloomberg dot com. And 570 00:28:04,000 --> 00:28:05,639 Speaker 1: Eric has a whole book coming out on E t 571 00:28:05,760 --> 00:28:09,439 Speaker 1: F So if you really want to dive more into it, 572 00:28:09,520 --> 00:28:12,040 Speaker 1: you should check out his book for sure. All Right, 573 00:28:12,160 --> 00:28:14,600 Speaker 1: I'm Joe, Why isn't Thal? Thanks for listening to The 574 00:28:14,640 --> 00:28:17,280 Speaker 1: Odd Lots Podcast. You can follow me on Twitter at 575 00:28:17,320 --> 00:28:19,919 Speaker 1: the Stalwart and I'm Tracy Alloway. You can follow me 576 00:28:20,000 --> 00:28:23,160 Speaker 1: on Twitter at Tracy Alloway and you can also follow 577 00:28:23,359 --> 00:28:26,280 Speaker 1: Eric at Eric Balcunas. Thanks for listening.