WEBVTT - Episode 18: The Obscure Report That Spawned the ETF Industry 0:00:06.080 --> 0:00:10.400 Hello, and welcome to another edition of the Odd Lots podcast. 0:00:10.600 --> 0:00:15.120 I'm Joseph Wisenthal, Managing Editor Bloomberg Markets, and I'm Tracy Alloway, 0:00:15.200 --> 0:00:18.880 Executive editor of Bloomberg Markets. So, Tracy, today we're going 0:00:18.960 --> 0:00:21.560 to be it's like a special episode. We're talking to 0:00:21.600 --> 0:00:24.720 one of our colleagues here, special edition of Odd Lot 0:00:25.120 --> 0:00:27.800 We're gonna be talking about one of the most important 0:00:28.240 --> 0:00:31.560 financial innovations of the modern era. Wouldn't you say? I 0:00:31.560 --> 0:00:34.280 would definitely say so. Isn't it something like a three 0:00:34.560 --> 0:00:38.519 trillion dollar industry? Is that right? And that industry is 0:00:38.800 --> 0:00:41.400 the e T F And I think almost everybody at 0:00:41.400 --> 0:00:43.519 this point who is aware of markets knows what e 0:00:43.600 --> 0:00:48.000 t s are. Their exchange treated funds. You can use 0:00:48.080 --> 0:00:51.120 them to make a bet on the STP as a whole. 0:00:51.640 --> 0:00:54.360 You can use them to make a bet on gold, 0:00:54.480 --> 0:00:57.000 and you can use them to do crazy stuff like 0:00:57.360 --> 0:01:01.120 make a three x levered bet on junior gold. Miners 0:01:01.400 --> 0:01:04.160 do that all the time. But it's like a basket 0:01:04.240 --> 0:01:07.240 of things, right, and it trades like a single stock 0:01:07.400 --> 0:01:10.200 on an exchange exactly right. And these e t f 0:01:10.280 --> 0:01:13.320 s have been hoovering up assets, as you said, trillions 0:01:13.319 --> 0:01:17.959 of dollars away from traditional funds, from traditional money managers, 0:01:18.280 --> 0:01:20.800 and it doesn't look like they're slowing down anytime soon. 0:01:21.440 --> 0:01:24.360 And not only that, they continue to innovate. So there 0:01:24.360 --> 0:01:26.000 are more and more new kinds of e t F 0:01:26.080 --> 0:01:30.040 s all the time. From what humble beginnings did the 0:01:30.040 --> 0:01:31.760 e t F market come to us? This is the 0:01:31.760 --> 0:01:35.399 fascinating thing. We're going to discuss with our colleague Eric Balcunas. 0:01:35.440 --> 0:01:38.440 He has a new article out in Bloomberg Markets magazine 0:01:38.760 --> 0:01:40.920 called the e t F Files, and that's based on 0:01:40.959 --> 0:01:44.720 a new book that he's publishing. And so it turns out, Eric, 0:01:44.760 --> 0:01:47.160 thanks for joining us, thank you for having me. So 0:01:47.240 --> 0:01:50.560 the e t F, this monster innovation that's changing how 0:01:50.600 --> 0:01:53.640 people invest, came out in a weird way. It came 0:01:53.640 --> 0:01:57.160 out thanks to basically a memo, right yeah, memo, will 0:01:57.160 --> 0:01:59.640 be putting it mildly at eight hundred and forty page 0:01:59.720 --> 0:02:03.360 governed report is really where the seed for the e 0:02:03.440 --> 0:02:06.520 t F was found. So what happened was in the 0:02:06.840 --> 0:02:11.119 seven crash called Black Monday, right the worst, the worst 0:02:11.120 --> 0:02:15.639 stock market crash in history. There was SEC spent four 0:02:15.680 --> 0:02:18.320 months writing a report about what happened. They were trying 0:02:18.360 --> 0:02:20.760 to figure out what really not the macro events that 0:02:20.840 --> 0:02:23.840 caused selling, but what exacerbated the sell off that it 0:02:23.880 --> 0:02:27.360 was so brutal, and Key tell us what did happen? 0:02:27.440 --> 0:02:31.120 Because we can't pass up an opportunity to talk portfolio insurance. 0:02:31.160 --> 0:02:34.320 I'm sorry. Sure. So what they found was, when the 0:02:34.400 --> 0:02:38.079 dark clouds were going over the market, institutions had all 0:02:38.080 --> 0:02:41.640 started using something called portfolio insurance, which essentially was a 0:02:41.680 --> 0:02:46.639 strategy that involved shorting futures right based on indices as 0:02:46.639 --> 0:02:49.720 soon as the stocks they held started hitting a certain level. 0:02:50.400 --> 0:02:52.960 So essentially what happened was on that day there were 0:02:53.000 --> 0:02:55.560 just weren't that many buyers for the people trying to 0:02:55.600 --> 0:02:58.760 sell insurance. Then on top of that, you had program 0:02:58.840 --> 0:03:02.440 traders who were arbitrage in the futures to the individual stocks, 0:03:02.720 --> 0:03:06.519 which involved buying the futures and then selling all five 0:03:06.600 --> 0:03:08.359 hundred or how many of our hundred stocks at the 0:03:08.400 --> 0:03:11.880 same time, right, So what happened was those program traders 0:03:11.880 --> 0:03:15.320 stepped in and they were putting all the cell orders 0:03:15.360 --> 0:03:18.520 on the individual stocks. That caused more panic and all 0:03:18.800 --> 0:03:20.720 all of a sudden, Really what you had was all 0:03:20.720 --> 0:03:23.960 these forces looking to sell individual stocks all at the 0:03:24.000 --> 0:03:26.320 same time and that's when you had the crash. And 0:03:26.360 --> 0:03:29.760 how much was the crash that day the crash it 0:03:29.880 --> 0:03:33.320 was a five D eight point drop in one day. 0:03:34.160 --> 0:03:37.040 I mean, we've had like some flash crashes in recent years, 0:03:37.560 --> 0:03:40.040 but that really puts it into perspective. It also reminds it. 0:03:40.280 --> 0:03:43.160 You know, we've blamed high frequency trading and all kinds 0:03:43.160 --> 0:03:45.839 of stuff on modern flash crashes, but you can get 0:03:45.880 --> 0:03:49.120 some extraordinary moves. It seems about just about any area, 0:03:49.560 --> 0:03:53.680 that's right. Yeah, Okay, So the SEC put out after 0:03:53.840 --> 0:03:57.680 several months of studying that crash in they wrote an 0:03:57.720 --> 0:04:01.160 eight hundred and forty page memo. And what was in 0:04:01.360 --> 0:04:05.200 that memo that led to the e t F Sure 0:04:05.280 --> 0:04:08.440 on chapter three, right deep into the into the actual 0:04:08.480 --> 0:04:11.640 white paper memo, there was something where they talked about 0:04:11.880 --> 0:04:14.800 if an alternative approach were to be examined, so they 0:04:14.920 --> 0:04:17.760 used that language, and what they're basically saying was the 0:04:17.880 --> 0:04:21.080 SEC was thinking that the futures market volatility and sell 0:04:21.120 --> 0:04:24.800 off had transmitted to individual stocks. So they thought, you know, 0:04:25.279 --> 0:04:27.719 if there was only a way to do basket trading, 0:04:27.760 --> 0:04:29.880 so you didn't hit sell on five stocks at once, 0:04:30.240 --> 0:04:32.640 but you hit sell on a basket and you had 0:04:32.839 --> 0:04:35.960 market makers and specialists who were able to trade those baskets. 0:04:36.279 --> 0:04:38.960 It might have provided a buffer in between the futures 0:04:39.000 --> 0:04:42.400 market in Chicago, which the SEC doesn't have any regulation over, 0:04:42.839 --> 0:04:45.200 and the individual stocks in New York, which they do. 0:04:45.800 --> 0:04:47.320 So they just put it in there is maybe a 0:04:47.360 --> 0:04:50.680 possible alternative approach. However, they did use the word product. 0:04:51.120 --> 0:04:53.000 And then the two guys at the m X, who 0:04:53.000 --> 0:04:55.680 were hungry for some more volume because that exchange was 0:04:55.760 --> 0:04:58.520 really in third place at the time, read this and 0:04:58.560 --> 0:05:00.479 really looked at it as a product propos Well from 0:05:00.520 --> 0:05:03.520 the SEC. I mean, it's kind of a creative approach, 0:05:03.680 --> 0:05:08.000 right to read an CEC paper on this huge negative 0:05:08.040 --> 0:05:11.200 event in markets and think I have a product idea 0:05:11.240 --> 0:05:14.400 out of that. Yeah, I mean the SEC does use 0:05:14.440 --> 0:05:17.080 the word product and they say alternative approach. Remember they 0:05:17.120 --> 0:05:19.760 worked at am X, right, So exchanges were really into 0:05:19.760 --> 0:05:22.960 this report. Because I asked Stephen Bloom, who was one 0:05:23.000 --> 0:05:25.280 of the two guys who read it, they said they 0:05:25.279 --> 0:05:28.120 were riveted by every page. I thought, who would read 0:05:28.120 --> 0:05:31.159 an eight d forty page government report, But they did, 0:05:31.240 --> 0:05:33.800 and they you know, they got rewarded for reading every 0:05:33.800 --> 0:05:37.279 word like that, So they were really excited. One of 0:05:37.279 --> 0:05:39.400 the quotes that we found from him was that he 0:05:39.400 --> 0:05:41.680 said he walked into his boss's office and said, here's 0:05:41.680 --> 0:05:44.240 an opening. We can drive a truck through this exchange. 0:05:44.240 --> 0:05:47.839 In particular, MX was hurting, so they were really looking 0:05:47.880 --> 0:05:49.840 for something. So they had their eyes wide open when 0:05:49.839 --> 0:05:51.720 the report hit. I just want to pause and say, 0:05:51.800 --> 0:05:55.120 I love that point that he who hears you, who 0:05:55.120 --> 0:05:58.440 reads an eight hundred and forty page government white paper 0:05:58.800 --> 0:06:02.200 and really notices all the details, there's a reward to 0:06:02.279 --> 0:06:04.760 that they deserve to make money. Yeah, exactly, I think. 0:06:04.760 --> 0:06:08.760 So Eric tell us about the product that they eventually 0:06:08.800 --> 0:06:11.560 came up with. What were the actual beginnings, right, So 0:06:11.600 --> 0:06:14.360 they thought, okay, well let's get a basket trading product. Right. 0:06:14.400 --> 0:06:17.480 Their first idea was to go to Jack Bogel at 0:06:17.520 --> 0:06:20.080 Vanguard and see if they could trade an SMP index 0:06:20.120 --> 0:06:24.159 fund for from Vanguard. Jack Bogel met with Nate Most, 0:06:24.279 --> 0:06:26.279 who Nate Most and Steve Bloom with the two guys 0:06:26.839 --> 0:06:29.400 and basically said thank you, but no thank you. And 0:06:29.720 --> 0:06:32.600 when I interviewed Jack Bogel, he said, Nate Most walked 0:06:32.640 --> 0:06:35.080 into my office. I looked at his proposal. I said, 0:06:35.560 --> 0:06:37.880 I'm not interested anyway, but I will give you three 0:06:37.920 --> 0:06:40.720 criticisms flaws that I think your product has that if 0:06:40.720 --> 0:06:43.200 you fix them, might be better. So that's what Bogel claims. 0:06:43.240 --> 0:06:45.839 So basically he said no, thank you, because Jack Bogel 0:06:45.880 --> 0:06:48.120 wants nothing to do with trading anywhere near his funds. 0:06:48.120 --> 0:06:49.960 You know, he's anti trading, and this would be a 0:06:49.960 --> 0:06:52.279 product that would trade. So that was really where the 0:06:52.279 --> 0:06:55.280 difference lies. So Nate Most said that that meeting got 0:06:55.360 --> 0:06:58.120 him thinking about a way where you could trade a 0:06:58.160 --> 0:07:00.599 fund but not drive up cast us and the fund 0:07:00.600 --> 0:07:02.520 from people coming in and out of it. That was 0:07:02.560 --> 0:07:05.400 the big problem. And this is where the I think 0:07:05.440 --> 0:07:07.960 the value from Nate Most than the AMEX came in 0:07:08.000 --> 0:07:09.320 to make the e t F more than what the 0:07:09.360 --> 0:07:11.760 SEC called for. And that is that Nate Most was 0:07:11.800 --> 0:07:13.200 seventy four years old and he used to be a 0:07:13.200 --> 0:07:15.280 commodities trader, and he used to be president of the 0:07:15.320 --> 0:07:18.720 Pacific Commodities Exchange, and he basically looked at the paradigm 0:07:18.760 --> 0:07:21.960 of the commodities warehouse receipt, which is where you know, 0:07:22.040 --> 0:07:24.640 palm oil or coco. You don't want to move the 0:07:24.680 --> 0:07:26.360 merchandise back and forth. So what you do is you 0:07:26.360 --> 0:07:28.760 store it in a warehouse, you get a receipt, then 0:07:28.760 --> 0:07:30.320 you trade the receipt. That way you don't have to 0:07:30.320 --> 0:07:33.000 move anything, and then he saves costs, and that saves costs. 0:07:33.000 --> 0:07:35.120 Then you could gather up the receipts at any time, 0:07:35.160 --> 0:07:37.880 go to the warehouse and get your commodities back. So 0:07:38.000 --> 0:07:40.680 that that paradigm was then applied to the sort of 0:07:40.720 --> 0:07:44.320 the SEC's general idea, and that really was the sort 0:07:44.360 --> 0:07:46.920 of foundation of the et start. So let's just break 0:07:46.960 --> 0:07:49.560 down what we've learned, because I think this is really fascinating. 0:07:49.640 --> 0:07:53.120 And for those who don't know, Jack Vogel famous for 0:07:53.240 --> 0:07:57.400 his belief in indexing not trading, the key to winning 0:07:57.400 --> 0:08:00.360 and investments is low costs, and so theoretic at least 0:08:00.400 --> 0:08:04.080 something like an SMP index fund could have appealed to him. 0:08:04.120 --> 0:08:06.800 When he saw this product, he said, hey, this is 0:08:06.800 --> 0:08:09.440 a trading vehicle. He's not into vehicles that make it 0:08:09.520 --> 0:08:11.480 easy to get in and out of the market and 0:08:11.600 --> 0:08:15.520 be there's too much costs involved in the internal running 0:08:15.560 --> 0:08:18.800 of the fund. But when they solved that problem, it 0:08:18.840 --> 0:08:21.120 still didn't really solve the fact that it's a trading vehicle. 0:08:21.400 --> 0:08:25.600 But it did become a low cost product that people 0:08:25.680 --> 0:08:28.680 can use to make a directional bet on the market 0:08:28.920 --> 0:08:30.720 in a way that we didn't have before. Yeah. And 0:08:30.720 --> 0:08:33.439 I think what it did was the meeting with Bogel, 0:08:33.440 --> 0:08:34.840 even though it was never going to happen with him 0:08:34.840 --> 0:08:38.080 because he was anti trading, the meeting pushed them to 0:08:38.200 --> 0:08:40.760 think of something different. And that's where bringing this commodities 0:08:40.800 --> 0:08:44.000 paradigm is why et f s can trade upwards of 0:08:44.160 --> 0:08:46.920 eighteen trillion dollars a year. They trade all day long, 0:08:47.000 --> 0:08:49.360 right uh. And if you look at like sp Y 0:08:49.400 --> 0:08:52.000 for example, trades about billion dollars a day. That's the 0:08:52.040 --> 0:08:54.319 big sp five, that's the big SMP. That's the one 0:08:54.360 --> 0:08:57.240 that they first designed, these two guys. But yet someone 0:08:57.280 --> 0:08:59.880 like my aunt Joyce could go into the SMP Spy 0:09:00.040 --> 0:09:02.720 for ten years and that trading every day does not 0:09:02.920 --> 0:09:06.080 bother or drive up costs for her long term investment. 0:09:06.559 --> 0:09:10.240 And that is where the model really was something special. 0:09:10.280 --> 0:09:12.920 And when you talk to the guy who was one 0:09:12.960 --> 0:09:15.760 of the lawyers who wrote the market break report, the 0:09:15.840 --> 0:09:18.280 SEC document, he said when he saw the proposal come 0:09:18.320 --> 0:09:21.440 in from am X with this design, he was blown away. 0:09:21.480 --> 0:09:23.679 It was way more than he thought when they were 0:09:23.720 --> 0:09:26.520 writing it. So he thought this product would had much 0:09:26.559 --> 0:09:28.880 more utility than even they thought when they said we 0:09:28.920 --> 0:09:31.240 need something for a basket trading product. So hold on 0:09:31.240 --> 0:09:34.640 one second. They borrowed the commodities warehouse idea with the 0:09:34.679 --> 0:09:38.720 sort of trading receipts, but you still need a virtual 0:09:38.920 --> 0:09:42.160 warehouse for the shares, right, how did that come about? Right? 0:09:42.200 --> 0:09:44.600 So there, right, there's no warehouse, right, So instead of 0:09:44.760 --> 0:09:47.680 a warehouse is called a custodian. So State Street was 0:09:47.679 --> 0:09:49.480 one of the first obvious places they went, and so 0:09:49.559 --> 0:09:53.160 that's became the custodian for the stock. So the custodian 0:09:53.320 --> 0:09:56.320 is the virtual warehouse that and today every et F 0:09:56.400 --> 0:09:59.559 needs a custodian to store those stocks or bonds or 0:09:59.600 --> 0:10:02.400 whatever holding. And that is what makes the e t 0:10:02.559 --> 0:10:04.679 F slightly different than a derivative. Some people say E 0:10:04.720 --> 0:10:07.240 t s are a type of derivative. The fact is 0:10:07.320 --> 0:10:10.040 that these stocks that are in the spy or any 0:10:10.080 --> 0:10:12.959 E t F our literal picture, and they're literally stored 0:10:13.000 --> 0:10:15.560 in a warehouse just happens to be a custodian's electronic 0:10:16.040 --> 0:10:18.920 But the fact is those are receipts for those physical 0:10:18.960 --> 0:10:21.520 they're physically backed and that that's what makes some difference 0:10:21.559 --> 0:10:23.880 in like a futures contract and tell us how those 0:10:23.880 --> 0:10:27.560 stocks actually get in the virtual warehouse, if you will, 0:10:27.600 --> 0:10:30.760 because that's a process that's really important for e t S, 0:10:30.880 --> 0:10:33.560 right sure, It's called the creation redemption process. And this 0:10:33.600 --> 0:10:36.079 is where I sometimes teach courses on e t S 0:10:36.120 --> 0:10:38.600 where the students get really like confused and bored. I'll 0:10:38.640 --> 0:10:41.520 be honest. That's why are our listeners are not going 0:10:41.559 --> 0:10:45.160 to give our Our listeners are very sophisticated, wonky people, 0:10:45.200 --> 0:10:46.640 and this is the part they're going to be most 0:10:46.640 --> 0:10:50.320 excited about. So well, and that's why I went into 0:10:50.360 --> 0:10:52.080 the story of how the first t t F came about, 0:10:52.080 --> 0:10:54.920 because when I tell the story, people get it more. Right, 0:10:54.920 --> 0:10:57.920 when I explain the commodities visual, they understand it. So 0:10:58.280 --> 0:11:01.640 the way creation redemption works is an authorized participant, which 0:11:01.679 --> 0:11:04.679 is a gigantic bank connected to the system with you know, 0:11:04.760 --> 0:11:07.960 a lot of money. Basically they are Every et F 0:11:08.000 --> 0:11:11.160 has several aps that are assigned to it. When a 0:11:11.160 --> 0:11:14.600 new creation is done, the AP will hand in the basket, 0:11:14.640 --> 0:11:17.760 which is say five s in the SMP into the 0:11:17.840 --> 0:11:20.720 state into the issure state Street and in return they 0:11:20.720 --> 0:11:23.600 get fifty shares of spy and that would be like 0:11:23.640 --> 0:11:26.160 the receipts. Then they sell those on the exchange, and 0:11:26.200 --> 0:11:28.439 that's where those receipts will trade. And then if there's 0:11:28.440 --> 0:11:31.640 a redemption, the same thing will happen. They'll take spy shares, 0:11:32.080 --> 0:11:35.080 hand them into State Street and get their five stocks back. 0:11:35.280 --> 0:11:37.440 And then that is sort of the creation redempture process, 0:11:37.480 --> 0:11:40.559 which I sort of equate to the flux capacitor from 0:11:40.559 --> 0:11:43.079 Back to the Future. You know it's in that movie. 0:11:43.080 --> 0:11:46.040 It's how time travel works. What I just described is 0:11:46.080 --> 0:11:49.240 how the e t F has been so resilient in 0:11:49.360 --> 0:11:53.080 several market stress events. And I think, you know, people 0:11:53.120 --> 0:11:54.760 are waiting for them to blow up, but that what 0:11:54.840 --> 0:11:56.760 I just described does make them, I think a little 0:11:56.800 --> 0:11:59.319 more resilient than people think who are sort of just 0:11:59.400 --> 0:12:02.319 learning about them. So what actually motivates the a p 0:12:02.559 --> 0:12:06.480 s to bring their shares and things to this warehouse 0:12:06.520 --> 0:12:09.000 and get the sort of the E t F share 0:12:09.000 --> 0:12:11.880 in return? Right, the AP gets a small cut from 0:12:11.880 --> 0:12:13.640 a spread when they deal with the market makers, and 0:12:13.679 --> 0:12:16.679 they also are able to do arbitrage, and arbitrage sounds 0:12:16.679 --> 0:12:19.320 like a bad dirty word, but it's actually really effective 0:12:19.360 --> 0:12:22.559 for e t s because if the basket, if the stocks, 0:12:22.720 --> 0:12:24.599 if the e t F price starts to go a 0:12:24.640 --> 0:12:28.560 little higher than the value of the stocks, the AP 0:12:28.720 --> 0:12:30.840 can arbitrage by handing in the e t F shares 0:12:31.000 --> 0:12:33.280 and buying the underlyings or vice versa. So they can 0:12:33.320 --> 0:12:36.520 always arbitrage the e t F versus the basket by 0:12:36.559 --> 0:12:39.720 using the creative redemption process. That in effect is a 0:12:39.840 --> 0:12:43.280 natural economic motive for them to keep the price close 0:12:43.320 --> 0:12:45.640 to the n A V. And that's a huge difference 0:12:45.679 --> 0:12:48.120 on e t F compared to close end funds, which 0:12:48.160 --> 0:12:50.559 don't have that ability to create and redeem new shares 0:12:50.559 --> 0:12:54.160 any time, because clothes and funds are limited shares outstanding, 0:12:54.160 --> 0:12:57.480 so that there's always massive premiums or discounts. That is 0:12:57.520 --> 0:13:00.160 one sort of way the E t F evolved. These 0:13:00.200 --> 0:13:03.240 then fun to you know, improve that model, because if 0:13:03.240 --> 0:13:06.360 I'm an authorized participant and I see a huge difference 0:13:06.440 --> 0:13:08.760 between the underlying shares and the share of the E 0:13:08.840 --> 0:13:10.960 t F, I'm gonna want to come in and take 0:13:10.960 --> 0:13:13.240 advantage of that and try to arbitrage it. Out right, 0:13:13.320 --> 0:13:15.880 it's free money, it's a risk free profit for that 0:13:16.040 --> 0:13:18.600 APay right, and that you know, again everybody wins. Again, 0:13:18.600 --> 0:13:21.600 that economic incentive is crucial, and that is the secret 0:13:21.640 --> 0:13:24.600 sauce that keeps everything going and makes the regular retail 0:13:24.640 --> 0:13:26.600 investors get a price that's really close to the fair 0:13:26.679 --> 0:13:28.800 value of those of the basket of stocks. All right, 0:13:28.880 --> 0:13:31.440 let's go back to the stories. So now we understand 0:13:31.480 --> 0:13:35.479 we have this the SPY which still trading, the gigantic 0:13:36.040 --> 0:13:40.360 SPI index fund. They launch it, how does how did 0:13:40.360 --> 0:13:44.000 it go? How did they do it attracting people do 0:13:44.200 --> 0:13:47.600 trade it? And how did that work out? Right? So well, 0:13:47.640 --> 0:13:50.199 first I had to wait four years to get SEC approval. 0:13:50.280 --> 0:13:51.880 SEC did not know what to do with this. They 0:13:51.920 --> 0:13:55.320 were even though they suggested the reason it took four years. 0:13:55.640 --> 0:13:59.000 It had to go through which is the strictest of regulations. 0:13:59.400 --> 0:14:04.040 So finally got approval under the that's what regulates mutual funds. 0:14:04.320 --> 0:14:06.160 So when it came out in ninety three, it had 0:14:06.200 --> 0:14:08.120 a good first day. They had a lot of hype. 0:14:08.120 --> 0:14:10.320 They had a large spider hanging from the ceiling and 0:14:10.720 --> 0:14:14.240 the trade a million shares, but a spider because because 0:14:14.480 --> 0:14:20.680 they're called the Standard and Poors Depository receipts with acronym spider. 0:14:20.840 --> 0:14:23.960 And back to the commodity warehouse receipts. Depository receipts is 0:14:23.960 --> 0:14:26.240 even in the name of Spider, which kind of connects 0:14:26.240 --> 0:14:29.560 to the commodities warehouse receipts. But they traded a million shares, 0:14:29.600 --> 0:14:32.480 but then it dwindled down. But even more, ETFs don't 0:14:32.520 --> 0:14:35.320 offer brokers any commission to sell them. It's why people 0:14:35.400 --> 0:14:37.320 like them, it's why they're so low cost. But it 0:14:37.360 --> 0:14:40.200 also inhibited some of the early sales growth. So what 0:14:40.280 --> 0:14:42.600 happened it was some true believers who really thought, wow, 0:14:42.640 --> 0:14:44.760 this is a great product. They were doing guerilla marketing. 0:14:45.240 --> 0:14:47.520 When it really came back after like two years, they 0:14:47.520 --> 0:14:50.000 were almost thinking of closing it. It It traded eighteen thousand 0:14:50.000 --> 0:14:53.960 shares one day about five months after launching, which is 0:14:54.280 --> 0:14:57.560 that's that's like less than the Global X Solar Energy 0:14:57.600 --> 0:15:00.240 e t F trades today, So it was not trading all. 0:15:00.400 --> 0:15:02.800 So you had people who were just out there figuring 0:15:02.800 --> 0:15:05.800 out ways to sell it, and some institutions caught on. 0:15:05.880 --> 0:15:09.880 But really what happened was the nineties kicked in was 0:15:09.960 --> 0:15:12.640 like an epic year for the market, so just buying 0:15:12.680 --> 0:15:15.400 the SMP became a big deal, and then that really 0:15:15.440 --> 0:15:18.040 was the supreme catalyst and it never looked back at 0:15:18.040 --> 0:15:22.240 doubled assets every year after. How important was the rise 0:15:22.600 --> 0:15:26.520 of sort of discount retail brokerages online brokerages in the 0:15:26.560 --> 0:15:29.080 mid nineties, you know, in terms of you mentioned that 0:15:29.120 --> 0:15:31.560 there was no brokerage commission on these things. But once 0:15:31.640 --> 0:15:35.280 people got into this idea during the nineties market boom 0:15:35.320 --> 0:15:39.200 of investing for themselves and trading, did that help their rise? Yeah? 0:15:39.240 --> 0:15:41.840 It did, believe it or not. Though institutions were some 0:15:41.880 --> 0:15:44.640 of the first early buyers, like pensions, And there's even 0:15:44.680 --> 0:15:47.800 a story about a rich Seattle investors in the mid 0:15:47.880 --> 0:15:50.600 nineties and the guy was like, he's very, very wealthy 0:15:50.640 --> 0:15:52.720 from Seattle. You guys could probably guess who it is 0:15:53.480 --> 0:15:56.520 like to use spy because they could buy options on 0:15:56.560 --> 0:16:00.160 it to protect their position. So the first adopted as 0:16:00.160 --> 0:16:02.840 were big institutions. Because some of the institutions like using 0:16:02.840 --> 0:16:06.160 in play who is the investor? I think it's Bill Gates, 0:16:06.160 --> 0:16:08.440 but he wouldn't tell me. I'm just thinking what they 0:16:08.440 --> 0:16:10.280 think that he got he was into them for his 0:16:10.360 --> 0:16:13.200 personal investments. Yes, interesting, yeah, but we don't know that. 0:16:13.520 --> 0:16:16.880 We don't know. That's the second. Very wealthy is why 0:16:16.920 --> 0:16:19.200 I thought and from Seattle. Maybe Paul Allen, I don't 0:16:19.200 --> 0:16:21.240 know one of those guys, probably Steve Jobs isn't that 0:16:21.320 --> 0:16:24.840 rich yet, but I don't think that's right. He was 0:16:24.920 --> 0:16:28.920 from California. Well, okay, wait, so we've told the story. 0:16:29.080 --> 0:16:31.440 We're now at this point where you know, the s 0:16:31.480 --> 0:16:34.520 p Y e t F is trading like twenty five 0:16:34.560 --> 0:16:38.000 billion worth of shares a day. But beyond just the 0:16:38.040 --> 0:16:41.280 story of that particular e t F, we've also had 0:16:41.320 --> 0:16:44.200 the entire industry kind of grow around it. We have 0:16:44.280 --> 0:16:46.640 all these new kinds of e t F. Tell us 0:16:46.640 --> 0:16:50.520 about what's changed since the early days when you look 0:16:50.560 --> 0:16:52.840 at it. You know, in the SEC commissioner who was 0:16:52.880 --> 0:16:55.720 around in the late eighties who I interviewed, he said, well, 0:16:55.720 --> 0:16:59.880 we didn't envision anything non stock baskets. We thought just 0:17:00.080 --> 0:17:03.320 some stock baskets would really help with the stock market volatility. 0:17:03.360 --> 0:17:06.720 But now you've got fixed income ETFs. You've got gold 0:17:06.840 --> 0:17:08.680 g l D was a game changer. That was the 0:17:08.720 --> 0:17:10.720 first commodities et F. Now you've got a hundred and 0:17:10.720 --> 0:17:14.520 fifty commodities ETFs. Fixed income. As you know, we've discussed 0:17:14.520 --> 0:17:17.520 this several times. It's a hot topic because bonds don't 0:17:17.560 --> 0:17:20.639 trade like stocks. So now you're taking something antiquated and 0:17:20.760 --> 0:17:23.000 over the counter and putting it in a stock like vehicle, 0:17:23.000 --> 0:17:26.040 and that's created some concerns. And then you've gotten things 0:17:26.080 --> 0:17:29.320 like leverage ets which whold total return swaps, or oil 0:17:29.400 --> 0:17:32.280 futures that hold you know, literally hold futures contracts, and 0:17:32.520 --> 0:17:34.359 now you're basically buying an et F that is like 0:17:34.359 --> 0:17:38.480 your personal oil futures trader. So they've expanded into every 0:17:38.560 --> 0:17:41.840 asset class and what I call standardization, just like a 0:17:41.960 --> 0:17:44.679 ubs port or a gas bump is standardized, you know 0:17:44.800 --> 0:17:47.880 that need for consumers. The e t F has basically 0:17:47.920 --> 0:17:50.440 made everything trade like a stock, which means you can 0:17:50.440 --> 0:17:53.240 see the pricing, you can buy it easily, and it's 0:17:53.240 --> 0:17:56.439 taxed like everything else. So that kind of standardization, I 0:17:56.480 --> 0:17:59.080 think is one of the big reasons people like using 0:17:59.119 --> 0:18:01.959 them and for a long time, or you know, when 0:18:02.000 --> 0:18:03.359 I think of e t F, so I think of 0:18:03.440 --> 0:18:07.480 something really simple like SMP gold, but something sort of 0:18:07.600 --> 0:18:12.040 underlying is passive. But increasingly the composition changes and they're 0:18:12.119 --> 0:18:13.960 active e t f s and their e t F 0:18:14.080 --> 0:18:17.760 based on formulas where the where the stocks are changing. Right, Yeah, 0:18:17.840 --> 0:18:21.200 that's a whole thing called smart beta also slightly controversial, 0:18:21.240 --> 0:18:24.320 but basically the early products were just you know, their 0:18:24.359 --> 0:18:27.320 market cap weighted beta one they call you know whatever. 0:18:27.359 --> 0:18:30.920 That very simple understand So some people came along and said, hey, look, 0:18:31.119 --> 0:18:35.240 academics have studied what factors active managers rely on to 0:18:35.280 --> 0:18:38.679 get alpha, such as tilting to small caps, tilting to value, 0:18:38.680 --> 0:18:42.439 tilting to volatility momentum, and they've taken these tilts and 0:18:42.480 --> 0:18:45.520 they've put them into rule based passive products. And so 0:18:45.800 --> 0:18:48.880 smart beta is sort of fills the void that existed 0:18:48.920 --> 0:18:51.840 between pure active and pure passive, and that's a four 0:18:51.920 --> 0:18:54.240 hundred billion dollars section of the e t F world, 0:18:54.640 --> 0:18:56.359 and that is where you're getting a lot of the 0:18:56.359 --> 0:18:59.640 new players like Goldman, Sachs and JP Morgan. They think 0:18:59.680 --> 0:19:02.359 smart BATA is the future because there's ten trillion dollars 0:19:02.359 --> 0:19:04.560 in active mutual funds right now and a lot of 0:19:04.560 --> 0:19:06.240 that money is going to go away because the mutual 0:19:06.280 --> 0:19:09.120 fund structure. So they think that a smart beta will 0:19:09.160 --> 0:19:10.960 be a place where a lot of the new assets 0:19:11.000 --> 0:19:13.640 will go from the money that's coming over from pure 0:19:13.640 --> 0:19:15.359 active because they want to try to beat the market, 0:19:15.440 --> 0:19:17.240 but they don't want to pay the fees and they 0:19:17.240 --> 0:19:19.320 want something that's easy to trade, and they don't want 0:19:19.320 --> 0:19:21.800 to capital gains taxes either. So smart beta e t 0:19:22.000 --> 0:19:24.680 f s are in some people's eyes, a real interesting 0:19:24.800 --> 0:19:27.080 arm of the e t F expansion. Well, can we 0:19:27.119 --> 0:19:30.440 talk more about how the sort of active fund management 0:19:30.520 --> 0:19:34.200 or mutual fund industry feels about e t F s. 0:19:34.320 --> 0:19:39.120 Uh I gather not so positive necessarily probably not. I mean, 0:19:39.119 --> 0:19:41.120 if you're an active mutual fund, you've got to make 0:19:41.119 --> 0:19:44.040 a decision do I ride the gravy train? Because if 0:19:44.040 --> 0:19:45.520 you look at the fees, like you know, I look 0:19:45.520 --> 0:19:48.439 at my mom's statements sometimes and I'm just I'm stunned 0:19:48.440 --> 0:19:50.600 at how much she pays and the load she already 0:19:50.600 --> 0:19:54.040 paid for mutual fund in a Class A share. So 0:19:54.080 --> 0:19:57.040 they're making so much more money than e t f 0:19:57.080 --> 0:19:59.160