WEBVTT - The ETF Story 5: The Sleeper 0:00:07.040 --> 0:00:09.800 Hey, this is Trillions presents the e t F Story. 0:00:10.280 --> 0:00:13.320 I'm Joel Weber and I'm the editor of Bloomberg Businessman. 0:00:14.360 --> 0:00:16.639 During the series, we've been tracing the story of the 0:00:16.640 --> 0:00:22.840 exchange traded fund from its origin in the SEC's market 0:00:22.880 --> 0:00:26.840 break report, to building its legal structure to finally bringing 0:00:26.880 --> 0:00:31.200 it to market. Today, it remains the largest GTF with 0:00:31.240 --> 0:00:35.000 two D seventy billion in assets. But when Spy first 0:00:35.080 --> 0:00:38.400 launched in let's just say, it didn't exactly take the 0:00:38.440 --> 0:00:43.239 world by storm. Gary Eisenrich is a managing partner at 0:00:43.320 --> 0:00:47.440 fair Field Advisors. At the time of spies launch, he 0:00:47.600 --> 0:00:51.519 was a specialist at spear Leeds and Kellogg, tasked with 0:00:51.600 --> 0:00:56.160 providing liquidity as the product's first market maker. A market 0:00:56.160 --> 0:00:59.000 maker is someone who matches buyers and sellers and then 0:00:59.040 --> 0:01:02.640 takes a small On its first day, Spy traded about 0:01:02.640 --> 0:01:05.400 a million shares, and eisen Rick says there was a 0:01:05.400 --> 0:01:08.520 lot of fanfare. There was the big spider, and there's 0:01:08.640 --> 0:01:10.920 all the T shirts and the hats, and a lot 0:01:10.920 --> 0:01:12.840 of dignitaries and a lot of people because it was 0:01:12.880 --> 0:01:16.600 a new issue. And then they put up the first print. 0:01:16.640 --> 0:01:18.240 It was two hundred shares and they had it on 0:01:18.240 --> 0:01:20.199 the ticker tape. I've got a copy of it, and 0:01:20.560 --> 0:01:22.520 they had a few of those, and and so I 0:01:22.560 --> 0:01:26.119 have the initial thing, and then some initial orders happened, 0:01:26.120 --> 0:01:31.760 and then it just sat. Yep, it just sat. Then 0:01:31.800 --> 0:01:35.360 over the next six months that volume went down very 0:01:35.480 --> 0:01:38.720 rapidly to where it was trading eighteen thousand years a day. 0:01:38.959 --> 0:01:42.280 Eric Baltunas and E. T. F analysts with Bloomerican Intelligence 0:01:42.280 --> 0:01:46.319 and our resident historian, says it was disappointing, and rumors 0:01:46.319 --> 0:01:49.440 about whether Spy would live on became spread. So kind 0:01:49.480 --> 0:01:52.480 of had this big hype first day, and but then 0:01:52.480 --> 0:01:55.360 it kind of trailed off. And I don't know if 0:01:55.360 --> 0:01:57.040 they were looking to close it. I heard that, but 0:01:57.080 --> 0:01:59.080 I'm not sure if that's totally true that. In fact, 0:01:59.080 --> 0:02:00.440 I had a number of people say, and Gary, are 0:02:00.440 --> 0:02:02.640 wasting your time. It's not gonna make it. But I 0:02:02.720 --> 0:02:04.800 really felt strongly that it was a good enough product. 0:02:04.800 --> 0:02:06.920 It was only twenty five basis points, and to be 0:02:06.960 --> 0:02:09.200 able to go in and trade that into day was great. 0:02:09.840 --> 0:02:13.160 So getting it adopted was the hard part. So how 0:02:13.160 --> 0:02:15.600 did they do it? How did Spy go from treating 0:02:15.639 --> 0:02:19.280 eighteen thousand shares a day to being the world's largest ETF. 0:02:21.160 --> 0:02:24.839 Gary Eisenrich was leading these guerilla marketing efforts. He said 0:02:24.880 --> 0:02:28.560 he was able to sell people on spiders structure, and 0:02:28.560 --> 0:02:31.040 when those people had success with it, they ended up 0:02:31.080 --> 0:02:33.520 telling others. Besides, if they have a good experience trading 0:02:33.600 --> 0:02:35.680 hunter of those shares, they're going to tell the guy 0:02:35.720 --> 0:02:38.079 that's going to trade ten thousand shares. And that's basically 0:02:38.120 --> 0:02:41.400 how Spiders was from word of mouth and and a 0:02:41.520 --> 0:02:45.400 cheap product, and and people that money managers that we 0:02:45.400 --> 0:02:47.360 didn't want to buy an expensive product that had an 0:02:47.400 --> 0:02:49.400 embedded hundred basis points. They wanted to have it at 0:02:49.440 --> 0:02:51.919 twenty five basis points. And it sort of had to 0:02:51.960 --> 0:02:55.760 be word of mouth because brokers had no incentive to 0:02:55.840 --> 0:02:58.680 sell Spy. So he hit the road with people from 0:02:58.760 --> 0:03:03.120 the American stock Age or am X to talk about Spy, 0:03:03.200 --> 0:03:04.919 and and it was a sale on the m X too. 0:03:04.960 --> 0:03:07.160 I mean, it didn't have the best reputation of that, 0:03:07.200 --> 0:03:09.760 you know, and I don't know that that was warranted 0:03:10.040 --> 0:03:12.120 at all. But I would go to people places and 0:03:12.160 --> 0:03:13.959 they say, I'm not trade on the antics, but to 0:03:14.000 --> 0:03:16.440 get that going, and after a while you would talk 0:03:16.480 --> 0:03:18.959 to people and say, I will make you with fair 0:03:19.080 --> 0:03:22.840 market and trade. So it caught on because people were 0:03:22.880 --> 0:03:25.919 happy with the experience, they were happy, they were happy 0:03:26.000 --> 0:03:29.600 with the return that they were getting. Eric says, people 0:03:29.800 --> 0:03:34.360 including Eisenrich, who are advocating for SPY early on were 0:03:34.360 --> 0:03:37.520 true believers in the product, and that got things moving. 0:03:37.600 --> 0:03:43.480 That's important because repetition, guerrilla marketing, that stuff matters. But 0:03:43.560 --> 0:03:46.280 then you need that plus some kind of an outside catalyst. 0:03:46.360 --> 0:03:48.760 And the outside catalyst was the nineties economy kicked in 0:03:48.840 --> 0:03:53.000 right around and that's just the good year to be 0:03:53.080 --> 0:03:56.760 offering SMP hundred exposure. So you had that outside catalyst 0:03:56.840 --> 0:03:59.280 mixed in with the guerrilla marketing at the bottom of 0:03:59.280 --> 0:04:01.839 from true believers, and that's when you started to see 0:04:01.840 --> 0:04:04.920 the assets grow and then from there basically double disassets 0:04:04.960 --> 0:04:08.480 every year for the next whatever decade. Whether it's a 0:04:08.520 --> 0:04:10.680 happy accident or whether it was the hard work of 0:04:10.720 --> 0:04:13.480 the folks at the m X really getting everybody to 0:04:13.600 --> 0:04:17.479 play ball at the same time for their own enlightened 0:04:17.520 --> 0:04:21.320 self interest reasons, it wouldn't have ever worked. Dave Nodded, 0:04:21.760 --> 0:04:25.000 the long time managing director of et F dot Com, 0:04:25.160 --> 0:04:28.679 says there was skepticism lurking in the background. As Spy 0:04:28.800 --> 0:04:32.080 and others moved into the marketplace, the skepticism was around 0:04:32.120 --> 0:04:34.279 whether or not you would ever get both sides of 0:04:34.320 --> 0:04:36.440 the market to participate. And what I mean by that 0:04:36.560 --> 0:04:40.560 is you had to have institutions willing to buy these things, 0:04:40.560 --> 0:04:43.800 willing to buy Spy to get their SMP exposure. But 0:04:43.880 --> 0:04:46.520 at the same time you needed to have people willing 0:04:46.600 --> 0:04:50.480 to be market makers and authorized participants that would arbitrage 0:04:50.560 --> 0:04:54.160 out price discrepancies. And I will admit when I first 0:04:54.200 --> 0:04:58.120 started waiting into this, I was enormously skeptical that that 0:04:58.320 --> 0:05:01.160 second part would show up, because there is a real 0:05:01.279 --> 0:05:03.160 chicken in the egg problem. Right If you only end 0:05:03.200 --> 0:05:06.000 up with one institution that buys fifty million dollars of 0:05:06.080 --> 0:05:08.960 them and then they never trade again, then the second 0:05:08.960 --> 0:05:12.120 side that that ap and market maker side never comes online, 0:05:12.440 --> 0:05:15.479 and the whole thing is a failure. So once Spy 0:05:15.680 --> 0:05:18.520 kind of took off and other people thought to use 0:05:18.640 --> 0:05:21.640 this structure in and track other things, not just the 0:05:21.720 --> 0:05:25.000 SMP five hundred. So one of those things was international, 0:05:25.920 --> 0:05:28.640 and so they had a line of ets from Morgan 0:05:28.720 --> 0:05:31.679 Stanley that came out that were called Webbs, Bob Tole 0:05:31.800 --> 0:05:34.960 began working with Nate Most on this very project from 0:05:35.000 --> 0:05:38.679 Morgan Stanley. So Nate and I start formulating what became 0:05:38.760 --> 0:05:41.839 eventually the filing for WEBS. I have to work with 0:05:41.960 --> 0:05:46.359 Nate because he's so far advanced into thinking compared to 0:05:46.400 --> 0:05:51.160 anybody else at Morgan Stanley. Even so, it's probably October 0:05:51.240 --> 0:05:53.400 ninety three. We get back together right after the summer, 0:05:53.680 --> 0:05:56.720 and we're gonna take and create what we know from 0:05:56.720 --> 0:06:01.799 our commodities world is a receipt. We draft the prospectives, 0:06:01.839 --> 0:06:05.200 We worked with the lawyers from Solomon and Cromwell and 0:06:06.080 --> 0:06:09.400 Lo and Behold, we designed the filing that goes in 0:06:09.839 --> 0:06:15.039 its world equity benchmark shares hence webs. Toll says he 0:06:15.120 --> 0:06:19.120 was very strategic about presenting this new webs product. He 0:06:19.240 --> 0:06:22.800 and Nate Most carefully educated people about what the product 0:06:22.880 --> 0:06:25.359 would really look like. One of the things that was 0:06:25.400 --> 0:06:29.320 so paramount in our thought process was that we wanted 0:06:29.480 --> 0:06:32.120 e t S to be a no fail environment. Even 0:06:32.160 --> 0:06:35.400 though we were trading international securities and packaging them all up. 0:06:35.839 --> 0:06:39.000 We didn't want to fail. Long story short, Spy was 0:06:39.040 --> 0:06:41.520 always known as the Spiders even when M d y 0:06:41.640 --> 0:06:43.600 CA met. That was also sort of the Spiders. That 0:06:43.680 --> 0:06:46.640 was just what they called them. So when they Morgan 0:06:46.720 --> 0:06:49.640 Stanley wanted to put out something that used this this structure, 0:06:50.400 --> 0:06:53.479 but they wanted to have it track international markets, you know, 0:06:53.560 --> 0:06:56.920 like Brazil and Mexico and that kind of thing, because 0:06:57.279 --> 0:06:59.839 traders like to trade the whole country at once and 0:07:00.000 --> 0:07:02.840 not just pick a stock. When they came out with 0:07:02.920 --> 0:07:06.760 their idea for these international type ETFs, they didn't have 0:07:07.160 --> 0:07:09.760 They couldn't use Spider because that's the state street name. 0:07:09.920 --> 0:07:11.280 So they said, you got to come up with a 0:07:11.320 --> 0:07:15.560 different term so that there's no investor confusion. So the 0:07:15.680 --> 0:07:19.040 first use of the name Exchange Traded Funds is in 0:07:19.200 --> 0:07:22.280 the web perspectives because we had to create something different. 0:07:22.320 --> 0:07:25.160 And so that's what's interesting is that the acronym and 0:07:25.240 --> 0:07:29.320 the name wasn't really put out there until six years 0:07:29.400 --> 0:07:32.960 after Bloom and most you know, actually filed for it. 0:07:34.200 --> 0:07:37.640 WEBBS was important because it coined the term exchange traded 0:07:37.720 --> 0:07:42.000 fund but it was also significant because WEBBS was driven 0:07:42.040 --> 0:07:46.920 by client demand, not a says. Unlike Spy, which was 0:07:46.960 --> 0:07:53.640 innovation driven, WEBBS was addressing specific demands. WEBBS was wells 0:07:53.640 --> 0:07:57.840 far ago of Brian Stanley realizing that there was this 0:07:58.000 --> 0:08:01.800 demand from a sophisticated insta cousinal trading market that wanted 0:08:01.840 --> 0:08:05.160 exposure to international markets in a way that they couldn't 0:08:05.200 --> 0:08:07.120 get access. And the way the reason they couldn't get 0:08:07.120 --> 0:08:10.480 access was primarily a custody problem. Um, you know, back 0:08:10.480 --> 0:08:13.960 in those days, if you wanted to trade uh, you know, Argentina, 0:08:14.120 --> 0:08:16.080 which I think was one of the very first in 0:08:16.360 --> 0:08:18.920 the first ones in the sleeve, you had to have 0:08:18.960 --> 0:08:21.360 a local desk that knew how to trade Argentina. You 0:08:21.360 --> 0:08:23.040 had to have a local bank that was going to 0:08:23.160 --> 0:08:26.440 custody those assets. Maybe you know, Bank of New York 0:08:26.560 --> 0:08:31.000 might have an affiliate relationship with somebody down there, but 0:08:31.080 --> 0:08:33.280 it was it was a pain in the neck to 0:08:33.400 --> 0:08:37.760 include Argentina in your international portfolio. And m c I 0:08:37.880 --> 0:08:40.040 was really trying to build out where them Morgan Stanley 0:08:40.080 --> 0:08:43.080 was really trying to build out their international chops, if 0:08:43.120 --> 0:08:46.120 you will. And so what they did was solicit from 0:08:46.360 --> 0:08:49.400 their biggest clients where do you want to trade? And 0:08:49.400 --> 0:08:51.240 so you look at that list of the fifteen or 0:08:51.280 --> 0:08:57.120 sixteen initial webs products, it's a bizarre list. Also, this structure, 0:08:57.679 --> 0:09:01.839 although it followed the same rapper concept Spy didn't follow 0:09:01.920 --> 0:09:06.200 the same unit investment trust or u I T structure. Well, 0:09:06.200 --> 0:09:09.360 the u I T structure is extremely restrictive, right, and 0:09:09.880 --> 0:09:11.520 for the SMP five hundred, and makes a ton of 0:09:11.559 --> 0:09:14.160 sense because you're never gonna not own one of the 0:09:14.200 --> 0:09:16.720 five d stocks in the SMP five hundred. They're all liquid. 0:09:17.120 --> 0:09:20.640 Everybody obviously wants all that exposure. So instead, Webbs used 0:09:20.679 --> 0:09:24.280 mutual funds because mutual funds were less limiting than a 0:09:24.400 --> 0:09:27.520 u I T. When working with international markets, when you 0:09:27.600 --> 0:09:31.000 talk about Argentina, it's a little bit different, and the 0:09:31.040 --> 0:09:34.920 custody issues in some of those countries were in the 0:09:34.920 --> 0:09:39.120 mid nineties still intractable. I mean, I literally remember a 0:09:39.559 --> 0:09:43.480 phone call in the mid nineties with our custodian bank 0:09:43.520 --> 0:09:46.640 in India at Wells Fargo, Nico, who was talking about 0:09:46.679 --> 0:09:48.360 the fact that we had to dec a whole bunch 0:09:48.360 --> 0:09:50.960 of trades because the courier got hit by a truck 0:09:51.400 --> 0:09:53.160 and there and all of the trades were on a 0:09:53.200 --> 0:09:56.360 paper in a knapsack going between the brokerage and the 0:09:56.400 --> 0:09:59.520 custody shop. So like that's the kind of stuff we're 0:09:59.520 --> 0:10:02.720 dealing with. Oh, in that environment, you had to have 0:10:03.000 --> 0:10:06.200 some latitude again, not that you weren't managing an index fund. 0:10:06.200 --> 0:10:08.679 You were managing an index fund. But um, I think 0:10:08.679 --> 0:10:11.200 there's a misconception that managing an index fund means that 0:10:11.280 --> 0:10:14.720 you own precisely everything, exactly when you're supposed to it exactly. 0:10:14.720 --> 0:10:17.719 They're a price and that's just not true unless you're 0:10:17.720 --> 0:10:19.680 a U I T, in which case you have to 0:10:19.720 --> 0:10:22.480 do it that way. Bob Tole says, the managing director 0:10:22.480 --> 0:10:25.840 at Morgan Stanley, didn't think et s would amount to anything, 0:10:26.080 --> 0:10:31.280 so he was happy to unload them. Eventually, Barkley's Global 0:10:31.320 --> 0:10:34.800 Investors bought webs from Morgan Stanley and it was a 0:10:34.920 --> 0:10:40.599 steal a dollar if I remember correctly, a dollar. Yeah. 0:10:40.880 --> 0:10:43.320 I had to have four phone calls with Bob Diamond, 0:10:43.320 --> 0:10:45.520 who was the president of Barclays in London, who was 0:10:45.559 --> 0:10:48.080 ex Morgan Stanley and a friend of mine. And he 0:10:48.160 --> 0:10:50.600 calls me four times to say, you know, what are 0:10:50.600 --> 0:10:53.040 they trying to do to me? You know, what's where's 0:10:53.080 --> 0:10:56.160 the land mine? Right? And I'm going just by it, 0:10:56.520 --> 0:10:59.520 I said, he goes. I said, what do you want 0:10:59.559 --> 0:11:01.680 as bar plays? He said, we don't have a retail 0:11:01.720 --> 0:11:04.720 footprint in the United States. The largest capital markets in 0:11:04.760 --> 0:11:09.880 the world. And nobody knows Barclays from IOTA, right. B 0:11:10.080 --> 0:11:13.600 g I is named at But if you asked a 0:11:13.640 --> 0:11:16.120 person on the on the street who heck Barclays bank 0:11:16.320 --> 0:11:18.360 was they they look at you like, I don't know. 0:11:19.320 --> 0:11:24.240 So here was the golden opportunity for Barclays to develop 0:11:24.280 --> 0:11:28.240 a retail brand in the United States for a dollar 0:11:28.840 --> 0:11:33.000 and get paid for doing it. Webbs eventually became I 0:11:33.160 --> 0:11:37.120 Shares after the Barclay's acquisition, and Noddix says, this is 0:11:37.120 --> 0:11:39.920 when the brand really started to change. And one of 0:11:39.960 --> 0:11:42.319 the consultants working in that process was a guy named 0:11:42.400 --> 0:11:44.680 Lee crane Fis. He was a consultant as part of 0:11:44.679 --> 0:11:47.520 that process, working with Patty Dunn, who would later become 0:11:47.600 --> 0:11:51.319 the head of b G I. And you know, he, 0:11:51.440 --> 0:11:53.719 I think recognized even more than me or any of 0:11:53.760 --> 0:11:55.880 the people who were in the business at the time, 0:11:56.360 --> 0:12:00.240 that these products were actually a solution not just for 0:12:00.240 --> 0:12:03.640 those big institutions, uh, and not just for people who 0:12:03.679 --> 0:12:06.800 needed to equitize cash, but but they were products that 0:12:06.840 --> 0:12:12.239 could solve real long term asset allocation investment needs for clients. 0:12:12.320 --> 0:12:14.959 And was really the guy who pushed for the rebranding 0:12:14.960 --> 0:12:18.320 of those into what is inarguably a more retail brand, 0:12:18.440 --> 0:12:21.320 I Shares. Tol says Lead craned, this was lucky to 0:12:21.320 --> 0:12:23.559 be in the position he was in as I Shares 0:12:23.600 --> 0:12:26.679 became more retail focused. But he wasn't the only reason 0:12:26.800 --> 0:12:29.240 for its success. It was the money that the AMEX 0:12:29.400 --> 0:12:33.000 kept telling him to spend. Right, and so what's Lead do? 0:12:33.240 --> 0:12:35.520 He tries a couple of things. If you remember, at 0:12:35.559 --> 0:12:40.640 one point every bus stop in Lower Manhattan from n 0:12:40.800 --> 0:12:44.360 y U South had an EYE Shares sign on it, 0:12:44.559 --> 0:12:47.080 and people kept saying, what does I Shares? Right? Then 0:12:47.120 --> 0:12:50.400 they started sponsoring Circus sole events and then they so 0:12:50.480 --> 0:12:54.480 they were targeting. In my opinion, League got the luck 0:12:54.480 --> 0:12:58.560 of the draw. The real brains who I think deserves 0:12:58.600 --> 0:13:04.360 tremendous amount of credit is Bruce Levine, Jim Polison, Craig Friedman. 0:13:04.480 --> 0:13:07.760 All of those guys saw the vision of how to 0:13:07.920 --> 0:13:12.480 convert basically an institutional money manager, which was the old 0:13:12.480 --> 0:13:18.079 Wells Fargo Investment Advisors, into a retail brand name. Today, 0:13:18.400 --> 0:13:20.840 I Shares, which is now owned by black Rock, is 0:13:20.880 --> 0:13:23.679 the largest et F brand not exasts. When you step 0:13:23.760 --> 0:13:26.680 back and think about it, Spy paid the way for 0:13:26.760 --> 0:13:29.320 I shares. If Spy had come out and continued to 0:13:29.360 --> 0:13:31.720 fail and not gotten any traction, I don't think there 0:13:31.760 --> 0:13:34.439 would have been a lot of move to to push 0:13:34.440 --> 0:13:37.560 webbs forward. Even so, it's a little bit of a 0:13:37.559 --> 0:13:40.600 miracle to me that Webbs ever launched. It wasn't something 0:13:40.720 --> 0:13:43.400 that I recall at the time. There was a tremendous 0:13:43.400 --> 0:13:46.960 amount of management enthusiasm and excitement about it was seen 0:13:47.040 --> 0:13:48.959 as sort of a bit of a flyer that we 0:13:48.960 --> 0:13:52.200 were doing to service a bunch of very high end customers. 0:13:52.480 --> 0:13:54.679 Not says it took a while for these products to 0:13:54.760 --> 0:13:57.600 start catching on, but they did, and there was a 0:13:57.640 --> 0:14:00.679 massive shift in how people started thinking about and it 0:14:00.720 --> 0:14:04.360 wouldn't be, honestly, I think until the early two thousands 0:14:05.000 --> 0:14:09.120 where most people started realizing, holy cats, these things really 0:14:09.360 --> 0:14:12.920 can change how we think about investing. He says. The 0:14:12.960 --> 0:14:15.720 same goes for him personally. He was on those original 0:14:15.720 --> 0:14:18.520 marketing teams for I Shares, but it wasn't until he 0:14:18.559 --> 0:14:21.560 actually used in e t F himself that he got it. 0:14:21.680 --> 0:14:24.160 I was not one of those guys that recognized greatness 0:14:24.160 --> 0:14:26.120 and jumped in. I'm not going to claim any of that. 0:14:26.440 --> 0:14:28.880 It wasn't until I was sitting on a trading desk, 0:14:28.920 --> 0:14:30.640 and all of a sudden, I could like hit a 0:14:30.680 --> 0:14:33.120 button and get a million dollar exposure to the cues. 0:14:33.800 --> 0:14:40.280 I was all in. Next time on Troyon's Presents, The 0:14:40.400 --> 0:14:43.640 E t F keeps getting bigger and bigger and bigger. 0:14:43.840 --> 0:14:46.120 It got to a billion dollars in three days. That's 0:14:46.120 --> 0:14:48.040 a record. As you know. It's that I called the 0:14:48.120 --> 0:14:52.120 Joe DiMaggio hitting Still the standing record easily, is it? 0:14:52.320 --> 0:14:56.640 You know what number two is? Can you guess? Bnd? Yeah, 0:14:56.680 --> 0:14:59.600 that's true nerd nerds him right there. Hardly anybody knows that. 0:15:00.720 --> 0:15:02.720 Thanks for listening to The E t F Story Until 0:15:02.800 --> 0:15:05.040 next time. You can find us on the Bloomberg Terminal, 0:15:05.320 --> 0:15:09.400 Bloomberg dot com, Apple Podcasts, Spotify, and wherever else you 0:15:09.440 --> 0:15:11.640 like to listen. The E t F Story is produced 0:15:11.680 --> 0:15:15.320 by Jordan Bell, with some production help by Magnus Hendrickson. 0:15:15.480 --> 0:15:18.000 Francesca Levy is the head of Bloomberg Podcasts.