James Sayffart on Navigating the Evolving Landscape of ETFs and Digital Asset Management

Prepare to have your perspectives on asset management and digital assets revolutionized as we're joined by the astute James Sayffart from Bloomberg Intelligence. Together, we navigate the complex terrain of the mutual fund and ETF industry, with an intriguing focus on the burgeoning world of Bitcoin ETFs. Our discussion is not just timely—given the legal entanglements like the Grayscale court case—it's crucial for anyone seeking to understand the implications of ETFs as both trading instruments and long-term investment solutions, and how their structure influences investor behavior within the tempestuous Bitcoin market.

Venturing beyond, we dissect the fabric of the Hong Kong ETF market, contrasting it with its U.S. counterpart and speculating on the future of a Dogecoin ETF amidst stiff regulatory winds. We address the seismic industry shift from high-cost to low-cost asset management, scrutinizing why traditional fund managers are hesitant to cut fees in the face of low-cost giants like Vanguard. Additionally, we look into the burgeoning realm of active ETFs, examining their role in market flows and the fine balance they must strike between innovation, cost efficiency, and the pressures to justify their fees.

As our conversation culminates, we forecast the prospective dominance of ETFs over mutual funds, debunk liquidity myths, and consider direct indexing as a rival to the traditional ETF model. We unpack the complexities of tokenized funds and how blockchain might redefine asset ownership and custody. As we bid farewell, we express our heartfelt gratitude for the community's engagement and leave you with a teaser for the future of these enlightening discussions. For those who thrive on in-depth analysis and foresight in finance, this episode is an invaluable treasure trove.

The content in this program is for informational purposes only. You should not construe any information or other material as investment, financial, tax, or other advice. The views expressed by the participants are solely their own. A participant may have taken or recommended any investment position discussed, but may close such position or alter its recommendation at any time without notice. Nothing contained in this program constitutes a solicitation, recommendation, endorsement, or offer to buy or sell any securities or other financial instruments in any jurisdiction. Please consult your own investment or financial advisor for advice related to all investment decisions.

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Transcript

Speaker 1: 0:08

My name is Michael Guyatt, publisher of the Lead Lag Report. I'm excited for this conversation with James Safer, who knows a lot about the mutual fund and ETF industry. We're going to go back and forth on some of the changes that are happening industry-wide which will impact investors and, of course, talk about everybody's favorite topic, especially on X, which is Bitcoin, etfs and the state of the industry from that perspective. James, real quick, just give a quick bio as far as your background for the audience.

Speaker 2: 0:37

Yeah, so I've been at Bloomberg actually since I was in college I interned here, so I've been here for 10 years and the whole time I've been working in the funds ecosystem. Essentially, I started off covering hedge funds and ETFs, brought it out to covering mutual funds and closed-end funds as well, and then, after three and a half years of doing that, I joined Bloomberg Intelligence, which is Bloomberg's research arm. So I did a lot of work. Basically all that data I used to maintain and update and relationships I used to keep I use still to this day, but it's more from analyzing that data than actually uploading it and maintaining it on the system, though I do still do a decent amount of that. So a lot of it has to do with that.

Speaker 2: 1:17

And when I joined BI, I worked closely with Eric Botunis, our senior ETF analyst, and then Mike McGlown are senior commodity strategists. I've since been moved over to just covering funds and the asset manager for the most part, but when we were on commodities, we started covering crypto and Bitcoin and digital assets. So that overlap of covering it that from a macro strategy point of view to covering it from the funds point of view has put me squarely as an expert on the Bitcoin ETFs and digital asset ETFs, but for the most part I cover the entire asset management industry and I'm leading a lot of Bloomberg's efforts to look at flows and breakdowns of the markets in the asset management industry.

Speaker 1: 2:00

So, given the insanity and the hype from the last let's call it five, six months, has this been sort of by far and away the most popular topic for Bloomberg readers.

Speaker 2: 2:14

For our stuff. Yes, like unquestionably For everything. Maybe not, no matter how you slice it, sorry, we're in research. Our stuff, technically, all of our research is only if you have a Bloomberg terminal. That's the only way to see it.

Speaker 2: 2:25

Bloomberg News was covering this very well. They covered the Bitcoin ETF race, these Ethereum ETFs now that have been filed, so it's being covered from multiple different points of view. But from our point of view, I've never had poor client outreach to ask questions about what was going on with the Grayscale court case with these ETFs being launched. It's really been going for about a year now because people everyone, even back to last summer, was focused on that Grayscale lawsuit. So, yeah, I've never had more interaction from our clients and some of it is.

Speaker 2: 2:53

It's funny like a lot of the teams here for the most part, they write their research for like no-transcript other people's points of view. But from our stuff particularly with these Bitcoin ETFs, but ETFs in general we end up getting a lot of people who are like there may be muni bond traders or trading other things, that are just like reaching out to us for their own PA. So there's a lot of people that I would Bloomberg terminals that read our stuff that aren't necessarily professionally interested, but more so personally interested as much as it's the superior wrapper from a tax perspective, is actually not superior from the standpoint of holding right.

Speaker 1: 3:49

So I'm sure you've seen these studies. People tend to hold mutual funds longer than ETFs, largely because mutual funds are priced once a day. Etfs are priced second by second, which creates this incentive perhaps to trade intraday and cause people to make mistakes, which to me, I think, in the context of Bitcoin ETFs, gets to be interesting because it might, I think, suggest that you're not going to have the same kind of Holdler mentality with Bitcoin ETFs now being a big driver of Bitcoin itself. What are your thoughts on the Bitcoin ETF side from the standpoint of generating longer-term investment interests? Because people are just going to be trading these Bitcoin ETFs because the ETF wrapper makes them want to. It seems like that actually could be a negative.

Speaker 2: 4:35

Yeah, well, if you go back to the creation of the first ETF, it was created as a trading vehicle. It wasn't created to be this long-term buy and hold vehicle. The tax advantage you talked about via the in-kind creation redemption that makes it non-taxable event those things were kind of like happy accidents in a way. So the benefit of the ETF yes, they are traded more, but they're also built to be traded more. They're like a Swiss army knife. If you want to trade these things, they can be trading vehicles. You can go in and out every single day intraday, you name it but if you want to use them long-term buy and hold, they're very cheap. They're very liquid. So what happens is you get all these different market players coming in. This happens for all ETFs, not just the Bitcoin ETFs. But you have people who are traders short-term traders, midterm traders that are more tactical but not necessarily trading every single day and then you have the long-term buy and hold investors. So I think you're going to see both of those in, just like we do in many ETFs. Some ETFs are more trading focused. Some are more buy and hold focused. The same thing is going to happen with these ETFs we're talking about here, the spot Bitcoin ETFs.

Speaker 2: 5:34

That said, I would argue that my view and my view has been my view is and has been that these things are going to be used as like a portfolio allocation tool and they're also going to be used as trading vehicles. So one people are obviously going to trade around this thing. It's very volatile. People love trading. It's basically like a casino in many ways. So that's never going to stop. But they're also going to be used as portfolio allocation tools. So say, like, you have a portfolio and it's usually a 60-40 or most people are not exactly that, but you might take like a little slice and put it into Bitcoin. So if you do the 5% slug, if it goes up 50%, 100% when you rebalance, you're selling, and if it goes down 50% when you rebalance, you're buying. So I think there's going to be a lot of that happening going forward.

Speaker 2: 6:15

That hasn't really happened yet. We'll see what happens over the next year or two, if that really we show that we see that in the data If there's a lot of buying of these ETFs after massive falls and vice versa after it runs up. So right now they're a little early to see if that's happening, but I think there's going to be the negatives that you talked about with the over-trading. Yes, people are subject to over-trading because they can trade them, but at the same time, they're built to be traded. So if you want to use them that way, you can. So it's really more. What it does is it democratizes a bunch of different things. It democratizes the investments and the ability to use them however you want to use them. And also, I would say specifically with Bitcoin ETFs, it's not like people aren't trading the hell out of this thing, even on these crypto exchanges.

Speaker 1: 6:59

So you and I both know there's a big challenge in the ETF industry, which is it's hard to know where the flows are coming from right With the creation redemption process. It's not like a mutual fund where you can see from the piping who's allocating. But I assume you have maybe an inkling or a sense, right of sort, of the makeup of retail versus institutional. There is this narrative that the ETF opened this up to the financial advisor community. I am not as convinced of that narrative. Maybe I'm wrong in that, but with all these flows that have gone into these Bitcoin ETFs, do you get a sense that this is primarily retail or is this legitimately asset allocators?

Speaker 2: 7:35

So mostly retail. So far, I would say that's mostly anecdotal. We'll get more information on May 15th when those 13Fs are filed. So 13Fs, anyone who's large enough will have to file them and say what they own, right, but it's retail and RAAs, registered independent advisors, investment advisors so these independent guys that are not subject to working on a wealth platform at a UBS or a Morgan Stanley or Raymond James, you name it. These people that are independent on their own, have their own compliance department. They are the ones that are buying these things early from the advisor point of view, from what we can tell, for the most part, that said, a lot of these issuers.

Speaker 2: 8:11

This was kind of a unique launch in the sense that you had BlackRock and Fidelity and Bitwise and ARK and all these different people out there talking to different advisor communities, different communities, for like a year before these things launched. So it's a little different from the point of view of how that would normally work. So the first thing is, yes, mostly retail. A lot of definitely independent advisors that aren't tied down to those brokerage platforms, advisor and wealth platforms because they don't have to wait for approval. So the way that these other platforms work the ones that I just mentioned UBS, that these other platforms work, the ones that I just mentioned, UBS, brokerage platforms, Morgan Stanley, Raymond James. It's like the way they get added to the system. It's not like you can add it and then automatically anyone can buy it. It's like the opposite. So you think everyone thinks like, oh, the ETF launch, everyone can buy it. But that's not the way it works. For a lot of these advisors at these platforms, they need to go through a due diligence process. For an actively managed ETF, there's a whole bunch of processes to understand exactly what the active manager is doing. Is there a track record? How much are the assets? All these different things. It's a little less complicated because this is a grantor trust. It's just one asset and you're trying to understand the asset and then potential risks with the wrapper. But a lot of those bigger platforms haven't really okayed these things to be what we call it solicited.

Speaker 2: 9:24

But the way you tend to think about it, or the way I think about it, is one these things are added and they're restricted. No one can buy them. This is on a red light, Do not cross list. No one can buy it under any circumstance. And then there's this middle ground where it's like okay, maybe you can buy it for your client if they specifically ask for it, or after you jump through these hoops to explain why you're buying it. But you have to fill up this paperwork and fill out all this information explaining why you're buying it, and that's probably where we're at with most of these platforms. You can't just do it. If the client comes to you, maybe you could buy it, or if you go through all these other hoops, you can buy it.

Speaker 2: 9:55

The third step is where I don't think any of those. I think this would make sense as a slug in your portfolio at a 1% allocation or 2% allocation. That's not going to happen. That hasn't happened yet. It probably will happen for some of these platforms in the coming this year at some point, but it hasn't really happened yet. So for the most part, it's either clients going to their advisors saying I want this, them going out and buying themselves, or it's an independent advisor that has already had exposure and likes it and wants to get exposure as quickly as possible.

Speaker 1: 10:27

I think it was interesting that when there was the realization that Vanguard wouldn't allow it on the platform, people thought it was a conspiracy, right. It was like, oh you know, vanguard, why not? Right. But it's like again you and I both know being in the industry. This is actually very typical, right, and it's not only in terms of it being a product that due diligence goes through. It's also a product that due diligence goes through after a set number of years. In many instances Now, maybe because it's BlackRock, there's going to be exceptions, right. That wouldn't be surprising, but the point is that there's a long tail to get that to really be opened up to the wire houses. There is a question on X. Do you think Hong Kong ETFs are more or less a drop in the bucket compared to the US base net flow?

Speaker 2: 11:12

Yeah, I mean on the Vanguard thing, I would just say real quick, that was not surprising at all. They don't like gold ETFs, though they do allow them. They don't have an actual ETF and they don't allow trading of leveraged ETFs on their platform. I think it was a mistake to not allow these things because, whatever, we don't have to get into it too much. But this is very in line with their thesis, their investment views, and it's not shocking at all. As far as Hong Kong ETFs go, yeah, I mean, I really do think near term and first year or two, I think it's going to be a drop in the bucket. If these things get a billion assets in the first year, that's a smashing success as far as I'm concerned. I mean, if you look at these things I put this out the other day I mean the whole entire Hong Kong ETF market. Every ETF that's listed in Hong Kong has less than $50 billion in assets. The US spot Bitcoin ETFs have $60 billion in assets. So even if they get 1% to 2% of the overall market share of $50 billion, you're looking at that.

Speaker 2: 12:07

And then people are like, well, they're going to connect to mainland China, which one? That's not going to happen anytime soon. They're not going to go through that connect program. We have a colleague, rebecca Sin, in Hong Kong, who covers this and she has an associate who works with her, jack Wang, and it's not happening anytime remotely soon. So this is going to be good, they are going to be in kind, but it's not going to be this massive blow off top. But again, even assuming which one, the stock connects not going to happen anytime soon with these ETFs. It's very few ETFs that meet that requirement I think less than 10 and they're only stock equity ETFs. So even if that does happen which again, it's likely not to happen the entire mainland Chinese ETF market is about 320 something, $340 billion in assets. I mean the US market is almost 9 trillion right now. I mean we're talking completely different orders of magnitude here.

Speaker 2: 12:56

That said, down the line, hong Kong is obviously a financial hub. It's huge in Asia. I think this could be the hub for getting these digital assets, exposure and traditional financial rails down the line, particularly because they're in kind. But the other thing is these ETFs they're likely to be very high fees. They're likely they're not going to be anywhere near the 20 basis points that we're experiencing here.

Speaker 2: 13:17

So people are like well, institutions out there will buy it. Not really. If you're a big enough institution, you have a subsidiary or some way that you can access to the US ETF market. There's like a 90% chance that you're going to just go with the US ETF if you really want exposure, versus going with the Hong Kong ETF. Right, it's going to trade a thousand times more, the assets are better. It's going to be a fraction of the cost. There is no reason, if you're a big institution, why you would do that, unless the only thing I can think of is that you want to access the in-kind ability that these ETFs are going to have. And again, it's Bitcoin and Ethereum here. So that is one big difference. Here. Ethereum is going to launch, but again, it's not comparable to the US.

Speaker 1: 13:58

Does that mean we're going to see a Dogecoin ETF at some point? Because I do think it's interesting, because now it does become a question of well, if there's enough demand for any one of these coins, why not make it an ETF? You already did it with Bitcoin. You're doing it with Ethereum. I mean, what about everything else?

Speaker 2: 14:14

Yeah, I mean. So Coinbase is launching futures on Doge and some other things. So the whole premise here this goes back to why I think the SEC won't call Ethereum a security. Basically, doge is going to be able to register as a traditional commodities futures contract. It sounds like so, theoretically, that's not completely out of the question in the next few years that we should get a Doge ETF, which I'm not going to endorse or say anything about really, but because of the way that it was created, the fact that it's based off of underlying Bitcoin code and the Bitcoin blockchain and things like that, uh, the, the creation of it was the same way. There was. No, there was. There's plenty of other things. We can differentiate it. I do.

Speaker 2: 14:53

I think there should be an ETF. Personally, no, I'm not much of a a a mean coin type of person. Um, that said, it's not out of the question that we get a Doge ETF at some point here in the US or elsewhere, but not happening anytime soon. I mean, honestly, anything we talk about right now in the crypto world, whether it's Ethereum happening or Bitcoin ETFs be allowing in kind or pretty much, or any other type of digital asset ETF I mean we can't know what's going to happen until we have the elections in November. But so you either need a completely change of administration you can't have Gary Gensler and the Dems running the SEC for any of that to happen or you need a literal act of Congress. People like to say use the hyperbole. You need an act of Congress to get that done. You might literally need an act of Congress to get done some of the things that people want to see happen in the crypto ecosystem, and it's not happening.

Speaker 1: 15:47

So one of the major selling points or narratives around the Bitcoin ETFs was you want to get ahead of the halving, right, you want to get into it now, before that happens. Every single ETF issuer out there was using that as the reason to buy their ETF, which gets to be interesting because it seems like now we have this real test of the efficient market hypothesis in Bitcoin because everyone's expecting the halving they start allocating with the Bitcoin ETFs Any sense of whether those narratives around what happens to Bitcoin after the halving if maybe those become challenged because of the ETF launch just before it.

Speaker 2: 16:21

Yeah, I mean. So I'm actually looking into some of this right now because I'm going to put out a note this week, but, like, the overall way to look at this is like, no matter how you slice it, yes, the halving the way I look at it, it's two different things. Right, the ETFs had a way larger impact on supply and demand, particularly marginal supply and demand of Bitcoin, right? So if you're looking at marginal daily new supply created the miners are likely selling. That's going to get cut by 400 and change Bitcoin. I think it's 450. I don't know the exact number off the top of my head, but, like Bitcoin, etfs bought thousands and thousands of Bitcoin. I mean, they're net up $12.5 billion worth of Bitcoin, so the marginal supply impact, or demand impact in this case, was way outstripped anything that the halving is going to do over any shorter timeframe. The difference here is, though, is that the halving goes on into perpetuity. It's 450 less Bitcoin you have to deal with every single day if a miner is selling that, so I think it's going to have as big of an impact. Just the launch the ETFs did Absolutely not I did like over any shorter timeframe, absolutely not.

Speaker 2: 17:26

Over the long term, though, these ETFs. There's going to be days and weeks where we see big selling in these ETFs and I think the market is like particularly the crypto bros are not ready to handle that. Like, etfs are built to efficiently handle inflows and outflows and that's what they do. And there are going to be times where these things see massive amounts of outflows and they'll probably be thankful that the miners aren't also dumping 900 Bitcoin every day on top of whatever the ETFs are doing. So the main thing is just like yeah, it's a consistency thing and it's into perpetuity. It's never going to go back up on the halving. So ETFs way bigger impact. The halving. I've seen people out there saying it's going to have zero impact. I'm sorry. It's going to decrease the marginal net new supply. Even if that's not that huge of a percentage impact, it's an impact.

Speaker 1: 18:10

So the implication, if I'm hearing you correctly, is it may make Bitcoin more volatile, which goes back to what I said at the start of the conversation, right, the hodling with ETF wrapper versus not. I don't know if you've done any work on this, but when the gold ETFs came out, was there a notable structural change in the volatility of gold?

Speaker 2: 18:33

once the ETFs were live and actively allocated to. So I haven't done the in-depth analysis to that, but I mean it ran up heavily. But the problem with that is they launched at the end of 2004, the first one and that was right into when the fall apart in the GFC. So everyone was also buying gold generically, including central banks and individuals, obviously, through those ETFs. That said, the volatility has, I don't think it was meaningfully impacted, based on what I've looked at.

Speaker 1: 19:10

All right. So, changing topics from gold and Bitcoin, let's talk about the state of the ETF industry in general, because there's a lot of interesting things that most people may not be aware of. When it comes to platform fees, I'm really talking about fidelity primarily there, as far as what they want to do with ETFs on their platform. Educate the audience for a bit on the difference between mutual funds and ETFs in terms of the fees paid by the issuer, because if Fidelity gets its way, there could be some big changes to ETF profitability and then fees as a result a lot of smaller issuers to be listed on their platform.

Speaker 2: 19:56

They want some sort of revenue sharing. The real answer is that there's always been pay-to-play in the asset management industry. It has gotten better. The pay-to-play hasn't gotten as egregious as it was in the 80s and 90s but for the most part there's always been this little bit of pay-to-play type situation going on with these platforms and larger issuers. For the most part, these larger issuers are already kind of playing this game. Already it's the smaller issuers, the smaller shops, the startups, that are going to get hindered by what Fidelity is trying to do. So basically, if they don't play game, fidelity is going to say all right, if your ETF is on our platform, it's going to incur $100 fee to even trade any amount of shares on these things. So basically no one's going to buy their ETFs on their platforms. I think it's a bad look personally, because it's really going after just some of the small and middle-sized ETF providers. But on the mutual fund side, there's all these other ways in the past that people were able to get kickbacks different fees, front-end loads, back-end loads, all these things that were able to give kickbacks for whoever was distributing the product For ETFs, as you kind of hinted before. It's not as clear to know exactly who's on it. The piping is not as clear. You can just buy and sell these shares on an exchange and there's no guarantee you know exactly who bought those shares or who did that creation order and put money into there. But with a mutual fund you know exactly where that money's coming from when it comes in and exactly where it's going when it goes out. So there's a whole bunch of nuances here.

Speaker 2: 21:14

At the end of the day, there's this overarching trend in the asset management industry. Everyone likes to talk about it like it's active to passive. We've been saying for years now it's not truly an active to passive, it's more a high cost to a low cost thing. So back in the 80s a lot of these managers they had these fees and the idea was, once they got economies of scale, the fees would come down a little bit and basically these managers got to billions of dollars in their funds and never adjusted the fees. So they kept the percentage basis, which went up by a ton as the assets went up, as the market went up, as their flows came in, and never gave that back to investors and that kind of fueled people going towards things like Vanguard and lower cost fees, because if the active managers aren't going to share their economies scaled and the growth that they've made, I'm just going to go with somebody that's basically not going to charge anything.

Speaker 2: 21:59

So that's hitting all different parts of the asset manager industry. We thought it was going to come to advisors a little bit. It hasn't really yet, but it's just hitting the industry everywhere. And that's what Fidelity is doing, just a symptom of all these cost pressures. And this one is more so. From when Schwab and TD Ameritrade and Fidelity went to zero cost trading, you always used to have to pay a fee to trade ETFs, except for a subset of ETFs in many cases, because they were doing that pay to play situation. So it was a subset of Vanguard and BlackRock ETFs that were paying TD Ameritrade or whoever so that there would be zero fees to trade their ETFs.

Speaker 1: 22:37

The big difference is mutual funds have the 12b1 fee.

Speaker 2: 22:38

Etfs don't right, so you can't really subsidize it by some, yeah. So yeah, some of the older, really old ones have a set marketing fees that are essentially like 12b1 fees. But 12b1 fee is a perfect example, like that was supposed to be, something that got to economies of scale and helped you gain. I just no one really ever did.

Speaker 1: 23:31

Is there? Is there a? Are there rumblings of of other platforms, like Schwab, following Fidelity's lead Cause? I mean, if that's the case, I mean, then I don't see what's the point of launching an ETF.

Speaker 2: 23:39

in general, Part of the problem is this whole pay to play stuff. It's it's happened behind closed doors. Everyone kind of knows it happens, but I don't know. I'm personally on the outside looking and I don't know. That's it. I haven't heard any rumors that anyone else is looking to do this and, like I said, I think it's kind of a bad look for Fidelity's platform. They make more money as a firm than the entire US ETF industry, so I mean, it's not like they're starving for capital or revenue and I kind of get why they do it. They're letting these guys like skate by but I don't know. It's a bad look in my point of view.

Speaker 1: 24:14

Okay. So there's two implications there. One would be it stifles innovation. You can argue right, Because, to your point, the smaller ones may not do it. Listen, it's hard to run an ETF, it's hard to raise assets, it's hard to know what cycle you're launching your fund in that might favor the performance Expensive. I know this myself. The other angle to this is well, you're probably going to have almost all ETFs going forward be active because you can charge a higher fee to try to pay for some of that. Let's talk about the growth of active versus passive ETFs. Do you expect that they're going to see more and more active come out? Because if that's the case, there's probably going to be a lot more underperformance.

Speaker 2: 24:54

A lot of active funds tend to not really perform that well, what it comes down to is, over the last two years there's been an absolute boom in launching actively managed ETFs, particularly equity focused ETFs on the active side. So if you look at equities, active equity ETFs are like 5% of the assets, but they took in over the last year and a half they've taken in like 25% of the flows. So they're way punching above their weight right now. So a lot of people love active, but part of the problem here is some of these active ETFs aren't like what you do or what you think of an active manager. Some of them are these buffer ETFs that are structured product ETFs where you have to actively manage the options that you're buying and selling on a differentiated basis. But it's not really like you're not picking things, you're just trying to make sure you hit the goals and you have the right options in your portfolio. Same with the likes of DFA and Avantis. They're very they're quantum mental and they're really rules-based. So they're very similar to what we call smart beta funds that rebalance every quarter. But for the most part, these guys they're active managers so they can rebalance on a way more frequent basis, but for the most part it's really just rules-based and it's not somebody out there actually picking stocks or making discretionary decisions. So part of it and the thing is these ETFs that we're talking about, these active ETFs one I think we're over 70% over the last year and a half of ETFs that launch, over 70% have been active. So there's been few things that lean towards advisors converting some ETFs to be active and launching active ETFs just more flexibility in doing those types of things. But all the money on the active side is going.

Speaker 2: 26:30

You said like people are going to go active, so they charge more. All the money on the active side. For the most part, these active ETFs that are taking in tons of money are very cheap, comparatively speaking, it's not like they're charging very high costs. So we have this thing called we'd like to call it the beta adjusted demarcation line. It's like, basically, if you have active share and active share is like how different are you from the underlying index?

Speaker 2: 26:51

If you are very different from the underlying index, which, like Kathy Wood, is a good example, whatever you think of her investment process, her thing is there's no index out there that's similar to what she's doing, so you can charge a higher fee because if I'm buying that ETF and I'm spending money on it, like I don't want to own the same stocks I own in my S&P 500 ETF. But if you're like a DFA or Avantis, where it's very similar, there's very low active share but you are doing active stuff and you put your charge like 18 basis points or sometimes less. People are going to do that Because if you're going to go out there and be super active trading every day and making discretionary decisions for the most part we see investors don't mind paying up for stuff like that, particularly in the fixed income side, but pretty much across You're going to do stuff that only tilts away from the index a little bit, tries to outperform a tiny bit. You're not going to be able to charge a ton of fees in this space anymore.

Speaker 1: 27:37

Which again makes it even more challenging. I mean it's great for the investor, I get it, but it's just hard to compete right and kind of sort of the big squash everybody else like in almost every industry.

Speaker 2: 27:50

But now it's really coming to the front Now the One thing I would add real quick, though, is basically what's happened is beta has become almost completely commoditized and extremely cheap. It's near zero fee to get beta exposure to the S&P 500 or even the total stock market in the world, right?

Speaker 1: 28:05

So the problem is like I could go here and pay near zero fees, or literally zero fees, or I could pay here, and if I'm going to pay over here for all this extra money, you better be doing something that makes it worth it Right, and what's missed in that is that, of course, means you have to have something that has the what Eric Balchunas, I think, termed as the shiny objects moment potential. Exactly, yeah, and of course, the dilemma there is that if you're going to create a strategy that does that, you also risk massively underperforming, because that's the way that this industry works from an investment perspective.

Speaker 2: 28:34

Over periods of time, you're highly likely to be massively underperforming if you have periods that you can massively outperform.

Speaker 1: 28:40

Right. But that becomes the only real way to raise assets because most people chase. I mean, that's just the hot dot right. And so it does become interesting from the industry perspective. I think a lot of people look at fund managers and don't understand why they create the products the way they create them and they're not thinking in terms of, well, what's the competition If you're going to come out with another Me Too beta, you're competing as Vanguard, you're going to be charging five bips. Good luck, you can't survive, you can't be an entrepreneur in that sense.

Speaker 1: 29:09

You sent me a note saying you said it might be hyperbole, but I've heard this for a while we're seeing the slow death of the mutual fund industry. Now I am skeptical and I say this as somebody who has played both sides of this. The challenge, as you know, with ETFs. I think this has gotten better over time, but the challenge with ETFs is, especially if you're newer, if it's not trading with good volume, people think it's illiquid, so it becomes a hindrance in terms of raising assets, whereas with a mutual fund you don't see volume, nobody ever thinks in terms of liquidity. But you see that real time with an ETF and I've always thought that was a hindrance of ETFs, really kind of eating the mutual fund lunch side of things.

Speaker 2: 30:05

Do you really think that mutual funds are not going to be around in decades? Is it all going to be ETFs? Is it going to die? There's plenty of reasons, the strategies that make more sense in a mutual fund wrapper than an ETF but it's going to be by far the minority. So if you look back to 2013, etfs as a percentage of mutual fund ETF wrapper, they made up about 14% of the assets ETFs did. Now they're 31%, by my most recent estimates, so last month. They're 31% by my most recent estimates, so last month.

Speaker 2: 30:31

So this is going one direction and it's not showing in stuff. If anything, it's showing signs of accelerating in the last year or two. So the ETF is just a better wrapper from a tax efficiency standpoint. And those issues you talk about volume are true, but people are getting educated in the sense that, as long as the underlying is liquid, it doesn't really matter what the ETF trades, as long as you can tap a market maker and they can make a market. So one thing for anyone listening to this I always use a limit order when trading these things, just generally speaking. That's just an overall assessment of how to look at ETFs.

Speaker 2: 30:58

But yeah, I mean, the trend is undeniably clear. Do I think they're going to go to zero? Absolutely not. I mean the whole industry right now is I mean excluding, excluding money markets? I mean the industry is way, way, way larger for mutual funds, but it's been consistent outflows basically since 2014.

Speaker 2: 31:19

And ETFs have done nothing but inflows and are very massively outpacing the growth of mutual funds, but there's still, I think, $18 to $20 trillion in these traditional mutual funds, excluding money market funds.

Speaker 2: 31:31

So they're not going anywhere. It's just slowly dying, essentially, and I think it'll be more similar. So I don't want to be as extreme as say it's going to be like the closed-end fund industry, but it's going to go the way of the closed-end fund industry unless something changes, because they're just going to be unique niche areas where you're going to have these and, for the most part, my colleague, david Cohn, actually just did a note and basically looked at mutual funds from companies that launched ETFs and mutual funds from companies that don't have an ETF, and this is just mutual fund flows and, in aggregate, if you have ETFs, whether that's because you're closer to understanding where the market is going and what things are happening in aggregate, irrespective of your performance, irrespective of anything else, if you have ETFs, you have significantly more inflows into your mutual funds Into, if anything else, if you have ETFs, you have significantly more inflows into your mutual funds, into the mutual funds I didn't hear that Into the mutual funds, so it becomes almost like a selling point.

Speaker 2: 32:19

Yeah, exactly, and part of the problem is this, right? So, like, a lot of this money is leaving mutual funds and they're going to ETFs. So what a lot of these issuers do? I mean, capital Group just joined a couple of years ago they're basically trying to slow their outflows and basically say, instead of leaving us all together, why don't you go to this ETF? Which is all this, and we're going to eventually have mutual fund share classes. We think we've seen a lot. We've seen over a hundred billion dollars in ETFs that were converted from mutual funds. So there's this overarching trend of ETFs are going to eat the mutual funds launch Right now. If the trend continues in the current trajectory, it'll pass mutual ETFs, will pass mutual funds and assets in the US, excluding money market funds, sometime in early 2032. But honestly, I think it could happen by 2030, particularly if ETF share classes are allowed and some of these other things really do accelerate. But I mean, the trend is undeniable. Etfs are going to be the dominant vehicle of choice for traditional finance fund exposure.

Speaker 1: 33:11

So I know it's impossible to know the answer to this question. I'm going to ask it anyway. Nobody really saw ETFs coming right. I mean in the US until 1993, you had it in Canada before that it obviously became the superior vehicle in most investors' minds over time. Is there any possible vehicle going forward that could challenge the ETF wrapper's dominance? And I know that it's hard to know because it's like innovation always comes up out of nowhere, you never know what it's going to be. But could anything unseat ETFs?

Speaker 2: 33:42

Yeah. So for years we've been hearing about direct indexing is going to do that, and we as a team Balchunas, even more so than me has been extremely bearish to direct indexing because the overarching changes we talked about is like cheap to trade, cheap to own, simplified exposure and, like the direct indexing, it kind of gets more complicated. Right, the fees are higher. There's all these different reasons it's not as transparent. That said, there's a lot of benefits to direct indexing. It makes basically what, in my view, there's a lot of benefits to direct indexing. It makes basically what, in my view, it's like lowering the SMA minimum investment.

Speaker 2: 34:18

There's a lot of technology that's making the ability to use direct indexing and SMAs, particularly for certain individuals. Maybe they have a bunch of restricted stock in certain different companies. There's a whole bunch of a whole host of issues, like if you have specific beliefs that you want to invest in, but there's no ETF that specifically fits that. That said, we think it's going to be a minor part of the fund system going forward. Even even if things do get a lot cheaper, even if the trading and holding of these assets and managing of those portfolios becomes a lot cheaper, it's it's still.

Speaker 2: 34:49

There's a lot of benefits for tax advantages too that you can get by doing direct indexing and trading around positions in an index. The problem is that it just kind of goes against a lot of the overall trends that we are seeing. So I think they're going to be moderately successful, but it'll be a niche successful so that. And then I guess tokenization could be something. But in a way I think that a product that does compete with ETFs in a tokenized world would essentially be a tokenized ETF. So I don't know how much that would be.

Speaker 1: 35:19

Doesn't WisdomTree? Haven't they tried that? Or they have an experiment out there.

Speaker 2: 35:23

Yeah. So there's a whole bunch of companies that are doing different things. So WisdomTree has a bunch of these tokenized funds and assets. They have the I think it's wisdom cheap prime um.

Speaker 2: 35:34

They've also tried a bunch of different things where they're basically using the blockchain instead of um for for, like, chain of custody, um, so I mean, and also franklin is doing this. So instead, what they're doing is they're using the traditional uh system to like, maintain ownership and look at who who owns these things and where it's going, um, but on alongside it at the same time, they're doing it with a blockchain, whatever blockchain it may be, and they're basically going to be able. They want to use that because eventually they want to see if they can go to use a blockchain for that process and if it will be cheaper than the traditional system that we currently use. So I think Franklin Templeton is doing that. I know for a fact Wisentree is doing that. I think there are other companies that are toying around with this type of stuff, but the only one I really know that is doing these tokenized funds and really at the game on that front is WisdomTree.

Speaker 1: 36:19

So I do write a lot of writings for Seeking Alpha and I write about different ETFs, talk about holdings and weightings, and I have to tell you I'm blown away by how many ETFs have basically the same top 10 positions, even though the ETFs are not supposed to track and they're supposed to look different and even the name of the ETF right. It's like suddenly you see NVIDIA is in the top 10, even though it's not a tech product or actually have anything to do with tech. I wonder if you think we're at this sort of stage in the cycle where because it's been, if you can't beat them, join them with large cap tech ETS maybe have encouraged a lot more concentration and a lot less diversification industry-wide in this last several years here.

Speaker 2: 37:37

Yeah, we talk about this a lot. So one of the things I kind of hinted at this, like if you need to be different from my portfolio, if you want me to pay up for it, right. But at the same time, like if you don't hold some of the things that have been crushing it, namely like the FANG stocks or the MAG7, wherever you want to call them you've underperformed. That said, I mean there's a whole host of issues. A lot of this has to do with index rules and network balancing and just the absolute massive outperformance of those MAG7 stocks. The other thing I would say is these ETFs, for the most part, they're kind of in the backseat. They're price takers.

Speaker 2: 38:13

That said, the marginal inflows that these ETFs do take, which you'll hear plenty I'm sure you've had people on I don't know what your beliefs are on this they do have marginal impact net buying on these assets. But when something does happen to these stocks, whether it's negative or what have you the active managers are in full control. So a good example is the ETF is taking in billions and billions of dollars every single day and still they're getting absolutely crushed because of things that are going on with idiosyncratic risk to their actual underlying stock. So, absent any moves like that, yeah, technically a lot of these stocks and those indices that you're talking about and there's a little bit of lack of diversification because some of these companies have gotten so damn big, but for the most part, when something really does happen, the active managers do take over and dictate the price or the value of those companies, which I think is where you were going with that question. I don't know if that's the exact answer to the question you had.

Speaker 1: 39:06

No, no, exactly. I often find people have a false sense of confidence around how diversified they really are. Right, it's more because of the top 10, right? So they have all these different ETFs and they're just saying, oh, this ETF must track this and this tracks that. I'm never saying. But again, if you look at the underlying holdings and see the top 10, which make up 40% of the weightings, it's all a concentrated portfolio. Then, from a look through, perspective.

Speaker 2: 39:28

Yeah, I've got a good story for you that's kind of related. So XLK State Sheets XLK, which is the tech ETF that holds all the stocks in the S&P 500 that are classified as technology companies. Theoretically it should have about 24% Microsoft, 21% Apple and 16% Nvidia. So basically you're buying three stocks, but there are SEC diversification rules that this has gotten so concentrated that they can't even hold the stocks in the right proportion. So essentially right now what happens is Nvidia is 4.5% of the portfolio, despite the fact that its market cap would suggest it should be over 16%. So I just wrote about that today.

Speaker 2: 40:05

But this goes to it's the opposite end of the spectrum, where the SEC rules are actually preventing people from partaking in the actual exposure to the underlying index. So part of it is people need to know what they're buying. You need to look under the hood and know what you're buying and understand the rules of the index. So people buying the XLK ETF probably have no idea. They're like oh, I want to get exposure to Microsoft, apple and NVIDIA and they're not really getting any exposure to NVIDIA. A broad-based S&P 500 ETF has more exposure to NVIDIA than the tech sector ETF. But so, like you got to know what you're buying. This goes back to something you said earlier, though. Like these indices are created, these ETFs are created because people are often using the trade-specific exposures and, like they're built the way they are, for very specific reasons.

Speaker 1: 40:55

In many cases, I didn't know that stat that there's more NVIDIA in the S&P than XLK, but it's not surprising if that's the case.

Speaker 1: 41:06

I mean, of course, of all the stocks I had to pick on on X, I had to choose the best performing one. That's all different discussion. There is this, and I think there's some degree of truth to this, although I haven't really kind of tested to see if it's valid that you and I both know Wall Street likes to come out with products after a run has already happened, because demand is there right and they can raise assets as a result. That's what happened really at the core of Bitcoin, but at the same time from my own observations I could be wrong that typically tends to mark somewhat of a cycle top. Wall Street creates products when there's already performance. If there's already performance, a lot of it's probably may have already been achieved.

Speaker 2: 41:47

Anything to suggest that when Wall Street comes out with a product, an ETF, it's going to work in the short term, but you want to be really careful in the years that follow. Yeah, so we've looked at this. One of the things like to look at is like how good or bad is the back test before something launches, whether it's a smart beta etf or a theme etf and exactly what you said is often the case, like these things that launch with like absolutely amazing back tests often you look a year from launch and it's not very good and the alternative tends to be true. So this is like just a rule. It's not a rule of thumb, even like it happens both ways, I guess. Guess you would say I mean, look at the Bitcoin ETFs. I mean those things have been on absolute fire since they launched, but it's kind of a different situation because a lot of institutions aren't really in that space yet.

Speaker 2: 42:28

But another one that we'd like to talk about Uranium. Uranium launched after. The chart looks like this it goes over and then down and then flat lines across the bottom of your screen. You can't even see what happens. But what happens in that, like they launched a uranium ETF and uranium miner ETF into the bottom of that and like all of a sudden, even a spike up that like on that super huge long chart like that doesn't look big, it's like a 70% up move. So there's been a handful of other examples like that.

Speaker 2: 42:54

So Altunus, my boss, actually like loves ETFs that launch with absolutely atrocious backtests, but the data says it's very mixed. There's no guaranteed thing. But anecdotally and some of the data proves that really good backtests often tend to get launched right afterwards, similar to if you look at index inclusion and exclusion over the near term it tends to really underperform or outperform and then it kind of resets after it's out of the index or in the index afterwards. So like when Tesla was added, it did very well as it was added and then it very much underperformed in the months after and then kind of leveled off and went up again. But like we see that over and over again with stocks that are added or removed from an index, how has demand been for bond ETFs?

Speaker 1: 43:41

Because I don't think there's that many that are launching in this kind of environment, but I could be wrong.

Speaker 2: 43:45

No, yeah, yeah. I feel like I see a new short-term bond ETF launching every day. There's a lot of demand for these I won't say cash-like, but cash-similar type ETFs, these actively managed short-term bond funds that are trying to eke out additional yield. And, honestly, last year was the biggest year ever for treasury ETFs. I mean those things basically single-handedly propped up the fixed income fund universe.

Speaker 2: 44:11

Actively managed fixed income funds, as rates were rising, took literally saw a trillion dollars in outflows, something like that. But the treasury ETFs themselves took in a hundred billion or whatever. It was like. They took in a ton of money, um, so a lot of the ETFs that are doing well on the fixed income side tend to be more passive type securities and trading vehicles. So, uh, fm investments launched those ETFs that are basically just on the run, treasuries for different, um, different timeframes, whether it's two year, three month, 10 year, you name it and they've done exceptionally well too.

Speaker 2: 44:46

So the ETFs that are doing well aren't necessarily the smart beta fixed income ones or the actively managed ones, but they're doing just fine. So we talked about mutual funds getting the lunch eaten by ETFs. For the most part, until rates started rising, that wasn't true in the fixed income world. Yes, fixed income ETFs were doing very well, but so were fixed income mutual funds, and then rates went on a run and everyone sold their actively managed mutual funds. I think it was literally a trillion dollars in outflows for fixed income bond mutual funds.

Speaker 1: 45:21

The thing that's been fascinating to me is watching the explosion of these options writing funds that have just come out, a lot of them on single stocks. A lot of them, from a total return perspective, actually don't have total return at all, but they're volatile and people love to hear something having high yield. Has that been surprising to you? I mean, that's got to be pure retail.

Speaker 2: 45:42

It's retail and advisors actually, I would say I talked about. It's like some of those active funds where they were not truly just active funds. This is another example of them. A lot of them are technically registered as active ETFs, even though they're holding an underlying ETF or underlying group of stocks and then selling calls on top of them. But for the most part, I mean this did really well when the market was going sideways and rates were rising, like equities were going sideways, they went down and then all of a sudden you were getting all this extra yields from something like JP Morgan's JEPI or JEPQ, which they did this options overlay strategy for income. So when things are going sideways, they're a really good investment because they're going to outperform the underlying market.

Speaker 2: 46:21

But when things start trending in either direction, they're not likely to outperform. I guess when things are trending positive, they're not likely to outperform. But if you're using these as like I don't know, a 30-year-old dude and trying to get exposure to these things, it probably doesn't make sense because over the long term you're going to underperform. Just from just math, the way it works, you're capping your upside when you use these things. But for anyone who's genuinely looking for income, maybe in your retirement, close to retirement wants lower vol. These products are great. Advisors tend to love these for those types of people, but on a total return basis, as you hinted. They're unlikely over the long term to keep up with the underlying index that they're tracking.

Speaker 1: 47:00

James, for those who want to track more of your thoughts, more of your work, what would you point them to?

Speaker 2: 47:05

Honestly, if you're on the terminal that we publish, my team publishes pretty much every day. We have a team of about 12 people now covering the SMM industry, but other than that, I do a decent job of sharing a lot of my thoughts and views and sharing some of our charts and images on on twitter. At jsyff or x, I should say not twitter, but um, yeah, happy to be reached there. I'm very active on there, probably more active than I should be uh, you're telling me that?

Speaker 1: 47:32

uh, yeah, non-stop on my feed, largely in between all these calls I'm doing. I think people think that people like you and I are constantly just sitting down writing and doing posts and that's our job, and it's not at all. For me, it's more of an outlet than anything else. James, I'll have this as an edited YouTube video shortly. Thank you everybody that joined live. Please support James here, and I will do these video interviews periodically, so stay tuned, appreciate it, james. Thanks for having me, michael Cheers.