Takeaways From the Carnage

you know, when he's spear fishing. But halfway through next week. Yeah, yeah, that's that's like end of April, I think. But I feel good. I you know, we're all healthy. We're just getting little cabin fever here that that beard looks healthy. Yeah. We have a four year old as well, and the four year old and the and the dog who a puppy who's one year old, both of which are testing our sanity. It good to see you, and um, I'm really excited to talk to you about what's been going

on in in e t f Land of late. We'll bring in Tom saraphagus Um also in Bloomberg Intelligence with you, and we're gonna kind of get a rundown of what's been going on. Yeah, so let me give you insight into our research team. So, um, we have two continuous chats going on. One on an IB which is the Bloomberg terminal chat with me, Tom Morgan, and James. That's our four person team. And then we have a chat on Twitter in d M where we're throwing in people's

tweets saying this is interesting, should we cover it? And I don't think both the chat rooms are as busy as as they've ever been. Um, even though we're we're all working from home and it's surreal and the streets are empty, we are as busy as we've ever been because of the sell off, because of e t s tend to be in the middle of this. They're so visible. Everybody talks about them. There's it just basically sell offs

or rough your portfolio. But if you're in the business of content, they're they're actually very good because there's so much to write about and talk about now. So we're we're very busy and those chats are very busy. And uh, you know, it's good to get Tom on because he is he's been in He's a guy who's been in the industry as an issuer and at an exchange, and he's very good about bringing in some of that to

our discussion. And it's a perfect time because we're literally we just saw like one of the most catastrophic quarters in investing history and we're at the beginning of Q two. By the way, Eric, I feel like you've been a little tone deaf just on how bad the virus is. Uh and uh, you know, I wanna just you know, straight up ask you, like, do you think the return

to normal is going to happen in April? Um? Yeah, I have on the podcast where we had the guy from the bio thread E T f on, I think I said my fear level was like point five out of ten or something. Yeah, among the words yeah, you know. Um. I even got crap from my mom. She said, you're you sounded glit. You're not taking this seriously enough. That's when you know you probably went too far. Um. But at the time, I don't know, I just um, I was kind of in the It's like when your mom

tells you you're an idiot. Yeah, I would say that you've gone too far. But I think what really turned me around is the obviously death there's the death rates higher than in the flu. And also, um, you know, when you think of elders like my mom, it really hits home. And I think I've definitely come around that said, I still think it's you know, May. I don't know. I've hear people say June. I still feel somewhat optimistic. And I'm just gonna do my part as a citizen

and stop. I'm not commenting on it anymore. I don't know enough. I just lay off it. I'm just gonna do my part as a citizen and you know, uh say six six ft away from people and watch Netflix this time on trillions Takeaways from the Carnage, Tom, welcome back to Trillions. How's London, man, Yeah, London is great. Um, you know, we're obviously on lockdown like the rest of the world, but London's going going great. It's been like a full year I think since the last time I

was on so one thing in New York. Um, I live in Brooklyn. I can get to go cocktails at a couple of places. For off, can you get to go pintes anywhere? Uh? But you can't. But luckily all the regular bodegas here or the Superman could sell beer, so it's really easy to be able to get uh, and not only beer, they sell hard liquor too, so fully stocked and I'm looking for you, so you're good.

The clubs are closed though, right, yeah, clubs are closed. Um, they've got like a little bow speaker, So I just recreate my own clubs here by yourself. Okay, the Tom dance party. Okay, well maybe I'll ask to see that later, um, Eric, But there's about five topics I want to hit on in this episode. Number one is the FED. Yeah, so my initial takeaway is, you know, for about a month there, every anything was just brutal uh in the FED step.

Then a couple of times, you know, they tried a couple of things, but we we you know, we look at the discount of a bond ETF it's price versus n A V as a sort of temperature gauge on how a liquid the underlying bond market is. And for most of the sell off that was of those discounts were there. The FED would come in here and there and it would close it for like a day or

even an hour. But then they go back and it just told you that there's just weren't any buyers and for bonds, and that was a real problem for everybody. Then they came in UM with this sort of bazooka approach and just said, you know, we're we're here, We're here, We're gonna do whatever it takes. That kind of a deal a lot of trillions being used, and that really

did change things. We saw a lot of those bond dislocations come in UM and we also even saw some people front run the FED, buying in e t f s like l q D. And what was also interesting about the FED is two things. Which is, first of all, not just that there you know, this powerful dying force that's sort of saying we're going to hold the aren't the hand of the industry here UM and make sure there's liquidity. But they're going to use e t s

for the first time ever. This is something that Bank of Japan has done India, governments elsewhere in the world have used the t s as part of their policies. This is the first time the FED has done it. I think it's somewhat of a credibility moment. I guess that they're going to use this. They also said they're going to hire Blackrock as an advisor and help all of that, all of that, that's huge. Yeah. So so Tom, when you think about the FED stepping in and using e t f s, you know, what what do e

t f s have to show right now? Yeah? I mean I think in in the main part, when you look at everything that's happened, right, I think a lot of active funds, oh thanks to e t s. And I know that's a bold statement, but if you look at et getting a lot of criticism about the discounts, right, they were saying, oh x y Z, et F was

trading at a big discount. But if you actually look what was happening with active funds, right, a lot of their navs weren't being adjusted downward as fast as they were on the e t F, right, which are exchange traded. So really what was happening is the e t F was signaling potential problems in the underlying market. Right. If you were just looking at funds, you would say, oh,

well things are down, they're not down as much. And if you look at the e t F you're like, wow, things are down probably a lot more than what some of these funds are indicating. So when the FED decided to come in and buy e t F and provide liquidity. Who I think some of the biggest beneficiaries of that we were mutual funds, right because they were just starting to see their navs come down um compared to e t F that we're settling this maybe a good week

or so before. So I think that that, you know, active funds are a big thanks to the ETS by being able to to signal distress a lot sooner than they could have. Yeah, and the thing with active mutual funds is we look at flows in e t F s and they were actually positive in March as a whole.

But bond ETF did see I think maybe ten billion over the month and outflows, but active on mutual funds saw a hundred and fifty billion and that was just through March, So they destroyed their monthly outflow record and the flows were getting worse and worse as the days went on, and we think, uh, you know, we we don't know exactly what went on, but we think that's probably something that FED was looking at because that's a

lot of money. And those active funds are now going to they can't um, they have to sell the bonds into a market where nobody wants them, so that actually added to pressure, and then the e t F is downstream from that because all that selling pressure makes it harder to do arbitrage and the et F discount grows.

So if if this the FED UH definitely helped ETFs, but they may have saved active mutual funds the bond side, because think about it, if the if they get to sell bonds where there's no buyers, they're gonna have to take bad prices. That's going to ratch it down the NAP further make their performance worse and probably trigger more outflows.

That creates this sort of doom loop illiquidity doom loop that people sometimes tie with e t f s. I think that was potentially about to happen with some mutual funds. We saw a couple where there ana went from ten dollars to three dollars in a matter of a couple of days. Although those were in since some exotic stuff, but they were kind of canaries in the coal mine.

So UM, I agree with Tom that mutual funds just just less attention paid to them, but they're way bigger, and I think they're the ones that really UH probably the biggest winner from the FED bailout. And what do you think of black Rock? I mean, this seems like a conflict of interest, right, How how are they going to navigate this? Look? I think, um, black Rock has to be very careful here not to look like there's

conflict of interest. They've come out and said they're not going they're gonna wave the fee for any FED money that buys LQD or whatever e t f s. The other thing is you gotta remember the FED. I mean, how much are they putting in two trillion or something.

It's the amount that they could possibly uses. I think the account they're going to use to buy bonds and e t f s is in the billions, and I think I think we whittled it down to it's possible a couple billion and get used on the e t f So we're talking, uh, speck of sand relative to their buying power and what they might ultimately buy. I think e t s they just wanted in the arsenal, so something they can do, and black Rock will have

to be careful. They've done taken those steps to say, you know, we're not going to take fees if the FED buys our fund Um, and they'll have to make sure they keep doing that because a lot of people are, you know, kind of out there saying that, how could the FED have the biggest asset manager. Uh, we're you know, be so tied with him. And then the people point to two thousand and eight and say this, this is what happened back then and it worked out. So I

don't know, there's a lot of debate over the whole thing. No, and I agree with Eric. And the other thing is you have to be realistic. If you look at the size of the fixed income ETF market, UM, black Rock is half of that market right between them and Vanguard like three quarters and the entire market. So really they are like the biggest issue of fixed income ets. They

were the first they know that market really well. Um. I get how it looks optically, but realistically, either of them or Vanguard are the only ones that have products big enough that the STEAD bought and won't have any type of impact. Okay, topic number two, are there any signs of normalcy returning to the market right now? It's interesting, Um, the sell off did kind of have a break after the FED. I think everybody exhaled. I'm not sure it's over.

Is this a as Rick Ferry put it, He's like it's like a roller coaster, you know, there was the first there's the the slow move up, the crazy dip down, and he thinks we're on that that little rise before you go down to the second little dipper. But anyway, who knows where we are. But we will say it's been a kind of a calmer last couple of days. And what we've seen is some normalcy return. For example, a five g e t F launched. That is something that is just that was happening dime a dozen a

month ago. Right. We also saw I saw people start to debate e S g um. That's something everybody forgot about. Remember that was all we were talking about for a while. Spy volume got a little lower. We also saw the fact that ants active non transparent ETFs are going to launch. That's now back into uh, into the debate. So there were definitely some signs of normalcy and alb is refreshing. To be honest, does that mean the sell us over? I don't know, but certainly, uh the industry is trying

to sort of move on. Uh. You know, even in the rubble tom which one stood out to you. Yeah, I think the ants ones that Eric mentioned are interesting because you had this like drought of not having any products launched in March. I think only three products launched the mark in March, so that five G one is

going to sort of break the drought. But the fact that ants are coming into the market, now, Um, they delayed their launch before this sell off, but apparently they're sort of making a call, right, Um, ones are gonna be really managed. Their performance is going to be really important to how much money they raised, So they're probably thinking that, hey, maybe we're going to see a little bit of a reversal in the market. Let's ride this

wave up. So I think the fact that these active non transparence are coming to market shows that maybe they're thinking that there could be a little bit of reversal in the market. But that was the one that really stood out to me. Okay, so that's an interesting transition to sort of like topic number three, which let's just call it winners and losers. Do you think active non

transparent could be a potential winner in all of this? Uh? Yeah, I do, And I think they're a winner because they avoided what happened, right, So they were going to launch, they were scheduled of launched in February, they would have

caught this downdraft. I think what could have happened to them is optically they would have faced a lot of the scrutiny that ets were getting about their discounts uh to NAB and whatnot, um and probably getting a little bit of criticism on how these things were going to trade. But then also they missed this huge downdraft of performance. And um, you know timing is important as well. There was just one e t F that launched right in February.

It was probably the worst type of If they could have launched as a travel one and the ticker was away out of the gig, I think potentially ants could have the benefit of having really strong performance out of the gate. So I think that you potentially could be away ner I'm coming out of this. Who else strikes you as a winner and all of this, Um, you know that when I look at the league table of issuers, I see Vanguard, and I see these issuers of leverage products.

It's interesting total bar belt, right, and we see this in if you break down flows by expense ratio buckets, all the money is going to stuff below twenty basis points as usual, or stuff over eight basis points, which is the trading tool, stuff like the you know, double leveraged to accuse and all this. UM. This kind of a sell off is great for those companies because the swoons up and down are where the adrenaline gets better

for traders, so they tend to attract more money. UM. People love to play the swing back, and so this has been been like like a roller coaster is what they're looking for. Most investors don't want that Vanguard that it's just it's amazing what they do. We looked at Q one flows. I think ETS took in about six the six billion Vanguard took in se of that net number. That is a ridiculous amount. Normally they take in maybe UM.

So Vanguard typically is always the big winner in bear markets and sell offs because everybody else is gets more hurt than they do, and they tend to just keep doing their thing so relatively, so their normal thing becomes strong when everyone else is suffering. That sort of signal that retail hasn't really freaked out that much on all of this. So that's a great question. I think it

depends Uh. If you look at mutual funds again, the two billion out of mutual funds, uh this year so far active mutual funds, that's retail, That would tell you. But I find that active mutual funds have less loyalty then e T. People who buy Vanguards seek Vanguard out. They're not really like sold Vanguard. They seek it out. So when you seek it out and you know you want cheap, you're usually kind of investor who understands behavior and like not panicking and long term. So I just

think Vanguard happens just attracts those types. So I would say the vanguard type retail investor not panicking. I would say, you know, the baby boomer who's close to retirement with some active mutual funds. We are seeing some signs that they are. Because the two billion out of active mutual funds is a ton. I mean, even in their worst year two eighteen, they saw just over double that. But that wasn't a year. This isn't a month, um, So I'm sorry, this is two billion years to date. Sorry,

so in a quarter. Either way, it's a gigantic number, and I think it does show some some retails, you know, crackage and Tom who strikes you as a as a loser? I want to say State Street, But the thing is most of it is Spy, right, um, But Spy is so big and the sheer size of its flows go up and down. So like for example, in February UH it was the flow laggard and this list month it was a flow leader. But what tends to happen with State Street is a lot of their products are used

for trade, but they slowly bleed assets. So, um, I think what ends up had happening Ultimately when the market sort of calms down and that trading advantage goes away for State Street, they sort of tend to lose assets a little bit, so they slowly bleed off some of the assets. Um when mark when assets sort of come

back after these sharp sell offs. Interesting about State Street is if you look at the UH flows during the worst of the sell off, the number one flow getter was built, which is there one to three year month treasury, which is basically cash. Big surprise cashes the top of the list, but normally you'd see s h V or s h Y the I shares short term treasuries up there. The fact that Bill was able to outflow. Um I shares products. I thought was an interesting maneuver, and I

think State Street was number one in March flows. So they've done better, I thought, than in past times when spy drags them down and they're negative. They've definitely sort of I think saw some reading on the wall a couple of years ago. They have cheap, dirt, cheap products now for the core and they're like really pushing some of the things, and um, it's it's working. I think they're less in the basement in the sell off thing

they normally are. Okay, Topic number four Smart Beta. Okay, Tom, I really want to pick your brain about this because during the financial crisis, there was this moment called the immaculate rebalance, and here we are just at the end of Q one going into Q two. Smart beta basically is this robot that hits a reset button at moments like this. It just strikes me as this opportunity, like

what can we learn from smart beta right now? Yeah, So you bring up an example in two thousand and eight where some of these smart beta funds bought financials right Worth. At the time, everyone was really afraid of owning those stocks. And I think we're seeing a similar parallel with some of the energy companies and especially some of the airlines. Right you sort of seeing people on Twitter just asking, oh, should I buy airlines? Is a

good time. But because smart beta is emotionless and it's just rules based, what I think you're going to see potentially some of these value ets to some of these multi factor et take positions and somebody's really beaten down sectors like airlines, Um, maybe some energy. So if airlines do come back and you see these funds that had been rebalancing to them, I think potentially it could be a really good trade, just like it was in two thousand eight that ended up benefiting a lot of these

multi factor funds that bought financials. The only caveat to that I would argue is that in two thousand and nine, I just remember literally everybody hated banks. They were scared of them. I don't know if people are scared of airlines that I did a poll yesterday asking people what what they thought the twelve month return of jets would be. You know, uh, and the majority picked over there was still half picked flat or negative. But um, a lot

of people have optimism there. I think, Um, this is slightly different in that regard in terms of people's view on airlines versus banks. In two thousand nine that said, smart Beta, this is when they should shine because they're going to just do things based done the robotic nature of the programming of the rules and not on emotion. And we'll see if that works again this time. Look, there's gonna be a couple that are like that that

really shine out of this. Uh. And we don't know who they are going to be yet, but this is the kind of environment that makes future winners, uh in you know, in terms of helping them out perform. Okay, you said it the future. That's the last thing I want to talk about. What do you? What do you? Let's make some bold predictions here, Tom, let's go first. Yeah. Sure, I'll keep on the mold on the smart Beata topic.

But really I was looking at multi factor and why this is so interesting is I looked at GSLC, which is a big golden multi factor fund. It hasn't had any outflows during this entire period, which I think is really interesting, and given all the outflows that have been coming out of active equity, I think when money gets to redeployed back into the market. It's going to come

in through these multi factor um ets. So I don't see why this is not gonna be the fastest growing smart BEATA category and why sets can't double in the next couple of years. Eric, you've got a bold prediction for me. Yeah, I'll go with um You know, again, as NTF analysts, most people won't be shocked by this, but I will say that in this environment, it's pretty shocking. I'll say, bond ETFs double their assets in three years. Right now they have like eight and fifty billion. I

see that getting to aout one point five trillion. And the reason I say that is because even though pundits and some critics are looking at these discounts as black eyes quote unquote, the volume in them has been more than double the old record. Uh. They've traded about seven billion, and that's as much as they trade in a quarter. So all of them are being used more and more in these crisis situations. If if the if the actual users of them thought these discounts were somehow a bad deal,

they would stop using them. The volume would plummet. They go look to do something else. So volume to me is a foreshadow of future assets, and in every sell off two thousand bond ETFs have uh gotten more investors you using them. People love low spreads, they love the liquidity. Plus you throw in the low cost, there's still much cheaper than an active mutual fund, and that's what the advisors like. So liquidity and low costs are to me are still the two big advantages of ETFs in general,

especially bondy tfs. And they're still intact, so I think they overcome any sort of perceived black eyes um and you know, continue taking in assets. But uh, you know, we'll see. We're watching them, you know, to see if anything in this sell off has turned anybody off. But so far I don't think it has. And that's all for Trillions tom As always, thanks for joining us on Trillians, Stay safe in London, Thanks for having me, Eric, keep it real and Philly, thanks for listening to Trillions until

next time. You can find us on the Bloomberg Terminal, Bloomberg dot com, Apple Podcasts, Spotify and where brails you'd like to listen. We'd love to hear from you. We're on Twitter, I'm at Joel Webber Show, He's at Eric Faltunist and you can find tom at Tea, Sarah Fagus, good Luck Spell on it. This episode of Trillions was produced by Magnus Hendrickson. Francesca Levey is the head of Bloomberg Podcast, but