The ETF Story 6: The Revolution

of them when we first did the eye shares. Okay, so that's but I didn't billion, but I didn't represise to fifty. We're already about the whole industry. What else mickcap, spider, diamonds, diamonds, gold, all the all the pressures. Yeah, g l D pre shares. Um, we're about already. Can we hit fifty? Let me think I'm sure. I'm looking market vectors any schwab Vandguard Vanguard. Oh jesus, okay, now we're this is trillions presents the E t F story. I'm Joe Webber, editor of Bloomberg

Business Week. In the early two thousand's, after webs becomes part of I Shares and it really begins to take off. Innovation in the E t F space is inevitable, and as you just heard from Kathleen Mariarty, she ushered in many of these innovations in the form of new ETFs which are still relevant today. Dave Nodded, longtime managing director at et F dot Com, says that in terms of et F history, spy definite innovation webs really more of a mainstreaming of an existing innovation LQT. I think a

genuine innovation which prize opened the door. Bruce Levin is a senior strategy advisor to a Story Advisors, but he was running product development at I Shares when it first launched fixed income ETFs, including what is considered to sort of be the Spy of fixed income l q D, the first corporate bond ETF. The bond market, of course, is a whole another thing, because it's an intransparent market where you don't have that ability just you know, put in a picker and get a quote on a bond.

He said, this also took a while to get the SEC on board with the product, but once we got the SEC comfortable that not only was it going to work, but we were actually going to provide a benefit to the market by creating of security that was a reference

point for where these these things to trade. I think they liked that idea, and I think it's been very successful as a result, Levine said, like the sec investors were slow to warm initially, he says it was only the most sophisticated advisors who liked these fixed income products. Like everything with ETFs, once people understood what they were

getting and they toe dipped, they ever went back. You know, once you've thought and got comfortable with something like an LQD, you're not going to try to assemble individual bonds on fifty companies for a small amount of money, which is never gonna do that not says l q D was one of the most significant launches in et F history.

It's not like there was a huge leap of faith required from a regulatory standpoint to launch l q D. What was required was that same leap of faith from the dealer community to be the other side of the trade. There was no question that portfolio managers and institutions and advisers would want to buy corporate bonds in a more convenient package. Because buying corporate bonds was a pain in the ass. So yeah, by all means, they were a

ton of demand for it. But getting the dealer community to show up and do creation redemption, the ability to do um cash and lou for part of the baskets because some stuff might not trade well enough, all of that stuff was really just a feat on the street, you know, ground effort to make that happen, a little bit like trying to get somebody elected who may not be that well known. You had to go out and knock on doors and get these dealers to understand that, yeah,

creation redemption was going to work in the bond market. Uh. And that I think was what really opened up people's eyes to what E T s could become. And another significant launch in that early two thousand's was Vanguard's first et F, the Vanguard Index Participation Receipts or VIPERS. I think it was more psychologically significant and maybe almost spiritually significant than it was from any markets perspective. Viper poisonous snake. This,

as you'll recall, is Vanguard founder Jack Bogel. In some ways, Bogel played a significant role in the ETS creation by giving Nate Most feedback when Most was first dreaming about what would become spy. Spy was also priced to compete with Vanguard expense ratio from the very beginning, but no that. Bogel has remained an outspoken critic of ETFs ever since. Well in e t F is just another form of index fun, a sort of bastardized form for the one

of a better word. Bogel says it's hard to pinpoint his reaction to VI first it was eighteen years ago, but he says he could understand why it happened. So there we are had to They looked at it, and many looked at as a way to get into the brokerage business, which I thought was not catastrophic. But you know, our our original premise was build a better mousetrap in the world, will beat a path your door, And all of a sudden we were out there hunting money other work. Uh.

And so it didn't warm my heart. I don't refe recall feeling bothered about him, and I even, to be quite blunt about it, said, you know, I'd probably have

done it too. I think the real kicker for the Vipers coming online was it signaled to individual investors and to a growing class of Vanguard focused advisors that e t F s were okay, and I think that that sort of anointment by somebody as revered as Vanguard really opened the door for a huge rush into these products by core asset allocation advisors, which is really what drove

all the growth in the two thousand's. Soon after Vipers comes to market, Power Shares launches in two thousand three, and the power Shares brand is where we first get the concept of smart beta ETFs in a big way. Bruce Bond, who had previously been the head of marketing at Nuvine, was leading the launch. Bond says he'd seen all kinds of product packaging in the et F space and he knew what the problems were for all the different products, and that's when I started to say, Okay.

At the time, there were no active e t s and I looked at it and I said, well, what is an index? An index as a group of stocks that track something, right, it doesn't matter what it is, so um now it has there's certain requirements and index has to have in order to be replicated by an e t F. But at the time they were all benchmarks, and you know, just static cap weighted or dollar weighted

or what you know. However, their waiting scheme was. But we looked at it and said, well, why wouldn't we create an index of stocks that are intelligently selected using a quantitative methodology, and we will build an index out of a stocks a rank stocks rather than just all stocks, and we'll have it waited like the market, so it will look like the market from awaiting exposure standpoint, but we'll do that with quality securities rather than just all securities.

And that's when the intellidux was born. And that's a really intelligent indexing or smart beta or whatever you want to call it. That was the birth of that whole movement. He says people really hadn't thought creatively about what an index actually was. And he says it was hard getting power Shares off the ground. So we had to convince something an intelligent index, quantitatively derived was better, you know, like an index with value. It was better than just

a benchmark that floated along out there. And then we had to also convince them, you know, of who power shares was, and what an e t F is, and

and y an e t F the structure is. We're going through all this to get the value through it from a tax standpoint and a cost an efficiency standpoint, not exaust The power shares products are so important because we first started seeing evangelism for smart beta et s and the form of ROB are not a a sticker pr F. I think PRF is notable because it brings with it ROB or not even more so than whatever

it's doing in the method adology. And ROB are not was and remains such an advocate of a smart data methodology. All right there, raffy waiting scheme in there that we've for the first time sort of had our are evangelists. The person you could put on radio or person you can put on television would sit there and talk about smart beta, whether they were using that phrase or not.

Are not says. The term smart beta has been commandeered by the industry to encompass practically anything, so smart beta now spans a whole array of strategies, some of which are smart, some of which are not at all smart, some of which break the link with price and have the structural rebalancing alpha of the original smart beta concepts, and some of them chase fads, chase bubbles, and are

the antithesis of smart. But smart Beta has grown hand in glove with the t F community because the e t F community, well, fourteen years ago it was boring, had a bunch of capuited indices. The only exciting thing in that whole domain was sector funds. All right, well that's not very interesting. And so once fundamental index was adapted to e t S, the doors swung wide open for a whole array of strategies. And I applaud the

product proliferation that's happened there. Why shouldn't investors have a wide array of choices. So, after we have bonds and smart Beta plus some major growth in the E t F space, g l D is the next logical innovation, Although the intellectual property to make it happen required yet another leap of faith and yet another bunch of structural shenanigans not exist. The people behind structuring g LD gold

really did have to invent the wheel. The way g l D works from an investor's perspective is, hey, it's just like everything else. You just buy it, you get exposure to gold under the hood. It's doing all sorts of stuff no other structure has ever had to do. All it had to create a whole way of accounting based on ounces. It was literally a whole new accounting methodology that you could never get away within a traditional Fortiact fund. They had to come up with a new

trust structure in order to make that happen. Um, they had a whole another gap of creation redemption problems to solve. And much like how l q D gave people access to a very difficult to buy security corporate bonds, not says g l D really opened up gold as an

asset class. Prior to that, the only people who really thought about gold as a portfolio asset were either sort of hedge funds that could afford to be, you know, buying certificated golden large amounts where they could be afford to be buying directly in the London volume market, UM, central banks, uh, you know, maybe major corporate treasuries that were trying to shelter money. But but it wasn't something that the average investor thought of it as a portfolio acid.

If anything, you thought of it as sort of a rainy day collectible that you literally stuck in a safe in the basement. It got to a billion dollars in three days. That's a record, As you know, it's that I called the Joe DiMaggio hitting still the standing record easily is it? You know what number two is? Can you guess? Yeah? That's true? Nerd nerds him right there. Hardly anybody knows that I thought m J might break it.

But the performance it was on Pace D and D was like a week or two, two and a half months, was it? Really? That's that's why it's the hitting streak. Bob Tool says that gold really helped demonstrate the vehicle use of the E t F. E t F s are rappers, right, cases into which you put something. The case is agnostic. What became wonderful about the case is that we could put anything into it. It could hold gold because you would deposit gold into it and you'd

have the shares. It would be a proxy for gold. And then you became silver. And then we did currencies, and we did all kinds of things. And part of the reason for it is by doing all of this, at the end of the game, if a person had twenty dollars, they could have a real assid allocation model as opposed to exposure to a couple of stocks. And since the realization that these vehicles are so effective in many spaces. Each have grown immensely over the past decade.

To give you a sense, they were at six and two thousand eight and since then they've grown sixfold to three point six trillion. This growth can provide a lot of opportunity for investors, but it can also feel like a lot are not. Likens it to being overwhelmed with choices at the grocery store, but if you see too much variety, your eyes started to start to glaze over and you wonder what the heck am I going to buy.

We're in sort of that situation, and in ets today, there are hundreds of smart bait e t s and a lot of them aren't smart. A lot of them are really pretty dumb ideas. We're looking at a world in which change happens gradually. People don't en mass pick up and move from one idea to another. Most of the growth in a U M and mutual funds has actually been on the e T S side, but most of the assets are still on the mutual fund side.

These things change slowly, and just as the dinosaurs in Jurassic Park were big and powerful, they eventually got wiped out. The best new ideas will gain tractions slowly but surely, and the worst of the old ideas will lose ground slowly bit surely, but they'll still be powerful participants in the market in the interim, and that interim will last many years to come. I don't expect this to be a sudden see change, but I do do expect the evolution of recent years to continue. E t f s

are a powerful tool and an investors stool kit. So where are et f s headed. Dave Nodding thinks the natural evolution is towards traditional active management, like how companies such as Fidelity or t row Price have skilled research teams that pick et f for other people. I think that's almost inevitable now. Whether those will be successful products

or not, I don't know. I give kudos to the folks like David's advisors who really just come out and said, you know what, traditional active we pick stocks better than you do. Give us your money, and I admire the hudsp of that, whether they end up being right or wrong.

I think what we're going to see is more um whether we call them AI based funds, whether we call them smart beta funds, you know, we're seeing more and more of those strategies get launched and get some traction on the AI e Q launched pretty recently, got decent assets pretty much out of the gate couple a million bucks. So there is an appetite for these smarter smart beta products. I think will eventually abandon this moniker smart beta. I

don't know anybody that actually likes likes that phrase. So we're going to just start calling these things quant active or quant funds, which is frankly what they've been all along. There are a lot of projections out there, not only about how eces we used like not I just explain, but also projections about how big these things can get. We talked about projections p wcs like ten trillion in five years, state streets twenty five trillion. Yeah, that's that's

even more aggressive than mine. I don't use the term aggressive, I use it less sober. And then and then we are thirty and thirty, which is thirty trillion. That's global. Those are global. Let's let's go with the global number we got. I forget what it is now, five and a half or six trillion. Where's this headed? Like, how far do you think the e t F can go? Where it doesn't? Again? Sort of eat up too much. Well,

too much is a relative thing. I mean, you know in the US right now, ETF zone about what six percent of market cap, right, So could you double that and still not substantially impact market structure? Yeah? Could you

quadruple that? Yeah? Right, So the idea that you can go from five trillion to twenty trillion doesn't scare me in the least, especially when we're talking about some of those assets going into enormously large markets like sovereign bonds and commodities and currencies and gold, right, and not everything is a small cap equity fund, right, Not everything is emerging market local currency debt. So these assets are going

to go into very large pools. And we're also to market where issuance is growing faster than people talk about, Like and you just think about the corporate bondspace where everybody worries about the ETF is getting too big. Issuance is doubled in the last nine years. They're total outstanding debt, right, So you know, the e t F portion of that hasn't grown by percentage basis at all. It's just the fact that that there's just way more corporate debt out there.

And so assuming that we don't have some radical global economic downturn that crushes asset values worldwide. Twenty trillion seems like a completely reasonable number. You know, we can't know if that growth will happen, But as my colleague Eric Baltunas points out, Nate most would most definitely be surprised if he were still alive. I don't think they think there would be three trillion. I don't think they think to be you know, six trillion worldwide. I don't think

they'd think they're being et f in Iceland. I don't think they would think there'd be a t S tracking the things they do. I think some of the things E t S track would actually worry them, you know, like Vick's futures. So you know, look, this industry has just exploded, and just like any evolutionary line, those lines run fast and they go into different places and it's interesting. You know, see, if we don't get Bloom, I can

sort of just say what he told me. But you know what his his really great quote was is we're we're trying to make a great product, but it turned into in an entire industry, or more simply, can you imagine a world without the e t F any longer, No, probably not never. Thanks for listening to the et F Story until next time. You can find us on the Bloomberg Terminal, Bloomberg dot com, Apple Podcast, Spotify, and wherever

else you like to listen. The et F Story is produced by Jordan's Bell, with some production help by Magnus Hendrickson. Francesca Levy is the head of Bloomberg Podcast. In stating the pilots and the triple Delusa and BA