On the Money with Dynamic Funds

PARTICIPANTS

Peter Tomiuk
Vice President of ETF Distribution

Alan Green
Vice President and Head of ETFs

Announcer: You're listening to the ETF Exchange, presented by On the Money with Dynamic Funds. Join us as we dive into the latest trends and investment strategies to help you navigate the ever-evolving landscape of ETFs.

Alan Green: Welcome to ETF Exchange, presented by On the Money with Dynamic Funds. This series will explore the world of exchange-traded funds, where we break down complex financial concepts into easy-to-understand discussions. Join us as we dive into the latest trends, investment strategies, and expert interviews to help you navigate the ever-evolving landscape of ETFs. Whether you're a seasoned investor or just getting started, our goal is to provide valuable insights to help you make informed decisions and grow your wealth.

Subscribe now for a deep dive into the exciting world of ETFs. Hello everyone and welcome back to the ETF Exchange. I'm your co-host Alan Green, and this is in fact our first pod of 2024, so we wish our listeners and investors a happy, healthy, and prosperous 2024.

Peter Tomiuk: Hello everyone and Happy New Year. I'm your other co-host Peter Tomiuk. We're really excited about today's episode for a couple of reasons. First off, we're going to continue our discussion on ETF flows. You may remember the last episode we gave a high-level breakdown of what we saw in the Canadian ETF industry in 2023. Now this episode, we're going to look ahead to 2024 and provide a bit more of a global perspective. Secondly, and I'm extremely excited about this, we have a well-reputed guest south of the border joining us to help provide us some insights on this.

Alan: Peter, that's right. I'm also super excited by our guest today. We're joined by Eric Balchunas, Senior ETF Analyst with Bloomberg Intelligence. Eric's been with Bloomberg for over 24 years and is a towering ETF voice and commentator. I would actually say ETF royalty. Eric and I first met in London well over a decade ago. He visited the iShares office. If I recall at the time, I was a recovering ETF trader having just joined iShares from Citi. We had some great debates on ETF liquidity. Anyways, it's been awesome to watch Eric's rise and success, and a pleasure to welcome him on.

I would also check out Eric's Trillions ETF podcast and his books he's authored over the years. Worth checking out. Welcome, Eric.

Eric Balchunas: Hey, great to be here, Alan, and good to talk to you again.

Alan: We can't start today without acknowledging the biggest ETF story of the year and maybe in history of ETFs, which I know kept you sleepless a couple of weeks back, which is the approval and trading debut in the US of spot Bitcoin ETFs. This is ETFs that hold Bitcoin directly. We actually had to reschedule this pod. It was originally scheduled to record on the day that Bitcoin ETFs began trading. Eric, I know you followed this story and commentated on a great deal, even covering the apparent accidental or was it a hack or Twitter hack where the SEC announced it approved Bitcoin ETFs, which at the time they very much hadn't.

We've also had fee wars before the launch, zero management fees, massive trading volumes, big swings in the price. I'm hoping you can cut through all that noise and let our listeners know what happened and maybe where the crypto ETF market going.

Eric: There's been a lot of ground broken in the ETF world as usual. I consider this industry the Silicon Valley of the investing world. It's where all the fish are biting. All of the attempts to evolve products are here and attempts to ETFize different asset classes. Once a decade, ETFs get into a new asset class. Bitcoin is obviously unique because it's a digital asset and it itself is new. This is like a 10-year process of the filings and then denials. It was an emotional roller coaster.

The week that I had to bail was the approval week in the first couple of days after they launched was really exciting because how much they're taking in, what's it look like. We're on day eight, I think. It's starting to calm down. I've gotten plenty of sleep since then. This is normal for me to cover the flows and stuff. It's much more fun, to be honest. Not knowing exactly precisely if the SEC would definitely approve them, we had high odds. We stuck our neck out. That was a little bit stressful. Since then, it's been fun and a great experiment.

As you know Alan, at iShares, they were first in a lot of areas like LQD was the first bond ETF. It didn't have Vanguard or Schwab or anybody competing with it. If you're first to market, you clean up for a while. That's how it went with GLD and gold. Here we have 11 launching on the same day and doing the same thing. For an ETF nerd, this was like Halley's Comet or something. This has never happened. This is why it took so much of my attention, even though it'll probably end up being one to two percent market share of all ETF assets.

In fascination, it's a 10 out of 10. I am starting to write about other stuff. I was looking at uranium earlier this week. I did my Vanguard primer that I was due. I'm doing our survey results soon. I'm already starting to diversify away, which is probably good for my health. You want to visit Planet Crypto, but I wouldn't want to make permanent residence there. I think I made it out with my mind intact, but I will say the flows are good. This is going to be a legit category. You're looking at top one percent flows and volume for new launches.

I think this will be a viable area. I'm not surprised ETFs make everything much easier. They're going to do that for Bitcoin. They are already.

Alan: Do you have a target AUM, do you think, in mind by the end of the year or something like that?

Eric: AUM is tricky because it includes the market appreciation or depreciation of the underlying assets. The number I'll give you, though, I think it's probably has less variability as the flows. We predicted 10 to 15 billion in actual flows and flows are truth. Your assets can go up and you can actually see customers leave. Look at the mutual fund industry. That's been happening for a decade. I think inflows, 10 to 15 billion would be a great first 12 months now. They're already at four. They're well on their way. That said, there was a lot of hype, a lot of marketing, a lot of pre-lined-up investors.

If they were to reach 15 billion, I'd call it a great success for the first year. This would be all nine of the new ones combined. There's an interesting phenomenon where GBTC converted into an ETF and it charges a lot. There was a lot of people stuck in there and they're leaving regularly since it converted. The nine new ones are having to absorb those outflows or offset them and try to get ahead. It's an unusual situation. Those nine new ones, which I'll call the newborns, again, if they get anywhere near 15 billion, that'd be a great year.

They're probably headed there. I'd say where it's going to be close. Then that would put them asset-wise, probably near 30 to 40 billion. Again, remember, they came over with 26 with GBTC. That's why that number is a little whacked. That's why I stick to flows. I think that's easier to explain anything. We'll take 10 to 15 billion inflows.

Peter: I actually want to pivot a little bit. I want to touch on a general trend revolving around the active versus passive ETF discussion. I remember when I entered the ETF industry over a decade ago, the Canadian ETF industry was roughly one-tenth of the size it is today. Passive ETFs represented well over 90% of industry AUM. Now, this has changed a lot, where non-passive ETFs are now roughly a third of the industry. We see plenty of evidence that the rate of growth and full discretionary active ETFs have been accelerating. Do you notice a similar trend globally?

Eric: Yes, it's funny. Active was more accepted everywhere, generally. It was in the US where we went all passive for a while. Active was almost like a dirty word there for about 10 years. Then smart beta came out, which is an index, but you tweak it to make it active. That was a boom. I would consider that like an evolution of active, and that was a big success. People forget about smart beta. Discretionary active was left out, but it's caught traction in the past year in the US.

I would say the US investors, to me, are probably the pickiest, because mostly the advisors here are fee-based, which makes them just like extra cost-conscious shoppers. I think 2022, the 60 and the 40 were down, so it opened up people to some other alternatives. Second, I think you saw fees come down on active. You saw DFA and Avantis and JP Morgan all offer sub 40 basis point active. Advisors are fee-sensitive, so that helped. Then they put a lot of like solutions in active. For example, JEPI, which in the US broke all the records in terms of active success.

It's an equity income premium income, something like that. It basically writes call options. It gives you the premium of writing those, but you give up your upside. A lot of boomers in America, I call these ETFs boomer candy, they're totally willing to give up some upside for some buffer on the downside and for income. Whether it's the buffer ETFs, the target outcome, or the premium income, that was a good chunk of the natural organic flows into active. Then the flows into like ones that are like DFA and Avantis, a lot of those were outflows from their mutual funds that just moved over to the active.

I would say that when you look at the numbers, they're all very positive, but there's a little more nuance. I think the idea of the all-foreseeing stock picker is a tough sell. I will say Cathie Wood did a good job owning that a little bit. I think the secret to getting into that lane, I think, is to go high active share. We look at beta-adjusted fees. Hers has 99% active share. You can get away with charging a little more because it's used in smaller doses in the portfolio. If you want to be a core active fund, you now have to compete with the free beta.

Beta is very cheap now. I think active is sort of like saying, okay, let's pick a lane here. If we go into the core, we got to lower the fee or do something that provides a solution. Like do some legwork here, cover calls, target outcomes, something, or we go to the hot sauce lane and we just go wild and we can charge more. This is where thematics live and arc and single stock ETFs. We do see a renaissance in active, but it's a little more nuanced than just the return of the Peter Lynch person. That idea of that really high-cost manager that takes up the core of your portfolio in a mutual fund wrapper, I don't know if that's coming back.

Alan: I think a lot of what you said there maybe resonates with dynamic being that high conviction active manager. It's interesting you see similar trends in the US, but it's certainly what we're seeing here. Maybe pivoting for a second back to our friend of the show, which is cash, right? The Canadian ETF industry in 2023 was really all about cash. Suddenly you got paid for return on the savings and the ETF industry, as you mentioned, evolves quickly, right? We saw the rise of high-interest savings ETFs where effectively the ETF takes in a deposit and then places that as a bank and pays that interest back to the unit holders of the ETF.

They proved very popular, went from zero to a few billion to over 23 billion in very short order. I think what Peter and I were chatting about the other day is that's a large amount of money on the sidelines. We started to see a little bit of hints that money is maybe coming back onto the field and playing. I'm curious if you see that similar trend in US ETFs and a lot of money in cash or cash proxies. Are you starting to see that come back into markets or what do you see?

Eric: Honestly, cash was pretty exciting last year because the yields were 5% for the first time. The idea that you could just like sit there and something that has no risk really and get 5% is pretty awesome if you think about it. Versus having to take all this equity risk to get that. What happened in the US is a ton of money went to money market mutual funds. Mutual funds actually had a bit of a comeback last year via the money market fund because here in the US, you can't have an ETF that has a fixed dollar NAV. They're working on it apparently.

There's a couple of companies trying to crack that code. In all the short-term treasury ETFs, the NAV moves, which is good. They took in money themselves, but they took in like one-twentieth of what money market mutual funds with fixed NAVs took in. I think at the end of the day, those money market funds took in a trillion dollars last year about, which is double what ETFs took in. Monster change and it made everything else have to work harder. In the beginning of the year, equities were doing really well, but nobody bought them.

It wasn't until the summer when some of the indexes were up over 15% that people finally were like, okay, 5% with no risk is good, but 15% is even better. Let me buy some equities again. I do think there's still some money stuck on the sidelines. In the second half of the year, certainly, a lot of people came back in. We called it the FOMO drought, but the drought ended around July. The returns got too good. The FOMO got too high and it poured. I wouldn't say all the money's in the sidelines, but there's still a built-up reservoir of money sitting in money market mutual funds that probably could be coerced out.

It's going to take more than in the past because you're getting 5% now instead of 20 basis points.

Peter: One thing I've noticed was that the year-end rally in 2023 was confirmed by ETF flows, especially when looking at the US ETF industry. In the month of December alone, there was $125 billion of net inflows that were deployed into US-listed ETFs, which according to Bloomberg, your shop, it's the highest ever. Now there were strong flows in both equity and fixed income, and I want to stay on the fixed income theme for a second. The last two months saw ultra-short and short-duration ETFs go out the door and money flowing more into the mid to long-duration areas.

Now this seems to be confirming a major shift in sentiment as traders position for rates to come down. Do you subscribe to that thesis and do you expect that to continue over the course of 2024?

Eric: Yes, I think everyone is expecting the Fed to lighten up because the numbers in the US have been pretty good. That said, I've seen this movie many times where your mind says the Fed should do something and it just doesn't. I don't know if we're completely out of the woods, but certainly the feelings are. That's why a lot of equity indexes hitting all-time highs this year already. What we think we're going to find is people will look to other areas of the market like mid-caps and small-caps.

That said, even so far this year, again, these large caps seem to take over. If you think about it, the companies that had suffered the most when it cost money to borrow, those are small caps value stocks, right? Not necessarily all value, but let's say smaller companies. When the Fed lowers rates, those should do pretty well. Will they take over? I don't know. A lot of my associates in macro here at BI expect people to play catch-up internationally and in small caps as rates come down.

Whether the Fed will lower them sooner, I don't know. Is there really any point to lower them given that the market's doing fine? We just got out of inflation. It's still fresh. It's not like we killed it two years ago. It just got good numbers. I don't know. The markets seem to be really optimistic. They bounce back from geopolitical news pretty well. It just seems like a really good market and with the Fed taming inflation, I can see a lot of other places playing catch up. The issue with the Super 7 stocks that we're seeing is, by all historical measures, they just don't have a lot of room to run if you look at valuations.

That's sort of, I think what we're watching is how much these other areas are going to play catch up in the bond world. I do think we'll see some duration rotation as rates go down. That should be good for like the long end of the curve. TLT, a lot of people lost money in TLT last year betting on rates to follow the Fed to break something and they didn't. Six billion just went poof of betting on that. Now it's working a little more. Those are some of the things we could see repositioning over the course of this year.

Peter: It's interesting. We saw some similar flows or similar behavior here in Canada as well. When you take a look at just fixed income flows in general over 2023, there was such a barbell in terms of where it was going. I believe it was 44% that went into money market style, fixed income instruments. Then you had about 17 or 18% that went on the long end. I don't remember ever seeing that amount of money go into the long end. Most of that came in at the end of the year in anticipation or in the expectation of these rate cuts to occur.

It is interesting to watch. It's incredible how fast people change their sentiment when it comes to where they want to place their money. It's unbelievable how ETFs can actually capture that when you analyze the flows.

Alan: Peter, you mentioned that year-end rally and some decent flows in the Canadian space. I think, Eric, we looked at some numbers for the US, some pretty staggering numbers, right? $50 billion into SPY in December. Again, if we looked at the vast majority of the US equity ETFs, saw pretty positive inflows throughout the year. I'm just curious if you're seeing those type of flows in the US and globally, do you think that equity sentiment picks up?

Peter: Yes. By the way, the SPY thing you noticed is interesting. This is a call I definitely got wrong. In our big ETF event in December, I did my typical PowerPoint outlook. Half of it was stuff I did not see coming. One of those things was SPY beating everybody. SPY was supposed to lose market share over the years, but it did enough flow getting earlier in the year. I think it was like $16 billion. It was probably in eighth place but in December, a lot of tax-loss harvesting money uses SPY, and it took in like $40 billion.

It basically rocket-shipped past IVV and VU to take the crown. It was sort of like an athlete. They still had some gas in the tank. Anyway, we did find that the S&P 500 ETFs broke the record. There's four of them in the US. They took in more flow share than they ever have. Even though we were focused on the Bitcoin race and all this other stuff, those did really well. Those are continuing to lead the leaderboard this year too. You can't shake a lot of that money. We divide our flows into the trading crowd and the buying holders. The buying holders tend to be Schwab, Vanguard, iShares Core.

The trading crowd is more like SPDR-leveraged stuff. The trading crowd flows are all over the place. They look like manic. They're performance-driven. If the performance takes a hit, the flows usually follow. The buying hold ones, they come in consistently. They're hard to shape. So far in the past couple of months, we've seen both parties on the same page in terms of buying into the market. Usually, that means something bad's coming soon. [laughter] The party's never that hopping for that long. Everyone's there. Usually, if you have a couple months of that, somebody calls the cops and there's a sell-off.

I've never seen the trading crowd be that consistent with the buying holders. Like I said, it's usually a couple months you hope to get but still over time, US equity markets have gone up and a lot of people are looking at the past data as evidence that that's going to keep happening. It could take a lot more to shake them this time because these large-cap US equities, they were supposed to have a problem when rates went up. They didn't. They kept doing well despite high rates. I'm talking about the Q stocks. People are even more emboldened now, I think.

I'm not sure what will change. Something Black Swanish, I think, has to come out or some inflation print that's like off the charts again and we realize we got to go back to raising rates. Outside of those things, like Black Swan or a CPI, like an inflation print gone crazy, I'm not really sure what disrupts this general, nice, utopian feel in the flows.

Alan: With time where it is, maybe we'll move on to a last question. I think we touched on this through the pod, and that's active ETFs, right? At Dynamic, we're a fundamental active firm. We've got a 75-year track record of this space very, very high active shares. Obviously, we stand for fundamental actively managed ETFs, which as a category are growing very fast here in Canada. I'm curious, any wages we can make on the growth of this space? I know you do occasionally bet steak dinners on your U.S. predictions. Maybe we could do maple syrup.

Maybe we have a wager about, are active ETFs going to grow faster than passive this year?

Eric: Ah, good question. Definitely in percentage basis. I would say active will grow faster. They're starting from a smaller base, although it's still pretty big, but definitely on percentage. Now, last year, they grabbed 25% of the flows. Here's the thing, though. If you count smart beta and thematic as active, they are. They're just index rules-based active. If you throw those in there, you get more up to 35, 40. If we were to be real liberal with the definition of active, they got a shot. Now, discretionary active, I don't know.

I'd say 25% would be a home run year again if they could just pull that off. The issue here is that the reason the beta and the passive still dominate, even though they're not in the headlines anymore and like they seem like yesterday's news, is because they make up the core of the portfolio. When an investor has new money coming in, the core has so much more of an allocation. If they are going to sell a little core to go into an active strategy, again, it's not going to be all 60% of their core. It's usually going to be a smaller dose.

That's why passive will probably rule for quite a while. It's just because it's a bigger part of the portfolio. We think the portfolios are changing. We think that it's a 60-40 and people look to get some lower fees there, but they're going to pull from bonds and stocks and form like a hot sauce bucket. In there, they're going to cure their speculative itches, invest in things just to keep them occupied while the other stuff has to compound. I try to tell these crypto maniacs that compounding is what it's all about, but you have to be very patient.

It could take 20 years but once compounding starts, look out. it gets magical towards as the years go on. People like to mess around while that's happening because it's like watching paint-- Paint drying is even actually more entertaining. It's like sitting there in your backyard, planting a seed for a tree and watching the tree grow. You'd literally be sitting there for 30 years. I just think there's going to be more and more tweaking and alternatives, solution-oriented products. If you can make an older boomer less nervous, that's something they'll carve out a little of their 60-40.

I just don't see anybody selling the whole 60 and going to something else like an active fund. The active funds are going to pick off little parts of the portfolio, but that's good. I think it's, I want to see active succeed because the more people that are judging and looking at stocks on their valuations, the more the market will be real and good. We'll have a nice balance between active and passive, which I think is healthy. Because for a while there, it looked like passive was just going to be 100% of everybody's portfolio but I think active is pushing back and it's good to see.

Alan: I agree. I think it's good for investors to have the choice. Maybe that's a hard bet for us to do because I think we both agree. Anyway, I think we should wrap this one up. First up, thanks, Eric. It's been a real pleasure to have you on here today. I think we'd love to have you back on again in due course. For our next episode, we're going to bring it back home, have a discussion with Mark Brisley, who's the head of Dynamic Funds, where we'll discuss a variety of topics like his views on ETFs, the importance of active management and where we as Dynamic fit in the Canadian ETF industry. Thanks, everyone.

Peter: Thank you.

Eric: Thank you.