ReSolve Riffs with Eric Balchunas: Crypto, Active ETFs, ARK Insanity, and the Beta Vortex

This is “ReSolve Riffs” – live on YouTube every Friday afternoon to debate the most relevant investment topics of the day.

Almost three decades since the very first launch, Exchange Traded Funds (ETFs) have grown to a multi-trillion-dollar segment of the market, with more than seven thousand spread across the world. The US market is home to approximately 30 percent of them, spanning the passive/index-tracking, actively managed and thematic categories, not to mention a handful of more exoteric niches. We drew on the expertise of our friend Eric Balchunas (Senior ETF Analyst at Bloomberg) for an update on the current state of the ETF. We discussed:

  • The hottest tickets in town – the ARK family and Cathie Wood
  • Soap opera drama – why haven’t crypto ETFs been allowed yet
  • Why thematic ETFs are actually a closet-momentum play
  • Value as the most intuitive factor – emulating Graham’s ‘Intelligent investor’
  • The Beta Vortex, how passive distorts price discovery
  • Biases and the narrowing gap between institutional and retail investors
  • The answer to 99 out of 100 questions in markets – blame it on the Fed

Eric also gave us the breakdown in AUM for each segment of the market, as well as his estimate for the current size of the entire passive investment complex. This was a wide-ranging and very entertaining conversation, with great input from the audience (especially from our friends Brian Portnoy and Dave Nadig – thanks guys), and we also learned there is such a thing as “conversational alpha”.

Thank you for watching and listening. See you next week.

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Eric Balchunas
Senior ETF Analyst
for Bloomberg Intelligence. 

Eric Balchunas is an ETF Analyst at Bloomberg. In this role, he manages ETF data on the Bloomberg terminal. He also appears in a weekly on-air segment for Bloomberg TV and Radio called “Exchange-Traded Friday” in which he discusses different ETFs and the way investors can utilize them.

In addition, he is responsible for training clients and conducting seminars on how to use Bloomberg to find and analyze ETFs. He is also puts out the Bloomberg ETF Newsletter and is a regular speaker at Bloomberg events. Eric has also written numerous articles on ETFs for Bloomberg Markets magazine and is a regular contributor to Bloomberg’s personal finance blog called Ventured&Gained.

Prior to joining the ETF team, Eric was a Public Relations Associate with Bloomberg. Before joining Bloomberg in 2000, Eric worked as a reporter for Institutional Investor Magazine. Eric holds a bachelor’s degree in Journalism and Environmental Economics from Rutgers University.


Adam:00:01:10There you go man, that’s Bloomberg quality right there. Am I right?

Richard:00:01:12Yeah that song is growing on me. How about you Adam? I like it more and more each time.

Adam:00:01:16It may be very uncomfortable but it is a little bit better. Eric, welcome. Ladies and gentlemen those who are joining us we have none other than Eric Balchunas. Put your hands together and welcome to the stage the lovely Eric Balchunas. Eric, welcome.

Eric:00:01:34Thank you, I’m going to pretend I’m in an actual physical location with you guys and there’s a couple golf claps.

Adam:00:01:41That sounds like a great idea absolutely. That’s a good visual right there.

Eric:00:01:44Thank you guys, it’s nice to talk to you.

Richard:00:01:46Yeah, thanks for joining us. Just before we get started I should just say that the podcast is for entertainment and informational purposes only, no investment advice is here at least not yet.

Adam:00:01:57I love how when Mike’s not here you took over the compliance role.

Richard:00:02:03It’s not going to be you or Rod, so it might as well be me.

Eric:00:02:05Is Mike not going to be on?

Adam:00:02:07Mike’s not on, no. He had another thing that he had on.

Eric:00:02:09Was he fishing again? I wanted to bring up deep sea fishing because I’m really into it.

Adam:00:02:14We can all absolutely chat about that, having been out…

Eric:00:02:18I know you’re in the community now, right?


Eric:00:02:20You been since you got down there?

Adam:00:02:21Yeah. I went out two weeks ago, 5 a.m. caught the sunset out at 12 Mile Bank, roped a wahoo within the first five minutes we hit, and then we dragged around for a while, we hooked a… What was it? Something that you couldn’t eat, I forget. Anyways, a Bara. And two hours later and then we dragged around and then we tried to jig some tuna and didn’t catch anything, but it was still a fantastic experience. Where have you been fishing?

Eric:00:02:50My dad lives on the gulf coast in Florida on the Panhandle and so it’s gold fishing and there’s … Lately we’ve been fishing in the surf and you catch smaller stuff, but when he was a little younger and I would go down there in the late 90s and early 2000s, he was really into it and he knew a guy who’d go deep and I went a bunch of times and we caught everything from the real dolphin which is mahi mahi, some people call it but that dolphin, red snapper, grouper which is so delicious, …, tuna, really everything. Nothing was left and the guy was relentless, he just wanted to catch. What happened, my dad got old, and then they also have limits more in Florida now for catching fish. I caught a nice little right time there, that was a fishing village and also that area has gotten so popular, there’s people everywhere and so it was nice to catch that. It was really awesome.

Adam:00:03:46What town was that? Because we used to vacation there like twice a year down near Sarasota, but you are further up I guess.

Eric:00:03:52Yeah. I’m not sure where Sarasota is in relation to him but he’s in Destin, or Miramar Beach, Panama City. Where they do the MTV Spring Break sometimes for the SEC Conference . It’s basically like the Jersey Shore for the SEC Conference.

Adam:00:04:08That’s the perfect analog.

Eric:00:04:09It’s a lot of – Alabama, LSU, Florida State, all that.

Adam:00:04:14Yeah. Those would have been absolutely rocking parties man. Totally. Which we probably shouldn’t get into as married men. Just so everyone knows I’m sure Eric’s face is a lot more familiar than our own, but Eric is Senior ETF Strategist at Bloomberg and can obviously talk about more than just ETFs, for example, deep-sea fishing obviously. So we’re going to go all over the place today. You’re in New York right? New York is wide open, you’re able to go out for dinner and stuff and like restaurants are open and how’s that work?

Eric:00:04:49 I’m in Philly which is…

Adam:00:04:50So that makes…

Eric:00:04:52They call it the Sixth Borough, that’s how big New York is, but no I’m in Philly, I’m going out to dinner tonight, I think it’s 25% or 40% capacity. I’m not keeping up with it, but we are dining indoors tonight and we’re somewhat liberal with it, but they closed restaurants for a bunch of months here, but people are starting to go out a lot more now. But in general, you can go out walk around, jogging, just wear a mask and, it’s been like everywhere else. I don’t think Philly’s been that much different. At the beginning, there was some Philly-like “hey, I’m not wearing a mask”. We’re definitely are a little more like rebellious down here with rules, but everybody adjusted especially after that second wave hit.

Adam:00:05:35For sure, I think in America it’s been a little bit more freewheeling about it than, for example, all of our team members in Canada are basically in lockdown right now and haven’t left the house other than to walk in the woods for two weeks and maybe go grocery shopping. So it’s a different mindset.

Eric:00:05:55My roommate from college who was one of my best friends still is in Toronto. I make it up there a couple times a year or used to for presentations, happening ETF scene up there.

Adam:00:06:08Yeah. We’re the progenitors of ETF concept as you know and…


Adam:00:06:15That’s right.

Eric:00:06:16Wait, when I go to Toronto now, you know how the Raptors beat the Sixers which in that game that Kawhi scored at the buzzer. It was probably one of the greatest endings ever. So congratulations but it hurts so bad, especiAally because I thought we had the momentum. Anyway, when you go to the Toronto airport and you’re about to fly back to Philly, I don’t know if they did this on purpose but in that terminal, they have this huge mural of the shot. The ball is only like a little bit off his hand so I went up took a picture blocking the ball, and now I’ve opened my presentations with that in Toronto, and I’ve been booed.

Adam:00:06:55That is brilliant. You don’t even need to say what shot it was. Like that was the shot that rang around the world like that was absolutely magnificent.

Richard:00:07:03We should be able to take it with a little bit of more sportsmanship given that we actually won the championship. So you should be able to block it in your own fantasies in the world…

Adam:00:07:12In Canada, it’s just good natured booing. There’s never any negative energy booing, it’s all just it’s all this….

Richard:00:07:14Yeah, it’s probably true.

Rodrigo:00:07:16It’s only the Americans doing the blocked shot move. I don’t know what’s going on. Can you guys hear me okay? Are my levels okay just before I blow anybody’s eardrums off.

Richard:00:07:25No, it’s pretty good

Adam:00:07:26That is way better.

Rodrigo:00:07:27Okay, good.


Adam:00:07:30So, what are the hot topics in the ETF space right now? I guess ARK continues to just blow the doors off. We saw the first major outflows this week I guess, is part of this market mini reset type action we’re seeing. Has there been a lot of chatter about that? You have any interesting takes on that?

Eric:00:07:54Yeah, for us, if something punches above its weight or defies multiple odds, we give it attention. We gave JETS, the airline ETF a lot of attention for that, and most of the flows go to boring Vanguard. Like, VTI takes in as much in a year as like ARK has in all assets ever. So, we try to cover that, but you can only say so much, okay it’s cheap beta. We do give outside attention to stuff that emerges and we were covering ARK early on. I remember I went back and looked, we covered them in 2015, three or four months after they came out because they immediately topped the leaderboard and we thought they were interesting because they went across sectors and it’s obvious in retrospect but the idea of focusing on a theme that could just, and be active, and they could just hop wherever they want. I was like, they’re onto something because the time these companies are starting to be, is Amazon consumer discretionary? What are these companies? They’re becoming so big and harder to find. It was actually a logical thesis, but she actually caught a wave, she caught it great. She caught every, talk about fishing, she hooked this particular market. So, the asset flows were minimal for four years, it’s also a lesson in patience. This is not an overnight success story. I remember watching a VH1 behind the music on “No Doubt”, remember that band?

Adam:00:09:18Yeah of course.


Eric:00:09:19“I’m Just a Girl”, and in my mind I thought they were put together by a corporation and made famous two days later, but they were a band for 12 years or something and I remember that VH1 series taught me that a lot. That a lot of these bands that maybe seem like one hit wonders, they’ve actually been a band for a long time.

Rodrigo:00:09:37The Black Keys is another one.


Rodrigo:00:09:40They have like eight records before that. I thought I was deep underground and then when they went pop, I remember seeing them in concert at a small venue in Toronto, and realizing as their song was going number one, that that was probably the last time they were going to be in that smaller venue.

Eric:00:09:57Yeah, that’s a good time to catch a band I think. I actually met my wife at a Black Keys concert, it was our first date I should say. I remember her ringtone was James Blunt’s “Your Beautiful”, in line to get in with all these hipsters with hoodies on, I’m like, man they’re going to throw us out. And I was like this date’s probably not going to go well. Ended up getting married, so you never know. But we had a good time, it was a good show.

Adam:00:10:21That really didn’t go well I guess, is that right?

Rodrigo:00:10:25We had a similar one with my wife, we went to a concert when we were first starting to get together, and it was a … concert and Drake opened up for him before Drake was anything. So it was just me and her and then a bunch of hardcore hip-hop people and my wife’s like, oh my God is that Jimmy from Degrassi? That’s wheelchair Jimmy from Degrassi, I’m like babe please be quiet this is like an up-and-coming artist, he’s a rapper now. You can’t call him wheelchair Jimmy from Degrassi, can we please? Anyway, I cut you off. So yes, the idea of being a 10 year overnight success is what we saw with ARK.

Eric:00:11:07Yeah. Then, it happens with hedge funds sometimes too where they’re just out there trying and trying and trying and all of a sudden the fish start jumping in the boat, and you hit this Malcolm Gladwell tipping point, and she hit it, and she made JETS look like a minor thing in the level of assets. At one point she’s taking in as much as BlackRock. This year, her and BlackRock are tied. So, this is just a phenomenon, and the reason it’s even extra interesting is because it almost seems like you’re watching someone on the high wire, because this is a very high level she’s at, but with the performance and the flows she has a long way to go down and obviously, you can’t take your eyes off. So as a story there’s all different angles to cover and it’s, I would argue probably the biggest story or thing to cover in the last couple of years. I remember writing about her back like two three years ago, I wouldn’t get much readership on the ARK stories. Now it blows up. You get a lot of… and that’s why you’re seeing more coverage. Those feed off each other.

ARK and Managing Flows

Rodrigo:00:12:03With an open-ended ETF, your options are limited in order to try to manage the flow. If you have a hedge fund you can say, okay listen, we’re not going to take any more assets in, we’re going to close it down for now. You have a bit more obscurity.

Adam:00:12:15The whole model works because they can take flows based on performance. So it’s like, it’s the perfect accelerating feedback phenomenon. Small companies, large proportion of the flows, huge flows relative to the size of the proportional ownership, driving prices higher at an accelerating rate. It’s absolutely the perfect story that encapsulates this entire period in markets.

Eric:00:12:41Yeah, in her defense I will say this though, she didn’t ask for these flows and she was doing the same thing for four years. I think in her heart of hearts, she’d probably want to be like a $10 billion fund and probably… there’s no way you’d expect to be this famous or popular or big. I think that the flow story is fascinating and it’s potentially a problem she’s going to have to deal with, and it’s also obviously helped her a little. There’s a tailwind too …

Adam:00:13:09For sure.

Eric:00:13:11But some guy on Twitter today was like, it almost seems like he’s accusing her of buying stuff just because the flows will make it go up and I don’t believe that. I think she just buys stuff she really believes in. I think she’s in the right place. The flow story is out of her control but something you have to be, now it’s a new variable you have to consider if you’re investing with her for sure.

Rodrigo:00:13:33The new revenues that are going into her pocket must feel nice but she must be terrified right now. Like you said, it’s a high wire act. What do you do? You own large positions in very small companies, and everybody knows what you’re doing because it’s a fully transparent ETF. I wonder if she could convert it into an active ETF to give herself a little bit more room to maneuver before everybody else knows what’s going on.

Eric:00:14:03I guess she could. We had her on the podcast before she blew up a couple times, and she kept saying I want to be transparent and this is my blueprint, I don’t want to hide my holdings, and she did. But it wasn’t done so people would copy her and lift the prices of the stocks. There wasn’t a, I don’t know, calculating hedge fund mindset in her in my opinion, it was very innocent in all of what she was doing. In retrospect you could see that if you had that mindset this is a good idea, but I don’t think that was her mindset per se, and that’s why I tend to try to defend her a little bit but there’s no denying some of these issues are now popping up with capacity, but I think a sell-off is probably going to handle all this. Last time I talked to her on the phone I interviewed her for this book I’m working on, and she was like… I could tell she was almost like, “we’ll have a big correction, we’re going to get smacked around and some of these late coming performance chasers will leave”, and I do think that her fund probably has a core base of maybe five or six billion true believers who will buy dips, which I don’t think she’ll have a complete meltdown. I think you’ll have a base, but I think there’s probably half of the flows or people coming in because it went up. And it’s interesting remember when GameStop had that just dramatic increase for a week, not the second ever…

Adam:00:15:24I’ve never heard of it.

Eric:00:15:25 Yeah, GameStop1. Her flow stopped completely on a dime, it was very weird to me and I know…

Adam:00:15:35It’s a really interesting observation.

Eric:00:15:36Growth stocks were hit because GameStop almost acted like the VIX a little bit, and so that’s part of it, but I honestly think that there was a shinier object in the universe for a week there and that’s how fickle I think, there is a layer of flows around her. So I almost think she would be fine with those being shaken out in a drawdown. That’s what I think she would say instead of moving to a new structure, let’s just let the market handle this, and she’ll go back to her five-year time horizons and she’ll say the stocks she picks are supposed to grow, and that all these new issues are coming out which will help bring more options for public markets. But I’m sure there is some degree of frustration that she has to deal with this other variable now.

Rodrigo:00:16:20Well, I just saw a chart about how when you look at VWAP based flows that at 78 bucks for the ARKQ ETF, 50% of people that own the fund will be underwater. Basically meaning that most of the flows, most of the people in the fund right now, hit the peak.

Adam:00:16:42I remember, I think it was MGI Global. I think I may have gotten this slightly wrong but, remember Bill Miller back in 2007, he was sort of the mutual fund manager of the decade, and he compounded at 18% a year, and I know ARK’s been like some obscene multiple of that.


Adam:00:16:58Yeah. Which I think is just how…

Richard:00:17:03For how many years? ARK’s done this, five, six years now?

Adam:00:17:05Six. I think that’s just more that the time and the liquidity environment and managing a public vehicle like transparent vehicles has amplified some of that but anyways, notwithstanding my own opinions, I just think this so rings of the Bill Miller story. I remember everybody wanted in MGI Global, and fully half of their flows came in 2007, and so even though the fund compounded at 18% a year for 15 years or something, the average investor had negative performance because the vast majority of the flows came in at the end, and it’s one of these things we talk about all the time, like what is the mission? Is the mission to get the maximum peak AUM? And I’m not sure.

By the way I’m not disparaging Cathie. I don’t know Cathie. I haven’t followed the story at all, I’m more interested in the general strategy of it all. But the challenge with these types of stories or phenomena, where you get this just incredible streak, you just catch, like you say catch a wave and I’m sure there’s some skill and there’s some strategy involved there, whatever happens, you catch a wave and your performance is just so strong that you attract this massive amount of attention, massive amount of flows, and it inevitably means that so much of your AUM comes in late and you just can’t, you can’t grow at 60% a year or you’ll own the market in like 10 years. That’s an unsustainable growth rate. Reversion to the mean is really going to hurt the vast majority of the AUM in that fund and this…

Rodrigo:00:18:39What’s also interesting, she’s launching a…sorry go ahead Eric.

Eric:00:18:45Let me just say two things on that, one is you’re right, history is littered with these hotshot superstars. in Bogle’s last book, or was it “Clash of the Cultures”? It was one of the two, he goes through like 10 funds that were exactly like this. Janus 20, even Fidelity, and they had the run and then they left and the thing is though, all those funds carry on, they still got a couple billions of dollars. If they start out here and then they have this huge rush and they do end up ahead of where they were, and they are managing money and in a lot of cases like Janus’, after the drawdown and then you look at the whole, they did well. The question is, we know people aren’t going to handle that “Act Two”, where it’s a drawdown and that’s ultimately a behavioral issue and why quants will always be in business because people just chase shiny objects, it’s just like human nature. It also reminds me of DXJ, remember the currency hedged ETF?

Adam:00:19:39Oh God yeah, for Japan, totally.

Eric:00:19:41Remember that was a whole craze, it spawned all, iShares had a whole suite of it, everybody who had currency hedged, they started doing currency hedge minimum vol, like they were combining fads together and the whole thing had maybe 60-70 billion. I think it might be down to 15 now. DXJ is 1.5 billion, that said 1.5 billion for something like a currency hedged Japan, isn’t that bad. It’s just that it had 18 billion at one point and I don’t think WisdomTree meant harm either and I think Cathie’s just like… I remember she pitched to Lyons Bernstein that she wanted to just do a concentrated fund with just the best innovative companies that she could find, and they said no. Maybe for the reasons that you’re mentioning but, ultimately she could finally do it over here, but I don’t think it was malicious. But certainly, if you are going that direction you almost, like you should have a warning label that this could go really well or really bad, it’s basically home run swinging, it’s like Babe Ruth style active.

Adam:00:20:38Yeah. Again, I don’t want to apply any nefarious intent for Cathie. I think part of it is “right place/right time”. Part of it’s, I’m sure there’s some skill and strategy there as well, I do also want to credit Vixologist who corrected me, it was Ken Heebner, CGM Focus, not Bill Miller. Sorry, brain fart they’re totally right.

Eric:00:21:03You’re talking about the CGM Focus?

Adam:00:21:04Yeah CGM Focus Fund, exactly.

Eric:00:21:07It’s very good of you to pick on, we actually did a note where we looked at this one, and the similarities are eerie. It literally, the 900% markup, same exact thing, but then it went down, and it’s got like 8 billion at the peak, then it went down 50% in 2008, so more than the market, and it lost half of those assets, but then it lost the rest over the years. I don’t know 400 million today, but lifetime it’s beaten the market.

Adam:00:21:36But not for the … Eric:00:21:38He did his job, he just took the hare instead of the tortoise route I guess.

Adam:00:21:43This is the time weighted returns versus the dollar weighted returns of funds and again, it’s just such a perfect fable lesson for investors. The historical performance that you see is not the performance you’re going to get, because your performance is path dependent upon when you enter. So just shifting gears a little bit, I’m just wondering whether you think the structure, the choice that Cathie made, whether it was intentional or not to remain the transparent vehicle, rather than taking advantage of some of the obfuscation that is available under the active ETF structure. How do you think that has either intentionally or unintentionally contributed to the effect she’s had, the halo effect, the attention and obviously the performance?

ARK and Structure

Eric:00:22:40It’s a good question. The big variable is probably not realizing your growth would be that parabolic when you set out in these plans, but again before the growth, she just thought the ETF was a disruptive vehicle itself and she’s all about disruption, so it fit her mindset first of all, and she was well aware that this was where most the flows were going and whatnot. And I think she felt that she wanted to be on that side, that growth area product-wise, the idea that she would show her holdings surveys, she had no problem with that. I remember she was like I don’t care, and I think it was something like, if people know, she just was fine with that.

I don’t know if she thought of it in the terms of you can follow me now because there is some degree of marketing where you can get into my world and follow what I do. I don’t know if that was exactly her goal, I don’t recall her saying that specifically, but it’s certainly helped build an ecosystem around her because now you can… Okay, why’d she buy this. I know now it’s a flow issue and it arguably is much more technical but at the beginning I think people just got into her thing, they could follow her trades, oh why is she buying this, they could ask her questions she has the Summit every year, and we thought that was a decent blueprint for active. The flow issue complicates it a little .

Rodrigo:00:24:00She did it too well.

Eric:00:24:01Yeah. Then the active non-transparent ETFs are coming out, not showing your holdings is fine and it probably would help them if they hit a home run. But I just don’t think they’re going to get many bites, doing something that’s like low tracking error but like a high fee. I think that’s a middle ground that’s just not seeing a lot of action. I think most of the flows go to literal beta for nothing, or something that just moves a lot and I guess maybe investors are like, I got the beta covered, let me put some hot sauce on the plate here and I’ll have fun with this, and it will take my mind off the boring part of the 80% with all the cheap beta, and potentially that’s made the middle tougher. It’s barbelled.

Rodrigo:00:24:51That makes sense.

Richard:00:24:53Will she be able to keep most of the holdings under these new rules public, but then keep 10% to 20% of it hidden, shrouded in a way that she could then hedge part of it. She would still accomplish a large portion of what you’re describing was her original motivation, but then also protect against some of the beta because this thing has gotten much bigger than her.

Adam:00:25:18Like delay the clients’ access to it.

Eric:00:25:19Yeah, well she’s in a transparent structure, one thing she can do, I believe she can do cash in lieu, if there’s some stock that’s just, she does not want to pump money into, she can accept cash, so they don’t have to go buy it and then she can deploy that cash how she wants. Being active is helpful. If she was passive like the way the S&P rebalanced into Tesla and everybody knew it, that lost a lot of money for Index and … and that was just the so obvious front-running trade right there, and it worked easily because the index is like dumb, it has to do it. She can make decisions, and we have noticed she’s putting more big cap names like Lockheed Martin and Google in, where they’re almost like the way a high yield manager would use HYG, they keep beta to that theme, but then they’re cash management facilitators, and so she could do that. But that would ultimately make her active share lower to the S&P, drift her up into large caps, and maybe take a little her edge off, so that would probably be the price she’ll have to pay over the next couple of years. If nothing calms down, she’ll probably have to just start finding good large caps too.

Rodrigo:00:26:27What’s crazy is that she’s created her own gravitational pull even with the obscurity, she announces that she’s going to do a Space-oriented ETF and the big Space names are up 10% that day.

Eric:00:26:41That’s crazy.


Rodrigo:00:26:42She’s already getting front run by simply announcing that there’s going to be another product coming out.

Eric:00:26:48That was when we knew this was rock star level. Only Buffett can do that, maybe Gunlock, a little bit. Sometimes Gunlock would give his picks and we’d see a bump in that, he goes, buy EM and short SPY, and we’d see flows in the EM. There’s only like five people maybe…

Rodrigo:00:27:04Don’t forget Deep Fucking Elon.  Eric:00:27:08Elon’s is the ultimate. He’s clearly odd over the market. Who has more power? Powell or Elon? It’s close, right?

Adam:00:27:16Ithink in terms of day to day dispersion within the market, I think Keith McCullough has the box at the moment. He is just unbelievable. I talk to all these people who are really just getting into markets the last two or three years and just worship at the altar of hedge giant Keith McCullough…

Eric:00:27:40I know who he is, and in a way he has the same vibe as Cathie and he’s open. So here’s what we’re thinking and… Bringing people into the universe, there’s people who want to have fun, they want to gamble, and they want to get into trading and they’re almost like gurus that are able to bring in a cult following to a degree.

Richard:00:28:01He gives him the framework. At the end of the day that’s what people who want to be in this market… which begs the question and I wanted to ask you, you’re definitely seeing a lot of flows and the hype, but did you overlay that to some degree with like a top-down macro framework in order to get your picks as you think about the space? Obviously the flows are a big portion of it, but do you pair that to some degree with a global view?

Eric:00:28:30Are you asking me just my general global view of the markets, or if the flows are telling us that people are doing more top down investing instead of bottom up?

Richard:00:28:41I think the former but however you want to take you can take it in both directions if you want.

Eric:00:28:45I’m one of these people who would have thought the market would have corrected like 100% ago and so then now I just don’t even stop thinking about it.

Adam:00:28:53You’re with your people dude.

The Fed and March 2020

Eric:00:28:56I mean, that’s the thing with all these pushbacks, and even the ARK people were doing the football spikes because they had a day of outflows. I’m like listen, anybody who’s tried to spike the football too early on anything that’s bearish, has just looked like an idiot. So I just take a deep breath… It seems to me as long as the market thinks the Fed has got its back, these things are usually short hiccups, it’s almost like the Fed is one giant painkiller, and so you don’t feel much and that’s the big thing for me. I just think, if you had I don’t know, Powell was replaced then you got a more hawkish Fed, that to me that’s when this you lose the medicine, and I think some interesting things could happen. Honestly, because I told people do you think that the March sell-off, and I’d like to hear your guys question on this, in March the market went down what was it like..


Eric:00:29:50Yeah. Now, let’s just say that the Fed did not act. It just said you know what? You’re on your own. Since March the S&P is up… I’ll tell you the answer and then you tell me what you think it would be up had the Fed done nothing.

Adam:00:30:07I think we’d be eating dog food or sort of farming our own vegetables and trying to catch chickens and stuff for food.

Rodrigo:00:30:20Oh my god. I have a different answer that that.

Adam:00:30:23There was no bid dude, and there’s no bid other than the Fed under this market.

Rodrigo:00:30:28This is where the value guys would have replaced the Fed.

Adam:00:30:31All you guys left, there’s zero AUM in value.

Rodrigo:00:30:35Most investors are disgruntled value investors that have been pounded to the pavement. The vast majority of investors are contributing to value; at the margin you have like…


Rodrigo:00:30:46You’re out of your mind. No, there would have been a bid. It just wouldn’t have been, there wouldn’t be a recovery in the same way.

Adam:00:30:53What about collateral calls?  If there’s nobody out there to provide collateral, then there was a global collateral call, all the entire market would have been dictated by margin calls, and this is the Mike Green thesis playing out in real time, without a backstop. We are so massively under collateralized as a system that if there’s a global collateral call and there isn’t somebody there to provide last mile liquidity, then this whole thing goes to zero.

Rodrigo:00:31:24Well, if the Fed didn’t come in, there’s always a backstop. It just may not have been the Fed. It might have been … anything but dog food and whatever else you said is a little pessimistic, even for you my friend.

Richard:00:31:36Rod you weren’t here for the, we actually said this is for entertainment purposes, as well I think Adam is just taking that to heart. He didn’t mean. Let’s move on but I think it’s interesting.

Adam:00:31:46How dare you undermine my assertion, dude.

Eric:00:31:49 I can see the Fed is a bonus… this happens, when I talk to people I’ll have one smart person say, no this is just markets, Fed or no Fed this would have, and then I’ll have someone else go, no absolutely. One thing I would say is I think people are discounting putting a floor on that particular moment in time, because I remember active mutual funds, especially on the fixed income side, had just seen 90 billion dollars in a week and PIMCO Income Fund was down 12% in like half a month or something. At some point you saw the ETF discounts, there was no liquidity. These funds we see we’re going to have to unload bonds, to who? And then they were going to have to halt redemptions and then there would have been a run on mutual funds. That’s the downward spiral I think the Fed stopped and ultimately, I’m more on the dog food side but I certainly don’t think he’ll be up 73%. I think at some point after the dog food was served, there would have, natural bids would have come in, but I still think we’d be down like 30% or something, that’s my…

Rodrigo:00:32:49Yeah, 100%. That’s a reasonable answer, you’d be eating dog food because you’re depressed but you can still afford the dog food.

Eric:00:32:56By the way, what Mike Green said.

Rodrigo:00:32:58… will have some value.

Eric:00:33:01Mike Green and I were…I talk to him all the time, I love talking to him. I know what you’re saying, my different take on Mike Green’s scenario is that, what I saw in March was that the problem’s going to come from active mutual funds, because that’s the demographic that’s going to fail the soonest, so they’re going to be the sellers. If anything, passive could provide a backstop because all those people do is keep investing, they’re taught to just keep buying, and if anything, they could put some floor on the bottom. It’s in 30 years after all the active funds go away and there’s just passive that I think Mike Green’s scenario will come through, where all the Vanguard investors leave, who’s going to be at 55. But I don’t think … We got to get through the active mutual funds first in my opinion, we saw that in March. Passive saw inflows, active had 500 billion payoffs.

Rodrigo:00:33:51Depends on the active manager. Again, market value. Value guys are buying, so there might be a period by which…

Eric:00:34:01It depends. If that active value mutual fund saw inflow, sure but the net outflows of active mutual funds was 350 billion dollars during that three week period. That is a lot of money.

Rodrigo:00:34:11I’m not talking about a value factor fund, I’m talking about actual legitimate guys that have been sitting on cash for a decade.

Richard:00:34:21I think it’s the marketability of those funds. I think his thesis is more the generational, the boomers were…

Eric:00:34:31If that market were to unwind more, they’re like, I got to get out of here and so they don’t have the time on their side, and I don’t think their loyalty to active mutual funds was that high in addition. The people who got into Vanguard sought out Vanguard or these RIAs who like saw the light, and they’re much better. We see it every sell-off, so I just think those people need another 30 years to become old and want to get out before it’s too late. I just think active mutual funds are going to be the first wave of the liquidity problem that is spoken about. I don’t think Vanguard or again, I just think they’re very disciplined, they’re taught to keep buying and they’re also younger, and I think that matters. It’s not the value guys and whether they buy value stocks, it’s more of their investors and whether they stay in the fund or not, because in a sell-off like March, value is down too. So, you might have just too much outflow pullage to really do much.

Adam:00:35:36The challenge is, I’m going to just come right in over the top, the challenges in a world like this with such low rates, and everybody looking to every dark corner of the markets to generate some sort of excess return or some sort of spread on yields, there’s a lot, there’s orders of magnitude, more leverage in the system than anybody would care to admit, and it’s, I hear you saying that the boomers behaviorally and probably for rational reasons, given that their actual, the duration on their liabilities is actually, is low and shrinking, that at the margin that they will also end up being a net seller at a certain point, just to preserve their way of life. But I think in these acute crisis scenarios it’s less the sort of typical investor making quasi-rational or even emotional decisions about their wealth and it’s more the structural leverage in the system that needs to be unwound in market neutral, in CTAs, in risk parity and whatever the leverage exists, in structured credit.

 All of this is such a massive amount of credit in the system that’s essentially VAR-managed and needs to be all unwound at the same time, and that is the dynamic that the Fed, it’s a bank run on the global collateral system and the Fed steps in to be the provider of collateral of last resort, and if the Fed doesn’t step in in those situations, the seven percent discount to NAV that we observed in TLP on February 24th or whatever it was, would have grown to 30% or 80 percent or something just because there’s literally no buyers. There’s no, no one’s accepting repo, no one is accepting collateral from on the run Treasuries, there’s literally no one with any collateral left to borrow to buy.

Rodrigo:00:37:51                             I can just see Warren Buffet backing up the truck. I agree, I think it’s degrees. I agree that it would have been much worse, I don’t think we go to zero, and I also think we’re in fantasyland. The Fed will always step in and now, we saw how quickly they stepped in contrast to 2008. They’re guns a blazing man, they’re going to keep on doing this every single time.

Eric:00:38:14I sometimes think though, what if like… Ron Paul’s son Rand Paul, Ron Paul was like I got to get rid of the Fed. He had a decent following, if one of these guys… I mean I don’t think Bernie was too hot on the Fed, if one of these guys gets in that’s like major populist, then he feels like the Fed just enrichened all the rich people, he could just install a hawkish Fed governor. I think that’s the black swan event that would change everything.

Adam:00:38:41I agree. My eight-year-old was wearing “End the Fed” t-shirts in 2010.

Rodrigo:00:38:49Was this from osmosis or did you actually like… that everybody has to wear this T shirt.

Adam:00:38:56You could order an “End the Fed” pink t-shirt for five-year-old’s back in 2010-2011. It was absolutely, but I had like all my five-year-old and my three-year-old pink and blue “End the Fed” shirts, walking around in their strollers.

Richard:00:39:16The other scenario is the market itself taking the printing press away from the Fed. At the end of the day, the Fed losing its credibility in back stopping. I mean to some degree what we’re seeing now is inflation expectations coming up and people are concerned about rates which is why the curve is steepening, but at one point or another you might imagine that the other black swan would be just the Fed coming in with this promise, and markets shrugging at them and saying you know what? No we’re not playing this game anymore, and moving out into other areas of the market, Europe, emerging markets, like not wanting to touch US sovereigns.

Eric:00:40:01I remember in March the Fed did a couple of half-hearted attempts and the market shrugged it off, but then they did what we call Kitchen Sink Day, March 23 2020 will live in infamy, and that did it. I guess literally buying ETFs and bonds was like, okay well there’s a buyer. I mean we watched bank of Japan, they owned 75% of all ETFs there, now I think that only adds up to about five or six percent of the stock market, it’s ETFs are a small fraction of the stocks. The fact is, they’re just comfortable living that life, and they’re going to go to six percent, seven percent and ultimately you get to a point where you’re kind of like a country like India, where it’s socialized, but India is actually divesting and wanting to go more towards the way we were and let animal spirits take over and capitalism, so they’re using ETFs to get out of stocks, so it’s interesting, bank of Japan and India are two different paths. We’re almost, I put us in the middle somewhere.

India and Japan

Adam:00:41:02The Indian model, what are they doing? Sorry the bank of India already owns a lot of equities or equity ETFs…

Eric:00:41:13They own a lot of companies in India and so what they’ve done they set up ETFs that the Indian government basically says, if you buy this ETF, we’re basically the seller of the stocks in it, and so anybody buying an ETF, we’re just getting rid of the stocks through the ETF, and then the ETF just goes live on the India Exchange for whatever. It’s funny, the ETFs have done pretty well because there was a lot of buyers, so the Indian government, we heard a piece once about how they were outperforming the market, and it has since changed, and also in the Bank of Japan, there’s an interesting one there, and I think the Fed should do this. If they ever go to buy equities, the Bank of Japan was like, we keep buying these stocks that just do buybacks which is, maybe not…we want them to do CapEx, so they had iShares. BlackRock designed ETFs that tilted towards CapEx and companies that hired, they looked at you know hiring and capital expenditures and it’s called the Human Capital ETF and that became a tool in the Bank of Japan’s toolkit which to me would be a twofer, A, you lift the equity prices and you at least get some of that money down to the economy, as opposed to the buyback.

Rodrigo:00:42:25That’s right, policy via the capital markets.

Adam:00:42:26That’s actually really clever, very interesting.

Eric:00:42:30And BlackRock, BlackRock is everywhere, like they’re everywhere man. Just ask around.

Active and Passive ETFs

Rodrigo:00:42:37That’s an interesting view. So what are you seeing in terms of active ETFs vs passive ETFs in the last year? We’ve always seen these flows out of active into passive but now with the new rules, are we seeing a shift in the ratio between those two, especially if there were a bunch of active funds that actually did fairly well during the crash. What are you seeing out there?

Eric:00:43:01There’s active to passive and there’s ETF to mutual fund, and those get confused in the press all the time, because the mutual fund’s dead, well no Vanguard has like trillions in index mutual funds, not only that there’s trillions in regular active mutual funds. The market return has been so good. Listen to this, this stat blows me away. Active equity mutual funds had 3 trillion 10 years ago, they have 6 trillion today, but they’ve seen 2.3 trillion of outflows. Think about that, isn’t that crazy? What other business does that, could you lose like 80% and still be twice the size. So we consider those mirage assets that will basically tumble very quickly in a bear market. We think the market share of passive will grow quicker and be expedited. If you took the market return away, passive would be 80% of mutual funds right now.

But the market return has been a great buffer. Anyway, in the ETF side, active has done better than it has in the past. We have this chart called the Cost of Session Barometer, where we track the percentage of flows that are going into products that charge less than 20 basis points. That means cheap beta. It got up to 99 percent two years ago in 2019, it’s now been slashed down, I think last I checked it was like 70% though the shiny object lane is growing big. That’s Cathie, that’s …, that’s ESG and that’s Proactive. But the middle of the road active, like the Davis’s and the ANTs, the active non-transparent, they haven’t really done much. All active non-transparent combined, there’s probably like 15 of them now and they’re a year old, have about a billion, and I would say probably only 300 million of that is true organic flow.

So 300 million, ARK would do that in an afternoon, that’s how little traction the middle has gotten and why our theme is bifurcation, barbelling. And so when you say active, I would say that there’s active and we consider it like new active which is, like what quants do, rules based smart beta. So it’s active but you’re using an index and then there’s things, like ESG to me is active, and then … are very active and it’s interesting my colleague…I’d love to get your opinion on this. My colleague Tom wrote a note looking at when it comes to value, investors are like okay I get value, I’m going to buy a value fund, but momentum for whatever reason, retail investors just, I don’t know if they don’t understand it or the word’s too scary but what they will buy, they’ll buy funds doing momentum, but they won’t necessarily buy momentum funds. So we think that themes in particular have come around and really just stolen the thunder from a part of the quant world namely … close to a little bit. So it’s an interesting battle within the active lane between all these different things and the labels they put on it, but a lot of it’s just growth and momentum by different names. It’s interesting to us and I think it could probably be frustrating to the rooted academic, momentum that is rooted in all this evidence and then you’ve got this theme ETF comes along that does whatever and future tech and it gets …

Rodrigo:00:46:18This is my point, everybody’s a closet value investor, they can’t even admit it when they’re buying momentum. Everybody wants to feel like they’re buying a deep value company that’s actually making a difference and creating something real like Tesla. That is for a lot of people a deep value play that nobody…that misunderstood deep value play, and they’ll never call it a momentum strategy. We used to be asked to pitch the University of Toronto Fund years ago and we did a lot of momentum stuff back then and the quant team was like this is amazing, this is like really solid work, it makes sense. We are never going to be able to invest this. Because the board is…

Adam:00:47:05The president is an ex-investment banker and there’s no way he’s going to invest…

Rodrigo:00:47:10No way, he needs to understand. It’s in our nature.


Eric:00:47:13Momentum’s done very well. A lot of the funds are up 40, 50%. Now, Cathie doubling that return makes it that she again, it’s taking a lot of the attention away but there’s theme ETFs that are a dish consistent with momentum and some of them overlap really well. You could tell they are. And now I think what’s going to happen is instead with value comes back, watch the theme people try to steal that thunder too. I just saw a filing for airlines, cruises and hotels, and that’s value? So you can see people put like names on what would be value, and so there’s this interesting coming collision between quants and themes I think, that’s one, but then traditional act, and that’s going to be more for things that can outperform and you’d put on top of your cheap beta, and then there’s traditional stock picking which is a very tough world. I’m not sure there’s much going on there beyond if you’re going to do Babe Ruth and go swing for the fences.

That said, there’s so much assets that you’re not hurting at all. I mean you’re very comfortable, like say six trillion, so that’s why I think you’ve seen much more griping or even layoffs from that side of the world because their revenue and assets are almost as high as they’ve ever been. But they have organic growth problems and so you’ll probably see a lot of consolidation over there, but the innovation and the flows are going to go to some of the stuff we just talked about. But that theme, quant versus theme, and I put Cathie in there, in themes. Those are going to battle over some of the assets from advisors in retail. I think institutions are knowledgeable enough to know that’s just labels and go for the academic stuff, I don’t know if you guys have any opinion on that?

Adam:00:48:54Our observation typically is that the institutions are not always that different in their decision-making process from many of the more experienced retail investors. I’m not sure, we used to think that we could have a clear separation and it’s blurred over the years, we’ve got some really sophisticated individual investors and family offices that challenge us in really cool ways and make us better, and institutions that end up really just hurting and more concerned with peer review than any sort of innovation. I think that designation is kind of blurry but the whole theme thing fascinates me beyond all..

Richard:00:49:47It’s closet momentum. Because whatever’s working, loads on momentum. Momentum is the underlying…

Rodrigo:00:49:52The theme creates the momentum.

Richard:00:49:54Exactly. It’s narrative-based…

Adam:00:49:58Let me connect the dots there, because I think it’s like, I believe something. Like I have a bias and then my bias starts to work and then you’re like Oh my God, this bias is absolutely biased, you think it’s like this is the way the world works, or this is like a manifestation of God’s values and you’re like, okay yes, this is exactly the way things go, and the capital starts to flow there, you’re like, yes. So you’re all in on this theme and the momentum guys are like, yeah you know, we actually don’t have any stories, we don’t care about themes and we don’t whatever but we love that you care about themes because that’s how we’re going to…

Rodrigo:00:50:40Drive these inefficiencies.

Adam:00:50:41 Exactly.

Eric:00:50:42… something like we should start advertising like, we’re whatever theme is working, like we’re our greatest hits of themes, we’re just going to theme for you, and I know he’s joking but there is something to communicating in a new way about what momentum is. In particular, I do lot of these tv hits and I talk to analysts and even people inside like the financial bubble get confused with momentum, and it’s almost counterproductive because you think performance chasing is bad, but here it’s good and trend following is in the same boat. But I think that’s, for some reason, value is so much more easy to lock into for people.

Rodrigo:00:51:24It’s because it’s based on balance sheet data.  Momentum is purely, wait you’re telling me your process, is to look at price and as price changes you do more of the thing that it just did. What about the price to earnings and meeting the management and understanding the underlying? No it doesn’t.

Adam:00:51:44Would you walk into a store and you look at something, it was $50 and then it went to 60 dollars you’d buy more of it? It’s just so counterintuitive for us.

Richard:00:51:54That’s the Colin Roche joke about the market is the only venue out there that…

Adam:00:52:02Will demand increases as prices go up.

Richard:00:52:03Out of the store when there’s a 50 percent off sale and we’ll keep piling in as prices go up. I think there’s like this historical bias that the intelligent investor like Ben Grant’s thesis is all about you buy something cheap, you waited for it to converge. So I think that value is the more intuitive of all the factors because it’s the easiest one for you to get behind, who doesn’t want to buy something that’s cheaper than it’s worth, and at the end of the day…

Adam:00:52:30I buy dollars for 50 cents.


Eric:00:52:42What is this ETF with the ticker dude, the sectors … Yeah. Do you know this guy’s, this particular is through Alpha Architect a white label, but it’s the Merlin AI. Anyway, the idea of calling itself a surfer, I think you’re going to see a lot of attempts to re-label momentum because surfing is somewhat of a decent analogy? You’re riding the wave; you’re getting off before it hits the shore. I used to compare it to almost being a chameleon, and you’re just sort of going to go with this crowd, then you’re going to bail before they go off the cliff and I don’t know there’s just probably some opening for some interesting communications I think. But I would say the quants I think have a formidable opponent in the theme people.

Rodrigo:00:53:30For sure, I agree. I think that there’s never more momentum than the last 15% of a theme move. I mean bitcoin is another one that we haven’t even started talking about. What’s going to happen there? How many how many ETFs are launching in the US right now? How many are listed?

Bitcoin ETFs

Eric:00:53:47So nobody has a 19v4 in yet. There are no technical ones on the clock. That said, there was I think 17 filed at one point before the SEC told them all to stop. To make a long story short, I believe there’s probably 15 issuers that are interested in watching and hoping to get out first. I think there you’ve got about 15. I equate it to the Cannonball Run, that movie from the 80s where they go from New York to LA and whoever gets their first gets like a million dollars, and they all have little tweaks to how they’re going to do it. One’s an ambulance, one’s like dressed as priests, because you can tell from the prospectus some will add this, take this away. Some have better lawyers. They’re all trying because whoever’s out first if they approve one, they’re going to be rich for life. The SEC is in the role of king maker now; it didn’t have to be like this. I think if they approved the Winklevoss and the first couple, the Winklevoss by the way, they filed in 2013 and bitcoin was $99. That’s how far ahead of the curve they were and…

Adam:00:54:50Did we just jump the shark? Let’s hashtag crypto here, like we’re now okay right here. I was hoping we would get here, keep going.

Eric:00:54:57I mean, I would say, in a year if the SEC evolves mentally fast enough which I think they should, you could see 10 bitcoin ETFs easily. The floodgates will pile open, the question is if they approve five at once to give some level playing field, or they let like one out first? Because whoever did that up first it’s like they’re born on third base and everyone else has to start at home plate, and we saw it in Canada, the one had a 24 hour lead and has like 95 percent of the assets and volume.

Rodrigo:00:55:33It’s crazy. Now we know the story, we know that the principals are the one that came in second and it’s a brutal, like nobody knew it was coming they just … Adam:00:55:44…jumpedahead of the line … opportunity where everyone was selling the closed end fund and buying the ETF. So closed end was like a 15% discount to half.

Rodrigo:00:55:53And the closed end fund was going to convert into an active ETF. I don’t know what it’s at. No, it probably still has a discount if there’s, that’s a good trade, no trading advice.

Eric:00:56:03Let’s see what it closed at.

Adam:00:56:05Probably somebody knew how to…

Rodrigo:00:56:11What’s the discount?


Rodrigo:00:56:1211%. Right now you could buy that, wait for it to become an open-ended fund, get NAV, because you can buy bitcoin at a discount, it’s amazing. And it’s because of this purpose, was the fund.

Eric:00:56:28You guys know them you’re from Canada, how do you do it?

Adam:00:56:31We know Som pretty well.

Rodrigo:00:56:34We know some stuff, we can’t say.

Eric:00:56:34I bet he’s got involved with half of those issuers that I just mentioned in the Cannonball Run to be like, how’d you do it dude?

Rodrigo:00:56:45Well, let’s take that conversation offline.

Eric:00:56:51And that actually had Dean Martin and Sammy Davis Jr., they were the priests remember that? If you go back and watch it, like an 80s comedy.

Rodrigo:00:56:58Yeah, I’ve seen that one.

Eric:00:56:59Very light and funny.

Adam:00:57:01That’s awesome.


Rodrigo:00:57:03 Canada is a small market and people think that we’re types of people that play by the rules all the time and are very nice, but in the capital market space if you know the right people because it’s a small community, it’s really about relationships. So I wonder if this is a question, we got five ETFs supplying the United States, you want to know who I think, I think you put a poll out, and I voted that it’s all about relationships. I’ve seen it happen over and over and over again.

Eric:00:57:34Lawyers and money was a close second though. But that said, if you hire a lawyer who used to work at the SEC, that’s relationships.

Adam:00:57:45You’re conflating two variables, you’re offside.

Rodrigo:00:57:52I’d be curious to know when that happens, what’s going to happen to bitcoin, because these guys have to come in and buy. It’s like Cathie and the Space ETF. She’s not even buying it yet and it’s already popped, how much it’s going to pop because of the anticipation of the ETFs and how much it’s going to pop once the ETFs go live?

Eric:00:58:09Yeah. I think Canada bitcoin ETF though came out and bitcoin has had a rough week, I used to think it was back in 2014, bitcoin would have popped major, but there’s a lot else going on. Like Elon could just say it’s overvalued that day, and all of a sudden that overwhelms the ETF issue, there could be something else. So bitcoin’s so big now that I don’t know if it’s a guarantee, it should help overall though but this week, bitcoins down heavily and ETF came out so I’m not sure but the back to the ARK and the Space, I can’t tell you how weird that was like. UFO is this, and you guys know Andrew Chanin? He put out HACK, then he got in a fight with the issuer and he got a raw deal. So he comes out with UFO and it doesn’t really go anywhere, but he got this nice gift from God in that ARK is filing this Space ETF, he goes from 30 million to 140 million in like two weeks.

Adam:00:59:03Come on.

Eric:00:59:06Just because he wants exposure to space in the three months before the ARK ETF launches, and it went on a nice performance run and I’ve never seen a filing that literally made another ETF’s career. That is unprecedented. That said, he might see some drain when she launches in April.

Richard:00:59:27How much more does this kind of price insensitive buying give you? I mean we’re back again to the Mike Green thesis, it seems like he’s top of topics a lot of the times, but he’s omnipresent absolutely. What do you think about it Eric? No, just this idea of how much of this price insensitive buying that you see from the index tracking passive vehicles, and what that has done to the market itself, It is the divorce from fundamentals notion that I think a lot of people are thinking about, but what is the solution at this point or where are we headed.

The Beta Vortex

Eric:01:00:30We would say 20 percent of the stock market is owned by passive mutual funds or ETFs, and then maybe add on another 10% for SMAs that you can’t see, maybe another five percent for CITs, so you get to 35%. And of that 35% though, I think only half is true beta, there’s all other weird stuff going on and like we said a lot of active that’s passive grouped as passive, so it’s not all just like one homogenous blob, but there’s probably 15% that’s a homogeneous blob, and sure that’s the money that drips into Vanguard but if you removed Vanguard and you put them all into Fidelity’s funds, they’ve been buying the same stuff. It’s really more the tyranny of the index, the S&P ultimately is dictating it and this is our theme that we write about sometimes, called the Beta Vortex, which is that it’s not necessarily an index fund or passive, but it’s just so many things revolve around the S&P now that it sort of sucks in it return and money and then the return makes more money come in and I think there is a sort of upward spiral that it creates.

That said, the price distortions I think are overrated, I think a GameStop is the situation you got to watch for because if you have a stock that has a low float and it’s not big and you have passive owners, you know are not to sell GameStop based on what Reddit does, they’re not moving. You could have stocks become targeted, but you cannot target Apple this way. There’s just too much else going on. So I do think you might have some funny wacky scenarios with smaller stocks if they decide to target one of those value stocks. The other thing is if you look at the S&P 500 what we try to remind people is companies go in and out of it all the time. Tesla got added but why? Because active bid it up. It only had about seven percent passive ownership for a long time, so active is the reason Tesla’s in the S&P. And then you have Macy’s getting kicked out of the S&P, why? Well active hates Macy’s. I would say that the passive is in the back seat and it’s following what active does.

Richard:01:02:11Now wait, but how much of the thematic? Because at the end of the day you do have some rules-based thematic that were probably owning Tesla, and that’s also back to the momentum narrative sort of thing and that may have begun, and that becomes a self-fulfilling prophecy that then drives more flows into it. I don’t know how big the thematic theme is.

Eric:01:02:32It’s small. See, theme ETFs have like 180 billion. The Fidelity Contra Fund is bigger than that. When you consider Fidelity’s and T.Rowe’s, the amount of money that they have, that’s why I’m trying to remind people to ARK like yeah, she’s got some big ownership in some mid-sized stocks but Fidelity Contra Fund is two whole ARK’s. We’re talking, there’s some whales out there nobody really…I think it’s because they’ve been around us so long they’re not new, so people just are used to these whales swimming around and they don’t…I don’t know. That’s why I think the demographic shift of people selling out of those funds is bigger than people, I think that’s being underrated. I think what’s overrated is the ETF issue and also the weak hands of index funds. I don’t think they’re as weak as people think, I think they will be a stable force for the next 10 years.

Adam:01:03:20That stability ends up, not to Minsky-ize too broadly here, and I think Dave Nadag triggered this memory for me or thought but, it’s not so much that the index funds are weak hands, or that they aren’t as influential, but the reality is every dollar that goes into index funds that are through systematic retirement purchases for example and are not like tactical, they’re just going to buy and they’re going to huddle these index funds. It is basically taking a dollar from the float and a cap weighted dollar from the float of these indices because it’s basically like insider ownership, it’s like these are shares that will never be sold for any sort of active reason, in the same way that insider shares will never be sold. So you’re systematically removing float from all of these companies.

Eric:01:04:27Again, let’s take Vanguard out of the equation, and say that in the next month there was no Vanguard or no index funds, you’d have to buy Fidelity Magellan and what are they buying? They’re buying the same exact stocks. Is the Fidelity Magellan taking away float?

Adam:01:04:44Yeah I agree. But there would be at least some variation behind it. And there are some legitimate at least attempts to deploy capital in its most productive and efficient form. There’s no attempt at the index level to do that.

Richard:01:05:12The passive is fully a knee jerk, money comes in…

Rodrigo:01:05:16Passive meaning market cap weighted, which means there is less of a float, andpeople at the margins are increasing it, there isn’t an active manager saying okay this is overweight maybe I should cut that off.

Eric:01:05:27That’s a computer, if big, buy it. I got it. This is an issue we’re going to live with, we think that it’s…I just don’t think it’s clear and present yet. I think there’s enough float, I think we see sell-offs. Look at news, stocks go up and down the sell-offs and ultimately the reason the index owns it is because active thought it was good, and the reason the index would not own it is active thinks it sucks. In fact, we have this list of stocks that have the least amount of index ownership for people who say there’s a passive bubble, I’m like, you want to invest outside of it for when it bursts? Well these stocks suck and you know why? Because you know why no passive owns them? Because active hates them.

Adam:01:06:07There’s a point when active is so large that just by virtue of active needing to own them it, overwhelms the impact that…sorry, passive needs to own them. It overwhelms the impact that active can have to modulate the price inefficiencies. So definitely there’s a point at which you cross the chasm and I’m not sure that we’ve observed any good models that describe when that is.

Eric:01:06:41 Again, we look at each sell-off, we look at March, there were some stocks that went up and down but there was some. Obviously the whole market went down, if you look at an index but in there, there was definitely some dispersion. Again, the rise and fall of stocks within an index to me, as long as that keeps happening, I’m comfortable with it. And this is something I brought up on a podcast I did with Mike Green which is that, even if you think this is an issue, there’s a lot of people even if they were like you know, you have a good point. Market structure could be a little tested here by all this passive and that person’s in passive funds, they’re not selling. They are not going to take one for the team and go buy an active mutual fund at one percent, because they know they’re going to lose like $300,000 in retirement. I tried to say to Mike, well active should get but more competitive then, either they’re going to do better because there’s more passive ownership and more active opportunity or they’re going to lower fees to the point where they beat their benchmarks more often.

Adam:01:07:36But you can’t lower fees beyond the operational burden of researching and generating alpha.

Eric:01:07:43Gravy, and these companies are so ginormous. I mean, Fidelity makes 18 billion a year. That’s like four Vanguard’s, and they have a fourth of the assets.

Adam:01:07:56We didn’t talk about this earlier but…

Eric:01:07:58That’s fine, it’s a capitalist society. I’m just saying that it’s capitalism that’s also the reason for this, people who have a choice and even if they agree with your point, they’re going to buy that cheap index fund that’s four bips. Because that’s their kids college, their retirement and until you change those hearts and minds this won’t even matter, it’s almost like an academic conversation.

Incentives to Change and the Beta Vortex

Adam:01:08:22We totally agree. I think Mike’s thesis is, and I’m aligned into a great extent is, there’s no mechanism through incentives where this dynamic can change. In fact, all the incentives are likely to accelerate this dynamic, but there is a point at which the trend is unsustainable and therefore it’s Stein’s Law:if something can’t go on forever it will stop.

Eric:01:08:56Can I push back on that just a little bit. Again, if you remove the Fed from this conversation, I think I would agree with you more. I think the problem with this conversation is the Fed, because index funds I don’t think they would be able to, their flows would be able to overwhelm that dog food scenario that we talked about. They might provide some bids a little bit but they’re not overwhelming that. So I think if you really start to unpeel the layers of the onion, you end up at the Fed and not letting the market just behave normally, and let prices settle down and that’s why you end up having this beta vortex because it’s just easier to buy the market or something close to it. And also, the demand side is also always let off the hook here, that’s why I brought it back to the retiree person and the other thing is people, advisors in particular. I try to challenge them on this, I’m like, you keep buying stuff, like if they buy a value ETF they’ll tend to buy VTV which is like not value. I mean it almost looks like…

Rodrigo:01:09:58The 98 percent beta at two percent value.

Eric:01:10:00Beta watered down. They keep buying watered down stuff when they should go and buy something that’s different, because when the market turns they’ll have that there. It’s like a soccer field, you don’t always go where the ball is, you want to have…But they don’t do it and so whether you’re an institution or an advisor or retail they keep following the vol and they keep buying things that look like beta and I think the Fed is the sort of, I don’t the word. Is like the fueling that or making it okay to do that… more shake up more often, and you’d have assets spread out more in my opinion.

Rodrigo:01:10:37The career risk of not participating in the S&P 500 right now is astronomical. So that’s why you see these people prefer, oh yeah, I’m going to call it a value fund, I’m going to say that this line item is value, even though they likely know that it’s pretty much the S&P. They’ll have a little bit of tracking error but not too much and so I think Nadig is the one that said or pushes back in the Mike Green conversation that everything is not passive. You in fact you said that true passive is only 15% I think.

Adam:01:11:0735%. 10% passive and SMAs then the rest.

Eric:01:11:15No, if indexed,

Rodrigo:01:11:19Which is what market cap indexing is what drives this theory that Mike Green has, but not everything is market cap indexing and people are actually taking their positions down because they’re actively managing it, and therefore this cycle, this self-reinforcing cycle doesn’t actually come to fruition, then it’s a problem. But having said that we now have discussed the fact that a lot of these active managers are just doing the same thing as a market cap index because they can’t. All these models try to be like…

Eric:01:11:51What you just said?

Rodrigo:01:11:53There’s something in between but I think we’re leaning more towards everybody trying to be an index, about trying to be market cap, because it’s too scary not to for your career.

Eric:01:12:02We call that the Beta Vortex.

Adam:01:12:03That’s the Beta Vortex.

Eric:01:12:06And we think the Fed powers the beta vortex and it’s nobody’s fault, everybody’s just acting and you’re right, the incentive system is you have to have it, because if you don’t have it, we looked at this. If you’re pure and God bless the pure guys, we really try to give them a lot of love because they’re walking a lonely road, but when the ball gets kicked to their side of the field they crush. So that’s why I sometimes say that things like DEEP or QVAL could be the ARK’s of their day, because when and if value comes back, they will be the shiny object in the room, but no one would have bought them ahead of time. Instead of buying VTV, if you own SPY you should buy the DEEP value one, that way when vol gets kicked there, you’re good and you get that initial spark in a diversity…

Rodrigo:01:12:49I tweeted about this today. I think there’s an opportunity here for the DEEP valley guys to finally have their decade of “I told you so”.

Adam:01:13:00Eric’s point is, if you’re going to take an active bet you want to actually take an active bet not like taking…

Rodrigo:01:13:06Like that concentrated value bet, that’s what you make the Alpha Architects Value ETF and what is it 40, 50 positions. You don’t see that in the large BlackRock value momentum ETFs.

Eric:01:13:17But the thing is that that’s where the money goes. So the demand side of the equation is definitely overlooked a lot in these conversations, but this is how consumers are shopping. I mean they’re buying, whether it’s institution or advisor, they’re going to buy stuff that looks like beta and that’s why I think when Mike points out indexes, maybe they’re at the core of this but I think it’s a bigger beta vortex.

Adam:01:13:46Okay. So now I’m tracking I wasn’t, I don’t think I was tracking what you were saying.

Eric:01:13:50My point to him is that active is part of this and I think if you were able to somehow get the Fed and rewind time, in fact I used to think that in March the Kitchen Sink Day was like Superman One, where he rewound time by flying around planet earth like at a million miles an hour, because the market went right back to where it was. It was like Superman. If you had not done that and you let the market get all jacked up and stuff dispersed, I think some of this would have taken care of itself and been less of a worry, but because the Fed comes in, and because it just means beta keeps working there, but I sometimes defend passive in that they’re a variable in this whole mix, but you’ve got the Fed, you’ve got advisors who refuse to buy pure stuff. There’s a lot of people who have their hand, you have that retiree you talked about who maybe they agree with you completely market structure, but when it comes to their kids educational fund they’re going to go cheap beta and like you said…

Rodrigo:01:14:54The Fed is fully aware of the wealth effect. They can’t allow spending to dry up and therefore they need to make sure that what people are using as expenditures which is borrowing against their stock or using their actual stocks to survive in retirement, you can’t have that go down. What was crazy about that V recovery that vortex I like that, the Beta Vortex is that what you call?

Eric:01:15:22Yeah, the Beta Vortex.

Rodrigo:01:15:23Remember when we had the… what did we call our podcast where we were like where is the market going to go?

Richard:01:15:30The Pandemic Portfolio.

Rodrigo:01:15:32The Pandemic Portfolio. We don’t know, and we’re like let’s create some narratives and the narrative for a full recovery is like, what if they come up with a vaccine tomorrow? What if Covid goes away, what if everything gets better? We are going to see a VIX recovery, we were dead wrong about the narrative, we saw VIX recovery and everything just got worse. But you know the Fed has that.

Conversational Alpha

Eric:01:15:58Did you ever hear the term conversational alpha? This is what the theme guys talk about with advisors. They’re like our theme ETF, it gives you conversational alpha. It gives tax alpha…

Rodrigo:01:16:13Come on, they say this out loud?

Adam:01:16:13Hold on, stop, drift drill into this for me Eric, just go right down the rabbit hole in this conversation. What do you mean by that?

Eric:01:16:23So conversational alpha is like advisors are always looking ways to get more engaged with their clients. So there’s tax alpha because it’s like okay I have these Vanguard funds here, but what are you doing different? Because I could go do that on my own. So it’s all about like making more value…

Rodrigo:01:16:39Taxing the one percent?

Eric:01:16:39Yes. So conversational alpha is this, and somebody I think GlobalX trademarked the term actually, and it’s like things you can talk about with your client, like hey there’s this huge trend in cyber security and they give you the numbers so you can discuss it with them. The fundamentals are here and it’s conversational alpha. To tell you guys are going crazy …

Rodrigo:01:17:03Should we end the podcast now? Eric:01:17:05I’m sorry, I didn’t make it up. I’m just a messenger. Richard:01:17:12Dave Nadig and Brian Portnoy are going crazy with this…

Adam:01:17:16Well, the problem is, it’s the truth, is terrifying here, we all know.

Eric:01:17:22It’s a lot uglier than we want to admit.

Adam:01:17:24Gartman did the same thing in the early 2000s or maybe 2000. Everyone subscribed to the Gartman Letter and then Gartman informed all the conversations that advisors had with clients and it’s compelling storytelling, it’s absolutely conversational alpha. But I do think that there is this weird tension because…

Eric:01:17:46I can tell you guys are just like your minds are blown, you don’t even know you…

Adam:01:17:51I just love that somebody tm’d this. Is there no..

Rodrigo:01:17:56No, it’s a meme that naturally occurred. The marketing team was like, I got it.

Adam:01:18:05But this is only for advisors, this conversational alpha can never leak to the end client, but we can never know this,

Richard:01:18:12But that’s about 60% on average per year man. That’s what drives flows, in that conversation with alpha.

Adam:01:18:20I hear you, I love it. I think it’s great.

Eric:01:18:22Well, BlackRock hired the chief marketing officer from BuzzFeed, so the big guys are they’re well aware you got to speak…

Rodrigo:01:18:32We’re going to hire another quant next week, now we know we got to change our strategy.

Adam:01:18:36Exactly. Brian Portnoy just … his IP attorney. They’re here you guys, he’s the guy who’s getting ahead of the trend here.

Rodrigo:01:18:47That’s right. My God.

The S&P and the Wealth Effect

Richard:01:18:49I really think Eric’s point earlier about the problem with this conversation is all about the Fed. I think that’s 99 of 100 answers to all of investment and finance questions today is Fed bashing, and I think what Rodrigo was saying about the wealth effect is a real problem because it’s become, the S&P is now the savings vehicle for the average American and so they have no exit, they’re cornered, and all they can do is keep doubling down and keep doubling down which is why eventually the printing press is going to get taken away from them either through inflation and here we are back…

Rodrigo:01:19:30Blah blah.

Richard:01:19:33Well, it could be a lot longer for sure.

Rodrigo:01:19:36But we are going to die before this ends.

Richard:01:19:39It’s quite possible.

Rodrigo:01:19:40We might have blips here and there but no, this ain’t happening. Hold a second, what is aspirational utility? Eric, have you heard of this one?

Eric:01:19:48No, but that that seems from the same brain. I don’t know it’s right up there.

Adam:01:19:54We need Vixologist on here to correct Ken Hebner and tell us what aspirational utility is.

Eric:01:20:00Whatever he is. But the point just made about the retirement, this is a good point Mike remakes, I never thought of it fully that way but, treating the stock market like the retirement of America, it does make it a much different scenario for the Fed, so that’s where you get more empathy for the Fed.

Richard:01:20:19The wealth effect, the wheels of the economy come to grind, everyone feels poor.

Eric:01:20:27The problem is, only half of people are in the stock market. So you’re purposely rewarding only half the people, so you could argue on a bigger picture that that’s not the best way to spend money, let the stock market work itself out, it will give you 10% a year if you could hang in there. You should pay your dues with the risk. Then let’s give the money to the economy in some other way.

Richard:01:20:50Which is why fiscal is coming up, as that’s prominent to…

Eric:01:20:53Yeah, the Fed acted. It’s very complicated but all of this I think affects the passive conversation and it’s all like, we wove it together and it’s hard to undo one of them.

Richard:01:21:02It’s a multi-dimensional problem. It is very hard to untangle.

Rodrigo:01:21:06Well, I like the idea Nadig says here that in the social safety net, sorry they’re outsourcing the social safety net to the S&P. I tend to agree, what they should do, every American would probably appreciate this, they should go and confiscate like Peru is doing. They should confiscate all qualified accounts, put it, take it in for the government then spend it all because they’ll just write a check at the end of the year, they don’t have to actually invest anything and then the wealth effect doesn’t matter. They just need to pay a certain check that they can devalue by inflation. That’s the solution here gentlemen. This is why no other country runs it this way. What is this qualified accountant nonsense.

Adam:01:21:47Wow. A moment of silence for Rodrigo’s capitalist libertarian roots.

Rodrigo:01:21:52It’s what’s happening in my country right now man. Remember we talked about the superannuation funds that are independent, they’re all being taken over.

Adam:01:22:00You’re allowed to grieve for the death of your libertarian roots man. I love it but it’s..

Rodrigo:01:22:04I just see it they’re only out.

Eric:01:22:08There’s that Sanford Bernstein argument like, passive is worse than Marxism, that’s a whole another level of craziness in my opinion in that the passive only owns a section of the market we’ve established that. But also, your example of Peru taking all the money and then just distributing it, what you do get in the stock market is the innovation of America, and I think that will never go away. It’s just a matter of how much that gets watered down by the Fed.

Aspiration Utility

Rodrigo:01:22:38Well there it is. We got the definition of what’s it called again? Aspiration utility, is it describes venture capital, private equity, ARK and other shiny objects. The idea of Tesla is worth this much because we are going to solve the energy problem of the world.

Adam:01:22:58I don’t think that’s what is implied there. I think what is implied is that every American had the opportunity to aspire to be Elon Musk. It’s not like, at the aspiration of the commons, it’s like the aspiration of the individual in order to be able to take on that.

Richard:01:23:17Are you equating that to the pursuit of happiness.

Rodrigo:01:23:19No. It’s exactly what Tesla has.

Adam:01:23:23Yeah, dreaming of rich, exactly. Portnoy nailed it as usual, distilled it into its true features here. So let’s not attribute everything to…

Rodrigo:01:23:39Well, let’s give my thing another name. I’m sure there’s something I can sell to the advisors, somebody in the chat come up with something.

Eric:01:23:50Yeah. You actually made me think of it when you said, what were you saying? We were discussing building a narrative. I mean sounds like you’re in the ballpark. If you’re not that far away from conversational alpha when you say that right.

Adam:01:24:07Totally, we struggle with quants all the time because the narrative of quant is the history of relationships between an x variable and a y variable which is really not very exciting, whereas the narrative of thematic is, I really think solar is going to dominate because the cost of cells, the energy rooted cost of cells relative to the carbon equivalent is accelerating and it will cross over the carbon equivalent by 2023 and at that point we’ll get singularity…

Richard:01:24:49I think it’s more dramatic Adam, it’s about saving the world, it’s about there’s too much pollution if we don’t move to clean energy the world is doomed, we all have to go into this together. It’s like is this mentality worldwide

Eric:01:25:05You’re going talk Uranium?


Rodrigo:01:25:07Did you guys hear the O’Shaughnessy podcast with Jeremy Grantham? The best 15 minutes were the last 15 minutes when he asked him, what are you excited about? Did you hear these stories? The stories about the battery that they can charge in 10 minutes and last twice as long, that are half the size, the plants that can sequester nitrogen from the air and double the amount that you can use for fertilization, the carbon credits and the secret…and indeed he talks about clean energy as nuclear power plants and doing it better. So these stories were so captivating. I mean even us as quants are not sitting there talking about the skew factor all day, we’re talking about bitcoin. I get it, I chose the wrong career.

Fundamental Stories and Themes

Eric:01:25:57Well, the other thing on that is it used to be a portfolio manager would be responsible for keeping up with these themes, okay there’s a new thing going on with nuclear energy, I’ll add a little to that. This is just essentially outsourcing it to people so they can make up their own mind, but they’re all driven. There is fundamental stories in these themes typically. If you look at their fact sheet, or if you listen to one of them talk about themes it sounds like a portfolio manager on Bloomberg TV, talking about a specific area, even the Millennial ETF which I was like this is ridiculous. But all it does, it’s not a bad idea, it’s like let’s invest in stocks that have, over 50% of their customer base is millennials. Millennials are pretty tip of the spear when it comes to new tech, it’s not a bad way to invest in the focus group or the early adopters of the consumer world, it’s done pretty well but ultimately again a lot of this is rooted in growth, but I think the themes essentially outsource the active management to the people as opposed to the manager doing it, but what he was talking about reminds me he almost probably just gave out three or four themed ETF ideas in that conversation. So they just take that idea and turn it into a whole fund.

Adam:01:27:05The challenge is that the themes themselves while interesting, if you’re not anchoring them to the price you’re paying for the companies that are channeling those themes, then you’re not investing. We all know that the most exciting themes are very highly priced and often they’re like priced well above their intrinsic value, and so there’s a reason why growth under performance value is a nice trope except that it actually hasn’t been true for 30 years. But you know there’s a reason why everyone says if you’re excited about an idea, it’s probably not a good investment because you’re not the only one who’s excited and excitement leads to higher valuations, and higher valuations leads to lower expected returns.  So, we’re in a narrative driven market right now where the story accelerates and amplifies the return but…

Richard:01:28:09That overpowers everything else.

Rodrigo:01:28:11You know what? I was thinking about like the idea of narrative and themes and how indeed value was terrible by 98, 99, when the story was the internet. Value was taken out to the woodshed and nobody wanted anything and of course it finally came when growth crashed, value crushed it. But I don’t recall anybody getting too excited about value. I do recall people getting excited about the BRICs, Brazil, Russia, India and China. The next story, the decoupling of the US to the rest of the world. Value doesn’t even get a day in the sun from a narrative perspective when it’s doing well. It’s overshadowed by the next exciting theme.

Adam:01:29:02It’s correlated with the performance of Ex-US versus US. US is basically a growth market, Ex-US is a value market. So taking a position in emerging and EV relative to US is a proxy value play.

Rodrigo:01:29:19 I don’t know if it was that or if it was like the inflationary aspect of BRIC countries and commodities…

Richard:01:29:25 China opening up to the world, binging on commodities into the emerging markets…

Rodrigo:01:29:30 It’s a completely different thing.

Adam:01:29:32I bought into that theme too. I’m just saying the value correlates with EV and emerging, so it all ends up being thematically analogous.

Rodrigo:01:29:48I’ll buy that. I’ll buy it.

Eric:01:29:50They’re playing with the names a lot. Like I said there’s a airlines hotels and cruise ships ETF, that’s interesting. Yeah it’s all in one name, it’s kind of a reopening trade also, when  everybody goes and starts partying again, but it’s possible they start messing with the names of value and you might find theme ETFs now, things that suck, or Wes will refer to his own ETF as dirt ball stocks. It’s possible that…

Rodrigo:01:30:20 Sink.

Eric:01:30:21If it works and people trust a little reverse marketing sometimes or reverse psychology. At least you’re being honest I’ll buy that, or like bargain basement or something. It’s possible value gets renamed in the next turnaround by all of the conversational alpha marketing people that have really popped up since this growth run, so they have yet to really try to relabel value, but I’m with you. The returns though were very nice for value. I was marveling at small cap value, was up a ton in the 2000s and the S&P was flat, and then if you go from the 2000 to today, small cap value is still winning. That’s how amazing that was and how much the downturn hurt the S&P. So when and if value comes back the returns will be sexy, whether it even needs a label I’m not sure. It will just be this objective …

Rodrigo:01:31:16I have an idea for an ETF company. You launch a single product, a single ETF and you call it whatever the theme is, let’s say in the beginning on the cover you call it Vaccine or something, and your theme is just vaccine. But it’s going to be like my favorite type of Netflix shows. I hate the Netflix shows that go on for 10 seasons that should have ended in season two. You don’t want vaccine to last for 10 years, you want vaccine to last for about 18 months from the moment it came up and then when it’s over you say by the way I’m going to change the ticker and the theme, you kind of redo the prospectus and then you do, I don’t know whatever the next theme is going to be 18 months from now, inflation or BRIC. You just literally say this is your chameleon ETF and I’m just going to theme the crap out of it. I think that’s gone be my next product.

Adam:01:32:06 Exactly.

Eric:01:32:10Plus once it starts humming people in it won’t care as long as it’s up and sometimes they forget they bought it. We do find that when a theme ETF has a run like the shiny object moment, let’s say it gets a billion and then it goes down a lot, I don’t know, a third of the assets will stay at least sometimes half stays.

Adam:01:32:25It’s the universal truth dude. If you can collect the assets at the beginning then you’re set because just a third of them will just forget they ever owned it, because they don’t want to actually look at the performance or they don’t want to see it…

Rodrigo:01:32:41They don’t want to crystallize their taxes.

Adam:01:32:48Yeah. Just ignoring it, is a really good strategy for …

Eric:01:32:53Sometimes I’ll look at some of these theme ETFs and I’m like I cannot believe that thing has 500 million now. They really are collecting assets. We just wrote a bit looking at, this week looking at how themes could be bigger than all Gig sectors combined. It could shake out over a growth sell-off but what the themes also do is besides stealing a little quant thunder, is they are finding this real hole in the sectors. Companies they go across too many sectors now and so themes have I think taken some of the sector, they’ve stolen some of that thunder too. I think in a way they’re disrupting a couple of systems that were embedded that weren’t able to capture this stuff as well, and because they can go across the lines. But right now the theme ETFs have 180 billion that’s bigger than any sector, tech has 150 billion.

Richard:01:33:57How big are styles because at the end of the day it just seems like themes are the closet styles and momentum and we should re-label momentum as a factor or it’s your narrative or something.

Eric:01:34:05So momentum is so under served to the risk, the academic community, respect to the assets, I’ve never seen a bigger ratio with momentum. Growth is big and I think growth probably steals some momentum assets. Growth has 200 billion, value has 200 billion. And then there’s multi-factor has about a hundred billion and then low vol might be 50 and then momentum I want to say it’s all MTUM by the way.

Richard:01:34:33Where does quality rank there?

Eric:01:34:33Quality is probably going to be, I’m going to guess 70 billion. I mean value and growth, it’s still that legacy from the 90s carrying over.

Eric:01:34:46Yeah. That meant a lot but low vol and dividend strategies, orby the way, do you guys think dividend is a factor. Don’t even go there. How about low vol, is that a true factor or is that lame?

Adam:01:35:03Min vol is a portfolio construction technique that seems to have merit, low vol is a concentrated sector bet in extremely low vol sectors.

Eric:01:35:15So low vol isn’t a factor. We should say value, momentum, size, those three we all agree. What about quality?

Adam:01:35:26Ask 10 quants and you’ll get 10 definitions.

Richard:01:35:31It’s so subjective and I think it’s used as a cloaking mechanism for people to just own what’s in vogue and not call it narrative or thematic…

Eric:01:35:40What would you say dividend, when we have dividend ETFs, what factor loading would you say they are? What are they stealing from?

Adam:01:35:47Well, it’s a deluded value factor but people that don’t understand Modigliani-Miller. If you understand that you should be agnostic about the way that companies distribute their cash flows, really is a capital structure decision and not anything to do with expected returns, that’s not. Dividend is not a thing.

Eric:01:36:15We have them in smart beta, we’re very liberal with the tent but I agree with you, when we have quants on, they’ll definitely – dividends don’t get much respect. Once in a while if an MSCI person gets up at a conference they will include dividend as the sixth factor they’re looking at but normally it’s just the five. But they do include low vol typically, but then when you talk to the real PhD type quants, they will just give you the three typically, and then quality they like you said they might be … and then that’s it. But the one, momentum of all we just talked about, all of them are healthy except momentum and quality. Only 21, 28 billion. And dividends have 225 and you just said they’re not really real. I think that also speaks to things that come out, that have a label that people can identify with.

Rodrigo:01:37:05What if dividend doesn’t have more? I remember the Dividend Achievers Index, is so intuitive for the average retail investor right?

Eric:01:37:12Well this is only ETFs, the mutual funds probably have probably a lot more

Rodrigo:01:37:19Yeah, it’s a Canadian ETF.

Eric:01:37:20That’s three percent of assets, it’s pretty good. To put that in comparison like ESG has 70 billion. So dividends have three times what ESG has. It’s 225 … especially the ETF world, it’s very hard to get assets there, so 225 to me I would call respectable, and then we have smart beta. Do you believe factors exist in fixed income?

Factors and Fixed Income

Adam:01:37:44Yeah absolutely. There’s definitely systematic factors. Actually, fixed income is the ultimate arbitrage because the construction, the benchmark is so flawed. Who in their right mind would construct an index based on the amount of debt outstanding?

Eric:01:38:03Every advisor.

Adam:01:38:05No I hear you, but it just is so silly when you see the…

Eric:01:38:08The gang is big. I remember the first book Josh Brown said, the Ag is total bullshit. It was made up by a guy who tried to sell bonds and it’s amazing how the stories of some of these things that grow so big are born in these really quirky stories, and just it gets a universe around it and it’s like he’s doing it, I’ll do it.

Adam:01:38:26It’s like buying miners based on the total square footage of tailing ponds or something. What is your total environmental footprint? It’s the strangest construction you could contrive and yet this like, 80% of total global credit and fixed income is oriented in this direction. It’s a great opportunity to outperform.

Eric:01:38:50Yeah that’s why bond managers, if they chose the right asset class, we always talk about how they were smart to pick that benchmark. That said, in March, only five percent of them or ten percent of them beat the Ag. Ag sucks until it doesn’t, when treasuries are a safe haven the Ag will crush a lot of these active funds, they’ve cheated. Honestly if the Ag doesn’t have high yield or international, is it really fair that the active fund can use those, but they do. And this is interesting to us because fixed income smart beta only has 40 billion total and some of those funds are pretty good, like at WisdomTree, they got ones that’s like Ag but they like work in some extra yield there or they’ll do one that’s like risk-weighted instead of which you guys can identify with as opposed to just weighted by market cap.

Rodrigo:01:39:40It’s the same thing for the commodity ETFs, right?

Adam:01:39:49Don’t give Jeremy shorts too much credit here, just relax.

Eric:01:39:54Aggie is pretty big. You want to know how big Aggie is? What would you guess? Answer it.

Rodrigo:01:39:58Man, I don’t even want to do. My ego is going to get hurt. Tell me.

Eric:01:40:07To guess or no?


Eric:01:40:091.1 billion which is respectable. It’s12 bips though. If you’re under 20, you got a tailwind going and it’s the Ag ,which they’re comfortable in that world, it’s not taking any extra credit risk but we think if there’s a huge sell-off like March but it goes on for six months, the beat rate of bond managers will go down so dramatically that it should open the door to the quant world more. Because it’s going to be very clear that well why are they all underperforming? Well, because they went into high yield international which the index doesn’t hold and that’s why the index is beating everybody because it never did that, and it’s going to look…the conservatism will look good. That said, they’re active, they might be able to go right into it and navigate it quicker, but this is an interesting phenomenon and brings us back to the whole conversation with everything and the Fed, it is interesting that bonds and stocks have gone up so much together for so long. The “everything up” thing also worries me as well, because sometimes you have these selloffs where everything goes down. What I remember, it was 2018, only cash was positive.

Definitions of “Active”

Rodrigo:01:41:17Well this is where I get confused when we talk about active. Our version of active is being able to short stuff. But that’s been gone for decades because how do you survive in this world? I don’t even know; I think it will be…it should be. The fact that we talk about active is if it’s just picking long only stocks is just appalling at this point, and everybody talks about it that way, but active is supposed to be tactical, go to zero, go short, that’s active and I think when the tide goes out, we’re going to recognize that we should have had more active options out there and hopefully there’ll be some more.

Eric:01:42:01Let me say one thing on that, which is that there’s this provider named AGFIQ or something, BTAL. Check and they do long/short quant strategies. They do it the real way. This is even more hardcore than Wes, but nobody cares. But when there’s a sell-off, BTAL will be the top of the charts, because they got the short position and that’s why a long sell-off I think will shift money around where this whole passive blob thing will regulate a little on its own, because there’ll be these things over here that have short positions or deep value which will start to outperform the indexes potentially and you’ll see money shift over to them. But again, we talk about this idea of, we have these little case studies of when there’s a sell-off and the stuff that is true and pure, shines. The problem is there’s this sell-off never gets to last long enough or to have a regime change.

Adam:01:43:06I never knew you were such a Fed hater dude. There’s a brotherhood man.

Rodrigo:01:43:10He needs to come out and visit us.

Eric:01:43:22Iempathize with their position though. I mean everything so like, it’s almost like everything’s too big to fail. It’s almost like somebody said once the buy side now is too big to fail. They’re going to have to bail out PIMCO and Fidelity and it just seems like because that’s where all the retirement money is.

Rodrigo:01:43:43Yeah, the Fed’s going to fail the moment I give up on my shorts and my active sense, the moment ReSolve asset managers like, that’s it we’re done, let’s just throw in the towel. S&P 500 long with a slight tilt.

Eric:01:43:53You know that guy where I live Ted Orensen, he was done, he was like, he had a value shop and he’s starting something new but, he just closed up he’s like this. Because even if it comes ripping back he was like, the track record will still suck. He did the forward prognosis and said there’s just no escape, it is pretty existential, it’s not funny. That’s a dark place to have the view from but I would blame the Fed if I wasn’t…like to me, I would point the finger at the Fed in that case because it never let the sell-off happen enough where you could have the glamour stocks sell off and then value looks good, and they never let that play out.

Adam:01:44:38Well look, this is an hour 45 minutes. I’ve now realized that we’re kindred spirits and until we can physically hug…

Eric:01:44:47Can you give me one of those? I have a ten-year-old and a four-year-old, so can you hook me up with the…

Rodrigo:01:44:52He’s got all the sizes man.

Adam:01:44:55I’ve also got the I am John Galt hook up too if you like those ones.

Eric:01:44:58Listen man, he’ll be the envy of the of the flag football team.

Adam:01:45:02No doubt. Like who’s the Fed? What are you talking about dude?

Eric:01:45:06He’s in south Philly…

Rodrigo:01:45:08You want to talk about it some “privileged to wear” for your children, when you’re working for like a few…

Eric:01:45:14… ETF on a shirt people think it’s like T-Mobile’s “eliminate transfer fees”.

Adam:01:45:26Yeah, everyone interprets it in the winning scenario for their context. That’s perfect.

Rodrigo:01:45:33Honestly this has been really fun, this is one of my favorite Riffs.

Adam:01:45:38I agree, totally it was a lot of fun.

Rodrigo:01:45:42Always enjoy our chats man.


Adam:01:45:44Hopefully we will be hiking next time we get, or if any luck we can also chat over cocktails but…

Rodrigo:01:45:50Pennsylvania in August.

Eric:01:45:52 I want to come down there and I want to go on a fishing trip.

Rodrigo:01:45:59Adam just fished last week.

Adam:01:46:01You, we already chatted about that.

Eric:01:46:04I went down there about three years ago because there’s enough terminals and a lot of the wealth managers down there will use ETFs in the US, so there was enough for a whole day or two of meetings and it was funny walking around the streets, I’m like how many trillions of dollars am I around right now? Because you know all the US corporations have all this money sitting there and you’re just like you can almost feel it. This building probably has billions

Rodrigo:01:46:32Zeros and ones emanating from the computer centers.

Eric:01:46:36Absolutely, but anyway thank you for inviting me on it was fun.

Eric:01:46:40Where are you going for dinner?

Eric:01:46:41We’re going to a place called Leviet, it’s a Americanized Vietnamese restaurant with a couple, with kids so we have a babysitter. I haven’t been out in a while to be honest, and we have certainly haven’t been on a double date hangout situation probably since the pandemic, we’ve gone out for steak dinner a couple times like just the two of us, but this is going to be fun. I’ve had my friends…

Rodrigo:01:47:07I’m going out dancing with Corey Hoffstein tonight, believe it or not.

Adam:01:47:11It’s just Rodrigo and Corey Hoffstein …

Eric:01:47:15Hold on a second, where are you physically? You’re in LA?

Rodrigo:01:47:17We’re in the Cayman islands.

Adam:01:47:19 He just moved down.

Eric:01:47:20He’s in Cayman right now? No.

Rodrigo:01:47:21He is Cayman yeah, he came in through the concierge program. He came in last week, two weeks of quarantine him and his wife, taking him out dancing with my wife, I got babysitters, I started drinking two hours ago, so I’m gone keep it going. It’s going to be a ton of fun.

Eric:01:47:34You’re going to be…

Rodrigo:01:47:37Just before anybody judges me about dancing there’s absolutely zero COVID here, there’s no mask wearing, this is a tiny island that they locked down.

Richard:01:47:45You should live cast it on twitter so there’s…

Adam:01:47:47Rodrigo can dance too.

Rodrigo:01:47:48Absolutely zero COVID people, please don’t judge. We are going to go and get sweaty and dance with a bunch of people, it’s going to be fantastic.

Eric:01:47:57That sounds so good man.

Rodrigo:01:47:59I’ll take all the pictures of Corey dancing to see. I can’t even imagine it. His wife said boogie nights, and said that Corey was coming and I said I’m in and I’m bringing two cameras.

Eric:01:48:11And is this like a straight club with techno or more of like a bar where they play like rock songs and you dance.

Rodrigo:01:48:17No, this is a legit, lights. It’s boogie night theme so 60s, 70s, and 80s. It’s a massive draw.

Eric:01:48:29It’s not like jungle house or something, okay.

Adam:01:48:31It’s literally like my 20s at university.

Rodrigo:01:48:34I tried to get Butler to come but he apparently says he’s not willing to get that drunk.

Adam:01:48:39I can’t get drunk enough at this age to function over the weekend with my family to have fun on a Friday night dancing to Pearl Jam.

Rodrigo:01:48:50Pearl Jam, that’s what your mind went to? Let me just abuse you, there will be no Pearl Jam, it’s boogie night.

Adam:01:48:57I saw the sign.

Rodrigo:01:48:59I don’t know, anything with it…

Eric:01:49:01Staying alive. They’re going to play all the stuff that makes you think like of like, it’s eight in the morning and I need to go to sleep .

Adam:01:49:16Or one in the morning, and I’ve drunk for three hours too long.

Rodrigo:01:49:20It’s going to be fantastic, you can still change your mind you’ve already started with me, we started together.

Adam:01:49:24I’ve already killed a good quarter of this bottle of … cap. I started with a good quarter of a bottle.

Rodrigo:01:49:30That was my plan all along. I’ll come pick you up at seven.

Adam:01:49:34Seven a.m., I’m in. Enjoy your Vietnamese Eric, thank you so much for everything, this has been a lot of fun.

Eric:01:49:43Enjoy the dancing.Take lots of pictures Rod. It’s fun talking, this is fun like going off the ETF reservation a little bit. Keep in touch and hopefully you guys come to Philly at all?

Adam:01:49:58Well we come to March.

Rodrigo:01:50:00We’ll come to the March.

Adam:01:50:02We come for other reasons too.

Eric:01:50:04That’s right, that’s a Philly-ish event. See you there although. I got ribbed for staying at the hotel.


Rodrigo:01:50:12That’s a no. I hadn’t got the couch last time.

Eric:01:50:15Me and Jeremy stay at the hotel and we never heard the end of it, but I think it was worth it.

Rodrigo:01:50:22Did the big bear hug you?

Eric:01:50:31Anyway, bye guys.

Rodrigo:01:50:31Love you guys.

Adam:01:50:33Have a good weekend.

Eric:01:50:35All right.

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