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Welcome to Inside Active, a podcast about active managers that goes beyond soundbites and headlines and looks deeper into their processes, challenges, and philosophies in security selection. I'm David Cohne. I lead mutual fund and active research at Bloomberg Intelligence. Today, my co-host is Athanasios Sarachanis, ETF analyst at Bloomberg Intelligence. Athan, thanks for joining me.
Yeah, man. Thanks for having me on. So, we are recording live from the Exchange conference in Las Vegas hosted by VettaFi. So, I do want to thank Todd Rosenbluth and the folks at VettaFi for having us. We are joined by our old friend Todd Sohn, chief ETF strategist at Strategas Asset Management. Todd, thanks for joining us today on this sunny day.
Hey, it's great to be with you guys.
So, this episode's going to be a little different than our typical Inside Active. I'm going to actually ask you both questions as opposed to Athan and I kind of going back and forth. And so, I want to kind of get the current state of active ETFs. And then at the end, we'll do a lightning round. So, Todd, let's start with you. What flow has surprised you most this year?
So, to start, in active, you're at 12% of assets and 40% of your year-to-date flows. I don't know if any category specifically surprises me, but it's the balance, right? Year-to-date, or really trailing year, 420 billion to equity, 388 to fixed income, and 207 billion to option income. So, right? So, this is everywhere. This is not just cornered into one area. I think the breadth of it is really impressive.
Where do you aggregate? Yeah, I mean, I kind of agree with Todd. Nothing really sticks out. So, like, you're seeing flows into international, emerging markets. VXUS, that's passive, but like AVEM has taken in quite a bit of money, you know, some of the option overlays. So, honestly, I don't think there's anything that shocking in active. I know this is not a debate with Todd, but I kind of agree that there's not really anything that stands out. What about anything that should be getting flows, but isn't?
Oh. You know, I would love to see more to active small cap because small cap indices are flooded, right? Russell 2000, which I think we all refer to, what is it? 40% unprofitable? Zombie companies galore. And yeah, there's moments in market regimes where you will actually want Russell 2000 exposure, right? You want to go out and buy junk. But as the cycles mature and the credit backdrop changes, I like having an active manager at the wheel to find those companies that eventually grow up and graduate to the bigger indices. So I would like to see more activity down there.
Okay. So I'll start you again, Todd. What's overhyped right now in active ETFs?
What's overhyped? Ooh, I don't... We're sitting in front of a live batch of people here at Exchange, which I'm not even sure if I might get in trouble here. So there's two areas. I think it's derivative-based stuff, right? I think it's fascinating that in the last three years option income ETFs have taken in more than dividend ETFs. So the way investors are getting income has changed. Does that mean it's overhyped? I think certain segments of it are, right? Single stock income ETFs I think are overhyped and there's a lot of issues in terms of the tax front. And then I don't know, buffers... I don't know. Buffers, depending on who I'm talking to, strike a chord. Some people love them and some people are like, I don't get it. And they're an $80 billion category and they're a little complex for me and I'm wondering how much more ceiling there is. I get it that they're coming from the structured outcome space and that's a big area. But I don't know. I think there's so many other alternatives now in the income space and the downside protection space that I wonder if maybe that's the overhyped area.
Yeah, I think with overhyped, I know the leverage stuff that counts as active, that for sure, because you see all these filings coming out. It's companies that already have an ETF on them. So I don't really get what the advantage is there. Like, why are you launching another 2x Tesla ETF that exists out there already? So unless you're literally competing on price point, but I don't even know if that's even a big advantage in something like single stock leverage. Buffers, too, I think are a little bit overhyped. Not the strategy, but the number of products that are out there. That's definitely, it's getting really kind of saturated product-wise.
The buffers are the minions of the ETF industry. The little yellow guys, right? There's like a thousand of them, and there's no difference.
So, this is more marketing than flows, you think, in terms of...
It's such an easy message for an advisor, and I get it, right? And it makes sense, especially if you are an older generation, you're close to retirement, you're scared of an '87 moment, right? Or you're about to buy a house or a boat, you want the downside protection.
Okay. Yeah, I agree with Todd. They're like really easy to sell, kind of taking the place of low vol, maybe even eating some of your bond exposure. So, like I said, at least you know your outcome, right? There's no surprises. And whether or not they're efficient, that's like another debate, but I get why investors want to use these.
So, Athan, I'm going to start with you on this one. Are we in a golden age of active ETFs or just a hot streak?
Oh, man. I mean, this is great. We do have more active ETFs than passive. Again, that includes all the definitions. It's not just like alpha-seeking stock pickers. Probably. I think golden age, I think when, you know, with the ETF rule making active more conducive and easier, cutting costs down, not having to pay an index provider, things like that. I think it's definitely going to be, you know, opening the door for more active. Then you have share classes coming, too. Again, another big floodgate opening for active. Golden age assets and flows, I don't know, but products, probably. Like, this is probably the start of just a massive influx of more active.
I think it's got to be golden age, right? And the backdrop for me, right? I agree with everything you're saying. You got share classes, you have conversions. Everyone is coming into the pool now because they realize that's where the flows are going, right? ETFs treat money better, largely speaking, than mutual funds. But the other angle of this is we are in an environment where, and I know everyone probably doesn't like this topic, 10 stocks make up 40% of the S&P 500. If you own large cap blend, if you own large cap growth, if you own quality, momentum, you're all in the same stocks, right? So, this is where active, and depending on if it's large cap, mid cap, small cap, international, right? Having a hand at the wheel to at least differentiate or diversify portfolios. I think that's so important and as much as the concentration might be coming off a boil, it could come right back in a given environment. So, I don't see it slowing down. This is literally everyone is in the pool here in Vegas.
But if the regime changes, like say we see less volatility, could the momentum fade a little bit?
You'd probably see it slow down. Like I wonder if that 40% of year-to-date flows number goes down to 30%. But I think there's a floor now in the 25% area, right? Whatever the number is. I think there's a floor on flows. And we just have to figure out what the ceiling is.
Okay, so Todd, I'm going to start with you on this. What active ETF changed the game? Is it ARKK, JEPI?
It's a good question. It has to be ARKK because they were the first one to say, 'Hey, we're going to show you, we're literally going to email you our trades every single night. We're going to be transparent about our holdings.' And they proved to you that an active equity fund can work in the ETF manner. And this was before the ETF rule and all that. I think it has to be them and then once JPMorgan had premium income come out, they showed that hey, derivatives in ETFs in an active manner are also going to be important because people want income. They want downside protection. They want leverage. All that. So that would be the second leg of changing the game.
I mean, ARK is a good one. That's probably the best pick, honestly, because then it kind of completely dismantled like semi-nontransparent ETFs and all that. All that model then just became like obsolete when, you know, Cathie was out there putting her holdings daily. But I'd say if I had to pick another one, I think that whole buffer category, not change the game, but it created a brand new category, which I think is so rare to see in ETFs. So there's very little white space. So to have a new product come out and literally create a brand new category that became really successful, I think that was a big game changer. And I think that just feeds into what Todd was saying, is just the ability to put derivatives in ETFs. I think that was definitely a big, whether you want to define that as active, but that definitely will, you know, change the game a lot.
Okay. Athan, if you were CEO of an issuer, and you could launch your own active ETF tomorrow, what would it be? Todd, that's a scary thought.
Yeah. You know, 3X, no. Okay, just depending on seeing where the market is now and when there's white space, I'd probably try to crack private equity. Like, you know, I'd probably work on something there. Just because, you know, like we mentioned, there's more active ETFs than passive. I don't want to go into buffers. It's probably really competitive. Option overlay and the covered calls, that is that. So I think private equity, if you can get a jump on it and get into that category pretty early, I think that could be a game-changing ETF. Like we mentioned, similar to ARK. So I'd probably be trying to focus in that space. What would you launch, Athan?
If it's already launched, is that a problem?
I'd put on my Strategas hat. I'm just going to copy somebody. Strategas Macro Thematic Opportunities ETF. Thematic diversification, right? That's what I would launch. It is live. Not to be the promo here, but it takes thematic funds and it puts them all in one fund together rather than taking the single theme risk. Okay. So, that's what I would launch even though it is live. I stand by that. If Strategas did not exist, what would I do? I would do something in the derivative space because there's still a lot of opportunity there and it fits both channels, retail and institutional, right? Retail loves income. The institutions want to know how to hedge, how to protect.
Okay. Do you think active ETFs are competing more with mutual funds or passive ETFs right now? Athan, you go first.
Oh, man. I think both. Yeah, I mean, I think it's just still the same argument like active versus passive, but now it's just all being moved over into the ETF. So, yeah, I think it's competing with everyone. Passive for sure. I think I don't know if it's a head-to-head competition. I think it's just evolving to live alongside passive, right? So, a lot of the active stuff we're talking about, you know, buffers or single stock leverage, that's not going to be a core position, right? Sort of like a satellite position alongside passive. So, I think that's how they're sort of learning to live. And then yeah, it's just this is all just the, you know, the money moving over from mutual funds into ETFs. So, you're kind of competing with everything. And then also I think the thing to mention is obviously ETF trading is so high even though it's a passive vehicle, right? People are just constantly trading these passive ETFs. I think in a way that's active, too, right? So, they're also maybe kind of competing on that level, but yeah, I think in ETFs, everyone's competing with everyone all the time.
That's fair enough. Okay. I agree with Athanasios. I do lean though towards the passive, right? Because we know largely speaking all the money that's coming out of active equity mutual funds is probably going to passive. That's been a function of 0% interest rates in the last decade and some other market mechanics. So now you have to negotiate with an advisor, you know, you have your core, but you should consider this active as either a replacement or a complement. Like you need to get the dollars away from the core now, which is largely passive, into active. So for me, I think if I'm really choosing one, it's the passive index funds because they're too good of a deal.
Okay. But if we single out just, you know, if we've got traditional active, which is security selection versus now the new active, which is defined outcome, leverage, and things like that. Do you think there's any movement with the traditional styles in the active ETFs kind of taking away from passive at all or just more of a complement?
I think it varies on where you are. Honestly, like we could do a tour around this conference. And some people say, well, I don't like passive because it's skewed. Some people are like, I don't like active because sometimes I don't trust the managers, you know? I think with a lot of the stuff that's come out, it's sort of like switched. Before it was like, if we mentioned Cathie Wood, you would invest in a fund, you're investing in the stock pickers, right? But I think a lot of the ETFs have made you the stock pickers. They're sort of like replacing all of that traditional stock picking and you're doing it yourself. So that's why I think some of the successful active stuff is not that stock picking security selection active. It's the derivatives, it's the leverage, it's the kind of that stuff. So I think in a way you've stopped subbing out that stock picking ability and just investors are doing it themselves.
But on the fixed income side, you still see a role?
Fixed income active, it's because it's active, you know, you follow mutual fund flows closely, like active fixed income mutual fund is still doing all right. And yet there is a massive amount of active fixed income ETFs. And they're doing well, too, but it seems like both sides of the industry are winning there. Right? That's a little unique.
Yeah, it's a good point. They've been pretty safe, right? Bond managers in mutual funds from the, you know, competitive intrusion of ETFs, for sure. What part of the active ETF story hasn't played out yet? So I hope you can answer this question.
