Matt Hougan, Chairman, InsideETFs, and Dave Nadig, Managing Director, ETF.com joined us at the InsideETFs Canada conference in Montreal to talk about what they say is the next trillion dollar opportunity in financial markets. The discussion might surprise you.
[backc url='https://sendy.advisoranalyst.com/w/J8pxsj3OgR4yxKxsA1169Q']Transcript:
Pierre Daillie: Joining us right now are Matt Hougan chairman of InsideETFs, and Dave Nadig, managing director of ETF.com
Gentlemen, It's really great to be with you again thanks for having us we had a great time last year.
Dave Nadig: Yeah!
PD: Second InsideETFs Canada.
I was expecting you to be in a Tom Wolfe white suit, and Dave, all in black, with a black T-shirt.
So this year you're here to talk about personalization.
DN: Yeah
PD: You think that's the next trillion-dollar opportunity.
What exactly do you mean when you refer to mass personalization?
DN: Well really what we're talking about is instead of putting all your investments in some sort of package, whether that's an ETF or a mutual fund, or even an insurance product, we're talking about directly owning all the individual securities. Now that just sounds like owning a brokerage account, but what we're talking about is using technology so that I can own thousands of securities with the click of a button, or with one conversation with an advisor, and achieve many of the same things I get with ETFs but with my own values represented in the stocks that I'm holding with my own employment situation taken into account.
Maybe I work at Apple and I don't want anymore Apple.
If I buy the S&P500 I'm gonna get a lot of Apple, whereas customization or direct indexing really solves that problem.
PD: This is a situation where basically people are creating their own indices their own personal index, like having your own ETF?
Matt Hougan: More or less like that it's a portfolio built specifically for you.
So one of the wonderful things ETFs have done compared to mutual funds and what came before them, they've made it extremely efficient for everyone to own the same portfolio.
Your values and my values are not exactly the same. Your work situation in my work situation right not exactly the same.
What if I could take this sort of core portfolio and tweak it just so it fits your exact situation.
That used to be impossible but technology has made it easy.
Now we've seen direct indexing be available for institutional investors for years maybe decades, but technology has now made it available for individual investors with a hundred thousand dollars or ten thousand or fifteen thousand dollars to invest.
It's really brought down that scale. So why have a mass stock solution when you can have something just customized explicitly for you.
PD: So how does that happen, I mean the technology exists surely, does it work on a blockchain platform?
DN: The implementation of this can actually be as simple as you know, I have a TV brokerage account, and I'm working with you as my advisor, and you're, in turn, working with a software provider effectively who has access to trade my account based on the conversation you and I have.
So maybe I'm owning the S&P500 or even the MSCI Acqui, owning you know thousands and thousands of stocks, but you and I have agreed , for example, that I'm going to minimize my fossil fuel footprint.
You take those 3,000 stocks with software; you remove those sort of worst offenders, and then those trades just get put in ā sometimes with fractional shares ā into my account.
So it's not it's not a lot of work for the individual investor. It requires some technology, and it requires generally an advisor who's willing to work with you.
MH: I think that's really important. I actually think it does require an advisor. I'm sure we'll see direct-to-consumer startups with this, but the the underlying technology, and the optimization is relatively complex, and this is really a conversation an advisor can walk you through. You get a portfolio that reflects your values but doesn't stray so far from the market, that you won't end up with the returns you need to meet your retirement goals and other goals.
So I do think it's actually a boon for the adviser.
DN: Yeah and I think that you know as advisors are looking towards increased competition from Robo-advisors, sometimes directly from the issuers who're putting together, sort of, balanced funds, or model portfolios, cutting the advisor out.
This gives an advisor a leg up. It gives them something else to talk about in that conversation, and it's something I think is actually really important for a lot of investors.
PD: Yeah it's definitely a value-added proposition for advisors, and I got a question for you.
So how does this differ from, let's say I work at Apple, I have a huge amount of stock options and I'm totally because I'm there, I'm stuck in those, but I don't want to own them, like you said, in my outside portfolio.
How is that any different than then the old school, "I have an advisor, we bought this basket of these you know these stock selections, how different is it from that?
Superficially it sounds very similar.
DN: and superficially it is similar. The difference is we're talking about starting from a position of indexing in quantitative finance. So you're not starting with a blank slate working with your advisor saying, "hey you know what I think Netflix is gonna do real well let's buy a bunch of that."
You're starting with the S&P500. We're talking about licensed indexes, like a factor models, licensed ESG data sources, that help you figure out which of those fossil fuel stocks (for example) you may not want, and you start from that position of a rigorous academically justifiable portfolio, and all you're doing is making those tweaks that make it personal.
PD: You're either eliminating or adding themes or SRI or ESG...
MH: Yeah but you're also doing it at scale. Like Dave used to be able to go to Savile Row and pay $5,000 to get a suit custom tied for him by individual. I mean look at him, he's as dapper as can be, right, but now you can get that mass-produced. This is the same idea. So it has all the same sort of hand touched elements, it's just now you can do it mass-produced, with an Amazon Cloud server for very cheap.
And that's the other piece of it that differs.
DN: Yeah, and that old brokerage relationship that you're talking about. Whether you knew it or not that you were paying with several percent a year, right?
We're talking about things that are, all in, going to be as cheap, if not cheaper than ETFs right, so we're capturing all those economies of scale from the ETF industry, but then adding a layer of personalization without adding any cost.
PD: So the real benefit here is scale without the cost?
MH: Yes that's right?
PD: And you see this as... is it already happening or is it something that is emerging?
DN: Definitely already happening. There are dozens of firms already doing this. Several of them in Canada already; you're seeing the asset levels (minimums) pushed down or the account levels pushed down, so, historically if you had a hundred million dollars, anybody would do this for you right? Because you're an institution. If you had a million dollars, well that might be tricky and there are firms that will do this now for a million-dollar account.
We're seeing that come down to the hundred thousand dollar account level.
That starts to be a real mass-affluent product.
MH: To put to put numbers on it in the US the leading firm is called Parametric.
They're part of Eaton Vance. They have over a hundred billion dollars in direct indexed assets.
Last year they pulled in ten billion dollars in net inflows, whereas the rest of Eaton Vance, giant mutual fund company, pulled in six billion dollars.
So it is already big, it is already managing hundreds of billions of dollars, and as Dave said what's happened now, this has expanded internationally and it's moved down the tier from the extraordinarily wealthy, you know, to to regular investors.
You know you guys are both from the ETF world. How does the ETF industry view this disruptive thing?
DN: Depends on what part of the industry you're in. Right now, if you were somebody with strong investment intellectual property ā an MSCI, a FTSE Russell, an S&P500, you're fine. You know, those IPS are still really important to this process.
If you're an issuer that doesn't have a lot of unique IP, and has licensed all that out, and your main focus is manufacturing, you're gonna be in a little bit of trouble.
MH: Yeah, all that said, this is mostly limited to developed market equities. This is a lot harder to do in the bond space, and maybe impossible, it's a lot harder to do in emerging markets. So if you're existing outside of developed market equities, I think you're pretty insulated from this trend.
But if you're in developed market equities, I think this is going to become a very big deal over the next five years. It's already becoming a big deal, it's just going to accelerate. Doesn't mean the ETF markets going away. ETFs will always have an incredible place for traders, portfolio managers, and for a big chunk of most people's portfolios.
PD: So now let's circle back to ETFs. you guys haven't left the industry.
MH, DN: No, no, we're not planning on it (laughing)...
So what's happening? What do you see that's happening in the ETF space that you find exciting?
DN: Well, so I mean, I think we're in the second act of the smart beta revolution. We've had a couple great panels here at this conference, already. I think people are starting to ask much smarter questions about Smart Beta; they're not just trusting that all these black boxes work. They're asking how they work, why they work, will they work in the future, what will make this value approach work in certain markets and not others?
Those are the right questions. So it's exciting to see these sort of next-generation products matching up with sort of next-generation understanding from the adviser community.
MH: Yeah I think that's right. Also here in Canada, of course, we're seeing a massive swing in flows. 2018 was the first year the Canadian ETF flows outpaced Canadian mutual fund flows.
Dave and I think that Canadian mutual fund flows will never again outpace Canadian ETF flows.
We've made the switch, and now we're we're in a tipping point, we're in an ETF focused market, and I think that's really important so just growth.
The other thing to add on to the smart beta space, the two other areas I'm really excited about:
I think there's huge growth coming bond ETFs. I think that places is massively under-penetrated ā eventually it will become bigger than equity ETFs and you're starting to see life even in the alternative space; more interesting option to overlay strategies, and I think if the market takes a turn downward, I think you'll see real flows into alternative ETFs as well.
DN: Actually I think this is a market where Canada has consistently led the way. Canadian ETF investors have options in true long-short alternative market neutral strategies, you've got options.
So there are tools that the Canadian investor has in the ETF market, that the US investor would die to have.
I think you'll see those strategies grow here and I think you'll see that infect the rest of the world's markets as regulators catch on
MH: Yeah
PD: Gentlemen, such a pleasure to talk to you again
MH, DN: Yeah, thank you for having us!
