Daniel Straus: 2022 ETF Market Review and Macro Landscape

[00:00:01] Pierre Daillie: Hello, and welcome to Raise Your Average. I’m Pierre Daillie, managing editor of AdvisorAnalyst.com. My co-hosts are Mike Philbrick and Adam Butler, Principles At ReSolve Asset Management Global. Today we’re gonna be talking all about the Canadian ETF landscape, the North American ETF landscape where the hotspots are, where each ETF flows are coming to and going from.

Our very special guest is Daniel Straus, the head of National Bank Financials ETF Research and Strategy Group, which focuses on providing both institutional and retail investors with value add, and actionable investment research relating to exchange traded funds. His group regularly publishes street leading reports on the ETF landscape in Canada and the US, including theme pieces, flow reports, model portfolios, trade ideas and strategy reports.

Their ETF research has been regularly featured in media outlets such as BNN, National Post, Bloomberg, Laissez-Faire and the Global Mail. He joined National Bank’s ETF Research Group as a research associate in 2010 and was promoted to director in 2020. He holds a bachelor’s degree in applied science and engineering from the UFT, a PhD in engineering from Brown and a master of finance degree from the Schulich School of Business.

[00:01:21] Disclaimer/Announcement: The views and opinions expressed in this broadcast are those of the individual guests and do not necessarily reflect the official policy or position of AdvisorAnalyst.com or of our guests. This broadcast is meant to be for informational purposes only. Nothing discussed in this broadcast is intended to be considered as advice.

[00:01:45] Pierre Daillie: Daniel, welcome to the show. It’s great to have you.

[00:01:49] Daniel Straus: Thanks for having me. I’m happy to be here.

So

[00:01:51] Pierre Daillie: Daniel,

[00:01:54] Adam Butler: Brown, eh?

Hold on. We should press pause for a second.

[laughs]

Sure.

Mike’s gonna wanna interrogate you and your experience at Brown, right?

[laughs]

That’s right.

[00:02:04] Pierre Daillie: Go for it [laughs].

[00:02:06] Daniel Straus: I will wait for that. Let’s go with the flow.

We can, [crosstalk 00:02:08] we can do it live.

That’s all right.

Okay. Okay.

[00:02:10] Pierre Daillie: Okay.

So we’re gonna, we’re gonna get to that anyway. Daniel, tell us about your background-

Okay-

… Or, and how, or why rather did you decide to get into the financial business after your doctorate in engineering?

[00:02:23] Daniel Straus: Sure. Yeah. Thank you, Pierre. As as you could tell from my biography I love school. I was a professional student for a very long time. I love school so much that I like to tell people that the third grade was the best two years of my life. I did repeat the third grade as I switched from one private school to another. But ev- eventually I I went into science because I always wanted to be a scientist.

I love science. I love math. I love technology. I love science fiction, all that geeky stuff, which maybe we’ll get a chance to talk about at the end. I don’t know. But I went into engineering in, I’ll… Roughly the turn of the millennium thinking to myself that, “Who knows? In the 2000s when I graduate the tech industry will be booming and I’ll be able to find a job very easily and quickly.”

And that was 2002, right? It was the collapse of the NASDAQ bubble. Canada’s largest employer of engineers, at the time, Nortel, went from being an enormous weight in the TSX to basically hiring zero engineers this summer that I was graduating from regularly hiring over 100. And then I said to myself, I still really love knowledge, science, math. I’m very curious. Let me do the grad school thing and continue in a PhD program.”

And by the time I graduate from that in, 2008 or nine after six or seven years, the global economy will be booming. It’ll be wonderful. It’ll be fantastic, so sure enough, I I surfaced from my submarine after defending my PhD thesis, which is on the subject of carbon nanotubes. In fact, it was called The Highly Ordered Carbon Nanotube Array and Its Hetero Junction with Silicon: Infrared Investigations. And it didn’t work basically, th- yeah.

But like a lot of grad school projects, it was it was a lot of fun. But when I finally did resurface, I noticed that the world seemed to be collapsing all around me. That’s at least what the newspaper headline said. And, again, nobody was hiring. I was looking for work in working either for government research or industrial stuff.

I didn’t really wanna do the kind of post talk track, which is a kind of revolving door of going from one school to another looking for professional academic positions. And I always had a hobby interest in business and economics, and sure enough, and, at the peak of the 2008 or nine financial crisis, one glance at the headlines and I realized very quickly, I need to know about this or I’m gonna have the world pull over my, [laughs] my eyes by the kind of financial machine and infrastructure, which really seems to make the world go round.

When we were studying engineering at UofT, we have a little little expression. I think a lot of the engineers put it on their jacket. It s- says ERTW. It says engineers rule the world. I don’t know if they know about the banking industry or the finance complex when they’re sewing that onto their jackets. I realized it’s something I need to learn more about. Why not do more school?

[laughs]

I didn’t wanna do an MBA by that point. I was saturated. I didn’t really want another two years. So I found a one year program, a master of finance, which is a lot of the same material. It covers a lot of the same material as the CFA. And to me, it really was a literal crash course in, financial analysis, macroeconomics, accounting, which I had never seen before. Maybe very little exposure simply as a hobbyist.

And that was a true eye opening and awakening for me. And I was very fortunate from there to go directly into learning about ETFs. One of my mentors at the program Pauline Chum, professor Pauline Shum did a lot of research in ETFs. And it was something that I realized, “This is a very cool toy. It’s a very cool technology. It gives you exposure to almost anything. It’s incredibly efficient, and it really drives costs down to the bone, passing on benefits to end investors.”

I really thought of it as unique in the world of finance as something that really does help the little guy. So I started to study it more. And it was that process, which probably gave me a little leg up when I went to interview with National Bank and, in the subject of derivatives and financial products. I thought what I would need to learn going into the interview was I needed to know my binomial trees and my option valuation because we’d be analyzing structured products and Himalayan notes and baskets and things like that.

I was very excited I was getting my modeling skills already. And the first question I received was what do you know about ETFs? Because sure enough, the previous set of research Pat Keflo, who now who went on to head at BlackRock and is now with Invesco, he started up the ETF research operation at National Bank in the aftermath of the financial crisis because so many new questions were coming in regarding ETFs.

So that’s how National Bank got its kind of toehold in the world of ETF research. National was already very much involved in ETF structuring and market making, but the research component was a very natural add-on. And I was brought in to be an associate. And now it’s, we’re almost 12 years later.

And I still feel like I’m learning. I still feel every single day there’s new facts in the marketplace that give me that kind of head spinning feeling that I s- that I got when I, like I said, opened my submarine hatch from where I was stand- my PhD dissertation and started looking at the headlines of a financial world in total disarray, the, we’ve through some boom bust cycle since then. And I’m, I still y- every day bedazzled.

[00:07:47] Mike Philbrick: I have a new market indicator now. And I just,,, I have one question and we can call it quits. Are you enrolled in or completing another degree at this time?

[laughs]

[00:07:57] Daniel Straus: If the ETF research thing doesn’t pan out, if it doesn’t pan out, I, I will go back to school and maybe get a PhD in finance so that people can-

[crosstalk

[00:08:04] Mike Philbrick: 00:08:03] Oh, God. Could you tell me when you go, when you make… ‘Cause that’ll be it. That’ll be the- Yeah.

[00:08:06] Daniel Straus: [laughs] [laughs]

That’s right. I would love to be able to, publish academic papers on some of the stuff that we that we research on here at National. But maybe one day as a retirement project I’ll do that.

[00:08:20] Pierre Daillie: Daniel, has it been useful? Has your your engineering and mathematics background, has that been useful in terms of your

[00:08:28] Daniel Straus: analysis?

That’s a great question. There are a lot of ways to answer it. That… I’ve learned as well in the world of finance that intangibles are very valuable, right? In fact in this kind of new economy that we are in, the intangible assets on a balance sheet may in fact be the entire bedrock on which our modern financial system of technology and intellectual property is built upon, right?

And I would say that I’m not designing bridges. I’m not designing circuits or anything like that or even doing, low temperature experiments in a vacuum on carbon nanotubes in my day to day. But the intangible benefits of an engineering degree, I certainly do use, the kind of, there’s a certain level of responsibility that comes from being trained as a Canadian engineer. It’s in fact why we wear an iron ring. And I have mine on right now. It’s more of a signal on the trading floor where there’s a few of us who who went through the ringer of Canadian engineering degrees. And we give each other this little kind of nod as we pass each other on the trading floor. This isn’t the before time.

So virtually it’s hard to do that, right? But but that kind of constant level of checking your work, that level of rigor of c- of being evidence based and relying on data, that’s something that I bring, that we I would hope I bring to the workplace, and I also feel very fortunate to be part of an amazing team with a diversity of backgrounds, I head up a team of four full-time analysts and associates at National Bank who we are just looking at the ETF market all day, every day. And we’re not all engineers, one of us has a background in economics, the other in computer science and financial mathematics. It takes a little bit of everything because, ETFs can represent any asset class under the sun almost as we’ve seen.

And you really do need to be a financial jack of all trades to to be able to analyze them. And the engineering component I would say is the least useful thing ma- maybe that I bring to the table on, on a day to day basis. Because, database management, programming, Python, statistics that is far more valuable [laughs] I would say. But in- intangibly I look back at the program that I went through at UofT Engineering Science and and I think, after having gone through that ringer, that kind of pressure cooker you can handle anything that Bay Street or Wall Street will throw at you.

So over

[00:11:05] Mike Philbrick: the 12 year span that you’ve been probably one of the first full blown ETF research desks-

Yeah-

… in in Canada and if not North America, what have been some of the changes that you’ve observed in the ETF technology over the last decade?

[00:11:24] Daniel Straus: Sure. One of the big changes we saw, I think that for the first I would say half of my career, for the first several years, ETFs were very much synonymous with passive index investing. So synonymous in fact that sometimes certain brands were synonymous with ETFs, right? Maybe I’ll name one now. Some people would say, “I want an iShares that gives me oil.

There, there was a there was a level of of education that we had to do. And the synonymity of ETFs with passive was and with ultra low cost was something that I think was accurate at first. But now as the ETF complex is swallowing up the entire rest of the asset management industry, we’re still in the early stages for that. It still has relatively low market share relative to mutual funds and other forms of direct investment.

A lot of the early markers of ETFs being low cost, being passive, being highly diversified, being very liquid. Those are the reasons we love ETFs. And we have an entire suite of an analytical s- tools to assign metrics to each of those qualities. We’re finding it’s not necessarily the case that all ETFs have those features. You don’t need to have those features to have an ETF.

There are ETFs now for senior loans, there’s ETFs for crypto as there are ETFs for all sorts of overseas assets. And I think we may one day see ETFs for all very exotic and strange kind of combinations of derivatives and crypto assets. who knows? But the kind of, there, there’s something of a holdover of ETFs as having those kind of boy scout attributes that gives the kind of modern ETF complex that… A kind of lingering halo effect which I don’t know if it’s entirely deserved. And and I think that culturally, there are some shifts that are yet to come.

[00:13:18] Mike Philbrick: Speak to those.

Yeah.

What would you think the, so you’ve seen a great deal of shifts over the last decade. What do you think are the shifts that, that might be brewing under the surface and about to bubble up?

[00:13:29] Daniel Straus: Yeah. Okay. So the… Lot of ways to attack that. So let’s let’s talk about what ETFs were when they were new, right? They were anointed as the kind of next great frontier of asset management. They were going to kill the mutual fund. They were going to kill active management. And now people have started to question, what’s the ETF killer, right? What’s the…

Do you remember when the iPod came out, it very quickly became the the kind of be all, end all go-to vehicle for MP3 listening, right? Bec- And MP3s had killed the record industry. And then absolutely every single new MP3 player that came out there’d be breathless headlines that asked the question, is this gonna be the iPod killer? Is this phone gonna be the iPhone killer, right?”

I think ETFs are now in the gun sites [laughs] of the asset management industry. And a lot of people are asking, “What’s going to be the ETF killer?” And already you, I believe maybe some of your guests have even attempted to address this question. I’ve heard direct indexing for instance be a possible way to do it. But in, in our view, direct indexing is a kind of new technological dressing.

Perhaps a new very sophisticated algorithm dressing for an older technology, which is SMAs, right? Which have always existed now. They have their pros and cons. And in fact some of them for some clients may indeed be superior to ETFs. We’re not married to ETFs. And I think that coming down the pike, there might be a form of cheap and easy delivery of SMAs, which for some investors, not all, it may in fact be an ETF killer.

Then… A- Another possibility is who knows if the digital asset revolution really does take root in a kind of very comprehensive way with regulatory clarity and all the amazing innovations that you’re seeing happen on, on, in the world of crypto exchanges, for instance, become absorbed into the world of of equity and bond trading even, in terms of transparency and instantaneous settlement and all that algorithm, automated trade settling.

Perhaps in the future there will be digital baskets. There, there will be some kind of like smart contract form of bundling whole portfolios and asset management styles. And maybe that will kill the ETF. But I think that’s a long ways off. And I… That’s like predicting self-driving cars. When is that going to happen, right? It’s like a lot of I think innovations will have to occur in the world of software and artificial intelligence before we start to see major threats ha- occur in the world of ETFs. That’s me putting a little bit of my kind of pie in the sky prognosticator hat on. I still think that we are in the kind of very kind of smooth elbow of the hockey stick growing up in terms of ETF adoption.

And in the ne- near term, three to five years I don’t see anything threatening the kind of dominance of ETFs and the mind share of especially new young investors. Because they are so cheap, easy, convenient for the most

[00:16:32] Mike Philbrick: part.

Any thought… Just what… F- the taxation, Yeah. [affirmative].

… The sort of unevenness of taxation in the US-

Yeah-

… which may or may not be addressed at some point in the future.

Yeah.

[00:16:42] Mike Philbrick: Do you think that plays a role in there at all?

[00:16:44] Daniel Straus: I do. Mike, yeah, l- just a little bit of background in, in case listeners aren’t familiar. You often hear when you’re gi- given the long laundry list of what makes ETF so wonderful tax efficiency on the list. And I don’t know if we play back the tape if I said that, right? I said the ultra loan cost they’re highly liquid very diversified high performing and tax efficient, right?

That’s often added to the list of the kind of boy scout attributes that ETFs have. And certainly amongst my US based ETF analy- anal- analyst counterparts they will list that attribute as one of the chief selling points for ETFs. And in the United States, it’s true. They do have this almost unfair advantage via the in-kind redemption mechanism to ratchet up cost based internally because of their law accounting method, right?

In Canada, we don’t have that. In Canada ETFs are much more similar to mutual funds and have to do average cost based accounting. They can do other little tricks with proxy securities and so on. And by and large, a passive strategy, which is market cap waited a- already has very low turnover. So there won’t be necessarily tax events coming from, new additions of, to the portfolio and dispositions on a routine basis if you’re in a cap waited index.

But the playing field is not the same. ETFs in the US do have this tax advantage. I wouldn’t call it un- unfair advantage. And if I could back up a little bit, back peddle a little bit.

Yeah.

It’s not really an unfair advantage. It is an advantage. But what’s really unfair is the way mutual fund taxation works. The way that the tax bill is delivered once a year, and if you are a mutual fund long-term unit holder, you have to bear the tax burden for all these entrance and exits that occur over the course of your holding period, which have nothing to do with you, right? That’s a little unfair.

So if anything, perhaps there’ll be some kind of amendment to tax codes in the US where the mutual fund industry will be able to pass along some kind of like nav or price based, cost based tax treatment to their investors so that they can be on equal footing with ETFs. I don’t know if that’ll ever happen. In fact, it’s more likely that it will happen when the Vanguard patent expires in 2023 and many mutual fund companies will be able to list ETF shares on th- in exchange.

And then we’ll be able to engage in these heartbeat trades so that they can wash out tax gains exactly the way Vanguard and other companies can do it if they have, multiple shared classes. And now we’re getting deep into the weeds into the kind of plumbing of how ETFs operate and where their and advantages come from. But it’s a very good question.

I think that it’s something we do think about it’s something that we’re monitoring. And and I think that tax advantage is why the US ETF market is in fact twice as big on a pre- on a representational basis as Canada’s, right? In fact, more than twice as big. Now, the US ETF market is 7 trillion USD. In the AUM that’s 7 trillion. Trillion with a T, right?

It’s a very big number. In Canada, the AUM is something like 320, 350 billion Canadian, right? So less than one 20th the value. Even though everything in the US generally is about 10 times the size. So there is a kind of a doubling of assets on a representational basis in the US relative to Canada. And I think that it’s that tax advantage that is, that has accelerated the uptake there even though Canada was the locus for the first ETF ever.

Yeah.

[00:20:24] Daniel Straus: In the early ’90s.

Yeah.

It’s… I’m sure that’s it’s come up on this podcast and many-

The tech.

Yeah.

Exactly. And it’s come up on this podcast and many others. The XIU has its it’s root in the first ETF ever launched. Canada had the first bond ETF. It had the first currency head ETF. It had the first physical crypto ETFs, the first marijuana ETFs. A lot of first you c- hedge fund like ETFs that do very unique kind of long, short strategies.

New since 2019 because of relaxations in the rules around alternative mutual funds. So it’s a world of first. But it still represe- proportionately small compared to the US for all sorts of reasons. And I think the taxation component is one of them.

Do think

[00:21:04] Adam Butler: advisors and investors use ETFS the same way as US advisors and investors use them, do you think? Do you see any differences in the-

Right-

… the behavior or how they fit into

[00:21:14] Daniel Straus: portfolios?

Yeah. Yeah. So there’s a lot of splintering in the way ETFs are used, right? They used to be used just for core allocations. And a lot of advisors especially use ETFs in the kind of core and explorer fashion, where they would use the ETFs, the big giant placeholder for the center of an ETF of a portfolio, of a managed portfolio. They would construct it out of building blocks, going to all sorts of different asset classes.

And then they would have exploratory positions either in, in individual security stocks, structured notes, what have you. And that’s been a very good model. And we know that’s been applied in the US as well as in Canada. But now there’s a splintering. People are using ETFs in manners that make my head spin. An example would be, certain thematic ETFs which have become memes unto themselves, right?

Not something I would’ve predicted. There’s, we see in the early days, there’s, there, there have been major changes out. So to your question, in the early days advisors and investors did use ETFs quite a bit to rotate amongst sectors and geographies. Those were the tools that were on the shelf at the time. Then with the advent of all these different kind of smart beta ETF, single factors, multifactor and so on,

We saw a slow, a gradual and then sudden uptake in the use of individual factors and rotating amongst them depending on market conditions. And factors in a sense became sectors. People were using them strategically and tactically. Sometimes rightly, sometimes wrongly. A case in point is what we observe of in terms of low volatility ETF flows, in the aftermath of the financial crisis, which is again the kind of the the fertile soil from which my career was born, right?

The there was so much demand for capital preservation and risk mitigation after having gone through the scarring experience of like 50% market draw downs very suddenly. There, there was a boom in the development of the low volatility ETFs, right? SPLV was the first one. Then SMVs quickly followed. In the, in Canada we have ZLB and a whole bunch of others as well that track this factor.

And it is a factor. It’s an academic factor. It’s an anomaly. What do you want to call it? But the inflows into this factor after the financial crisis were phenomenal. Year after year many billions of dollars going in. And and then what we saw, [laughs] in the last kind of corona apocalypse. The low vol factor, which had done very well for about 10 years, it faulted a little bit as every factor would expect it to do, like it… No factor can win 100% of the time, right? It’s a… In fact, if it wins 51% of the time that’s pretty good, right? Better than the coin toss. And and what we saw with the low vol factor was that it in fact delivered what the academic practitioners and index developers said it would deliver through the Canadian oil crisis and crash.

Those companies became the high vol companies and the low-vol ETFs rotated out of them. Those products did very well. In the back test certainly they all avoided the financial crisis having rebalanced out of the bank stocks early enough. And if the back test extended to the tech crash of 2002, it avoided that as well.

And… So in Canada, the low-vol ETFs did not circumnavigate the 2014, 2015 oil route. But then during 2020, they participated almost completely in the 30 some percent drawdowns that we saw in the market. And in fact did not recover with the market at all, because it was a growth led recovery. And the high volatile w- FANG stocks and their ilk drove that recovery at cloud computing, all this kind of interesting stuff, which was not in the low vol indices.

And as a result, they lied. And investors flowed out of that product category in subsequent months. For the first time, we saw big turning. When do these outflows occur? After the fact, right? So you have performance chasing, you have negative performance chasing. ETFs factor strategies sectors, they’re wonderful, but they do not cure an investors or even an advisors worst tendency performance chase and go after what just worked, right?

Yeah.

Amen to that.

Yeah.

[00:25:35] Adam Butler: So how do you… On the desk, first of all maybe tell us a little bit about what National Bank’s ETF end switch desk does and, Sure-

… that might lead in

[00:25:49] Daniel Straus: a couple directions I’m keen to explore.

Yeah. No, th- great question. So one way that it… One direction that it doesn’t lead into is having a short list of recommended ETFs. We are often asked what’s on your recommended list. And I know that in the traditional world of fund analysis, having the recommended list is very powerful and very helpful thing to advisors even. And I don’t want to I don’t wanna disparage that practice.

Because now that I’m now, that the world of ETFs and mutual funds is blending [laughs] I have to blend myself into being not just an ETF analyst, but also a fund analyst. And so having a recommended list is something that is, it’s a sacred tradition. I don’t want to dump up on it. But it’s not something we do.

Because so many ETFs are similar to one another, but with very minor differences that matter to, on, to the individual circumstance that you’re in. Whereas other ETFs are in fact, almost carbon copies of one another. That’s one of the kind of dirty secrets of ETF analysis. There are dozens of ETFs that track the same index. And if they have the same structure and same fee and more or less the same market making plumbing behind them, they’re physically replicated. There’s no synthetics. They can reinvest dividends.

They don’t have weird old fashioned kind of rules against that. For instance, SPY might in the US because it’s a UIT and not a 1940 act fund. If ETFs are identical, we don’t want to recomme- recommend one over another. That would send the wrong message we feel to the street, to our advisors who follow our research. So what we do and to answer your question, is we will consider the whole playing field the whole landscape of potential ETFs that might qualify for the exposure a client or an advisor is looking for.

And then we will work with the advisor or client to understand what they’re trying to do for, on behalf of their clients. What are the kind of exposures they’re really looking for? What are the risks that concern them? What what else is happening in the portfolio? Where do they have any overlaps or gaps? And then we will give the advisor or whoever we’re advising, ’cause sometimes it’s institutional clients of our trading desk a menu of options with some analysis supporting why you might pick an ETF or an- or another.

So we really see our mission as education, as lifting the hood on every ETF that’s out there and explaining how they work and how they might differ to anybody who wants to make a decision so that they can make a more informed decision. We do publish a model portfolio report for instance, which does highlight in the tear sheets in the back and in back tests and so on specific ETFs for specific exposures.

But that’s more of a kind of everything including the kitchen sink kind of research product, where we’re trying to show the various different kinds of ETFs that could slot into a very, diversified portfolio. National Bank does have, for instance, UMAs and portfolio baskets of its own that it sells. And they… We don’t manage those, but they do come to us and leverage our research capability.

When the actual PMs of those projects wish to make an allocation, they will use our research to help them decide which is the right one for the for the client, right? Very often and in the early days especially, the decision would amount to, “This ETF is very large in liquid has very narrow spreads, but it has a higher fee. This other ETF is a little bit newer. Its fee is a bit lower, has a larger entry costs, but has a lower fee.”

So if you’re going to trade tactically, go for the liquidity. Prioritize that. If you’re going to invest with a very long term, prioritize the ultimately low fee so that you can compound your returns for longer. And then there’s a breakeven point. What’s the holding period? We’re talking about basis points here, right? Very often the decision does amount to understanding where those breakevens occur and how many basic points exactly we’re talking about.

But in the new era we have to do so much more than just that understanding the factor exposures, the concentration. And then sometimes in fact, the structure, is it in the corporate class, is there a synthetic backdrop to it? How does it hold its international securities? There’s so much that that can be done and that each individual investor, because their own situations are different, we will try to custom and tailor our research for that particular investor. That’s all a very roundabout way of saying that it’s a lot of work [laughs]. Because there’s a lot of individuals, right? And there’s no cookie cutter solution for any one of them.

A lot of the major

[00:30:25] Adam Butler: banks have… And I think this has been guided by the OSC.

[affirmative].

But they tighten the screws on, about your product rules-

Right-

… over the last year or so.

[affirmative].

You’ve also noticed a shift in the way… It used to be that for the major banks, the asset management arm was a pretty substantial profit center. I remember the days when the Royal Bank Balanced Fund… Maybe this is still true. But they used to launch mutual fund in Canada and they th- for their balance po- passive portfolio, effectively they were charging 2.4%. And…

Obviously the ETF industry positioned to disintervene that for the Canadian banks that I think the Canadian banks should last the while, retaliate by issuing their own suite of ETFs.

Yeah.

So now every bank basically has their own suite of ETFs. And these new KYP rules make me offer cover for these banks to make the case that they know their own products the best, right?

[affirmative].

[00:31:33] Adam Butler: Ha- have you noticed any shift way that advisors are using ETFs now as a lot to these sort of strategic and competitive forces manifest over the

[00:31:48] Daniel Straus: last couple of years?

Yeah. Yeah. No. So you’re absolutely right. There, there have been strategic and marketing of- forces happening in, in the back- background of all this, a massive asset growth and product innovation that we’ve seen. And that is a big part of why the Canadian ETF industry is now at 320 billion. It’s… And it’s why it’s been growing at 22% cumulative annual growth rate for the past 10 years.

Because there are decisions coming from the top that have discovered that the ETF works very well as part of a, for instance a fee based business model, right? When… If you’re part of a bank and you have a slew of advisors who are each engaging in their own kind of practice encouraging a migration to fee base is a way for you to get as the parent bank revenue certainty over other models.

And and, when revenue is less volatile, cost of capital is cheaper. There’s a lot of reasons to understand economically why that’s in the interest of the parent bodies. But it does also happen to be in the interest of end investors as well. When you look at the history of how, in the kind of Wild West early days of, commission based business models many clients and then, may have found themselves encouraged to perhaps over trade their portfolios.

Now, this is the amazing thing. ETFs are wonderful buy and hold vehicles. But they don’t… They’re not a silver bullet against that either, because they’re liquid and tradable. You… They may in fact still encourage perhaps excessive trading on the behalf of, as we see even discount investors as well. To go to what you’re saying, I’ll put it this way.

When I started at National Bank, there were four ETF providers. Okay. BMO, I think was one of the earlier banks on the scene. In fact, TD had ETFs prior to when I even joined that they launched and delisted before I even got into this business. At the time there were four providers. And even though there have been some mergers and consolidations, we’re now at 40, right? There was one bank at first. There was one then zero, then another one. And now all six are in the business, including National Bank. National Bank investments also-

[affirmative].

[00:34:14] Daniel Straus: … Offers its own ETFs. And, our research operations sees them as an important client as all the banks are an important client, because it is like one big kind of, the Canadian banking industry for better for worse is is is… It’s a different kind of competitive landscape than it is in the US, right?

And that very much does apply to to banking, to, and to ETF market making. They’re a lot of kind of regulatory reasons why the Canadian, for instance, active ETF landscape has grown quite a bit faster than the US. 25% of our assets are active in Canada. As opposed to now, what is something like three, maybe pushing 4% in the US when it was sub 1% for a very long time. And that’s because-

[00:34:57] Adam Butler: So what drove

that? What drove that difference? Why is it… Why are there some many

[00:35:01] Daniel Straus: more active funds in Canada?

Great question. Yeah. The primary reason for that is that the regulatory landscape is friendlier for active ETF portfolios in Canada than until recently it was in the United States. In the US ETFs required I believe more… Two, sometimes three authorized participants that’s, designated market makers to receive a fully transparent representation of the portfolio every single day in order to support the market making function.

And that portfolio needed to be com- communicated in full and with total transparency every single day. A lot of active managers in the US. That would make them bristle because they don’t want to… You’ve probably heard this. They don’t wanna tip their hand or reveal their secret sauce or anything like that. In Canada for better for worse ETFs are… I don’t need to disclose their portfolios any more frequently than mutual funds do, which is quarterly with a one month lag and only top 10 holding or something like that. And maybe only annually for the full portfolio.

There’s a lot of opacity that is afforded to active managers in Canada, which is what they want so that they can conceal their trades and protect their asset management style from leakage onto the street. In Canada an active manager is satisfied to, perhaps sign an NDA with an ETF market making desk for a few of them and say, “Please don’t divulge my entire portfolio and trades to your own institutional equities desk, which is, just down the hall from you, Whereas in the US, I wouldn’t even fly, right? There, there’s less trust, in, on Wall Street than is on Bay Street, probably because it’s a bit, culturally more shark infested there. I don’t wanna say that the Base Street and Wall Street culture isn’t, is that different. It really isn’t. But, the Canadian environment is perhaps a little bit friendlier on, on many scores.

Regulators are more supportive and friendlier towards the the asset management industry. And so when active ETFs were first coming to market here, they got approval to be semi-transparent. Which took a long time even in the Uni-, in the United States. And now they have to go through all these unbelievable innovation and patent hoops in order to have active non-transparent portfolios, which is a relatively new innovation there.

And may in fact, spur whole new waves of growth as we saw in 2021, when a number of large mutual fund providers started to convert. Dimensional being one of them. They converted about 40 billion in active funds to ETFs in, in 2021. And that was the first time that happened in the US. We haven’t seen mutual funds convert to ETFs here in Canada, but we have seen mutual fund companies launch ETFs many times over. Insurance companies as well.

Manulife is there McKenzie is there. Other funds like Dynamic partnered with Ishares at first and now have their own ETF businesses. A lot of the ETFs in Canada that people would not necessarily even think of as active, we treat and think of as active because they don’t track the third party recognize index.

BMO has been a pioneer of that. These kind of algorithmically driven quasi index like strategies that are running with a black box, on BMO’s quantitative desk for just their dividend ETFs, or even their low volatility ETFs. There’s no third party index that you can track. Those are effectively active. And those have been very popular.

And

[00:38:21] Mike Philbrick: How have you and your team adjusted to the explosion in that thematic space and the liquid alt space?

[00:38:30] Daniel Straus: Sure. So the first thing we had to do to adjust the explosion was upgrade from Excel to SQL. That was the first thing we had to do, in fact, when I staff it [laughs] at National Bank the research department was still spooling up in its Toronto office. And I had a very old version of Excel on my PC when I sat down in my cubicle.

I don’t remember the precise calendar year of it. Excel 2000 something. But it only had 128 column, right? And a nice even power of two. And I said, “120 columns. That’s fine. There’s what? 100 ETFs in Canada. This is plenty. No problem.” and sure enough, I needed to to just keep a spreadsheet of the ETFs. I needed to break up ag- into two files.

And when they finally upgraded to, to, to the, to a newer or version of Microsoft Office that allowed for, I don’t know how many tens of thousands of columns, I was like, “Okay, this is enough.” But it wasn’t really. We needed to migrate technologically to SQL and Python, a bu- other bunch of database tools just to run our statistics. That’s, that was a big change.

But now we’re up to 1200 ETFs in Canada, Mike. And I often get the question, is that too many? Are we due for a wave of consolidation? Is there going to be a moment of reckoning in the future where there’s massive waves of delisting some termination? I don’t think there will be because, I… Not a lot of people can even answer how many mutual funds there are in Canada.

I’ve looked it up myself and I don’t know how many there are. So sometimes I see the number 8,000 coded. But when you count the alphabet soup of different kind of series and so on… A, O, F, C, D. I don’t know how many letters there are. The, you get to something like 20,000 mutual funds. Nobody bats an eyelash. Th- Nobody ever says, that’s too many, right?

I… You could say that maybe there’s too many S&P 500 ETFs because every provider has one and they have a currency hedge version, and a whole bunch of them have USD versions as well. And, in the US there are three. Does Canada really even need more than that? So I don’t know if there’s gonna be like maybe some differentiation on that score. But that is the most famous index in the world.

If there was any index that’s going to have a dozen versions on the TSX, then it would be that one, right? I think that we are gonna see many more ETFs launch. Because it used to be that a theme once it would start to resonate in mind share, and we’re talking about things like, robotics and automation and cloud computing, social and media and so on there would be an ETF listed or launched that would capitalize on that craze.

Marijuana, the cannabis industry. Another one. That ETF from Horizon launched before legalization and it was originally a life sciences ETF tracking what was medical marijuana at the time. And now it just tracks the broader cannabis industry. And there were a few other ETFs that launched as well. One since, delisted in that space ’cause first mover advantage is very hard to dethrone.

But I think the coming environment means that ETF and asset managers are going to have to try to guess what the next trend will be and try to plant the flag before anyone else even sets foot on the territory so that it can be there before that craze takes off. And that’s… We saw that in the after, in the aftermath of the COVID sell off with the phenomenal popularity of a airline ETF in the US.

Some travel ETFs happen to be in the right place at the right time. I can’t tell you how many advisors ask me, “Which ETF will give me the highest exposure to cruise lines.” They ask me right at the peak of the pandemic and I’m like, forget the coronavirus. Aren’t you worried about like rotaviruses? And there’s like other, there’s other viruses you can catch on a cruise.”

But I don’t know if that industry will recover. Maybe I’m wrong. But but, and we would show them. We would show them that there are some consumer discretion in ETFs, there’s some travel and leisure ETFs that have very high weights and some of these are very beaten down cruise companies. So travel has been a theme that needed to be one of the exchange just as the demand coming in.

So I think that we will see a raft of launches from very creative and forward thinking ETF issuers who are trying to imagine what will be the n- next thing. And that doesn’t necessarily have to be a sub-sector theme, right? Like virology or, gene therapy or mRNA treatments or something like that. It can be a quantitative theme.

It can be an alt strategy that, that will soon come to be in demand given the inflation fears that we are seeing in the economy right now, given the ultim- incredibly low prospects for returns from fixed income and so on. So I think that… Or even given the the long foretold death of the 60/40 portfolio, right? Those are an enormously popular category in Canada that have themselves been a gangbusters source of growth.

These kind of balance ETFs that first came from Vanguard in the form of ultra low cost products. But iShares, was quickly retooled their lineup to compete. BNO launched their own. Horizons has some total return vehicles. We’ve saw Fidelity just launch one with a little kind of s- crypto sleeve. But I think that there, there will… O- Once we start to see an in sample period where the kind of 60/40 portfolio falters, because it hasn’t really thus far.

But you can easily imagine certain kind of market environments where it would. There will be demand for strategies that can prove themselves as as delivering that kind of true diversification. And if they are on the exchange, if they’re there now, then then that live performance will be a better, and premature than any kind of piece of marketing collateral. And I think that’s what we’re going to see in the next three to five years.

I like that.

Yeah.

[laughs]

[00:44:27] Mike Philbrick: We’ve got… Obviously we’ve, we manage an ETF in the Horizons [HRAA] group that does some of those types of things and thinks about that inflationary exposure and and impulse that might be happening. But that, that falls in this liquid alt category.

Okay.

[00:44:42] Mike Philbrick: So a- are you seeing enough-

[affirmative].

[00:44:45] Mike Philbrick: … Product flow yet to start to categorize in that area?

Yeah.

[00:44:50] Mike Philbrick: Or is that something where you’re looking at saying, “Oh, we’ve got a few entrants, but it hasn’t had that impulse yet in, in Canada.” Certainly in the US, there’s a little bit more of that.

[00:45:02] Mike Philbrick:  We’ve launched a paper called Return Stacking- which is, about having that 60/40 in the portfolio but doing it in a way that allows for more portfolio real estate. So using some levered ETFs that give you the balanced fund.

[affirmative]. Yeah.

So you have less money exposed to that and can think about some alts within the portfolio. But we haven’t seen those innovations quite take the grasp in Canada.

And maybe because it’s in more an inflationary economy.

Yeah.

But what are your thoughts

[00:45:27] Daniel Straus: there?

Yeah. I think there’s a few reasons for why they haven’t really started to sprout up in terms of asset flows or even demand or even client questions. One of them is that when it comes to that category, I, in our experience, and this is anecdotal advisors who are looking for those kinds of coin strategies really do to see live in sample performance.

And the a case study for that would be smart beta ETFs. Certain kinds of smart beta or even single factor ETFs. There were some in Canada that launched in, in the, in, in the early 2010s. And then you could clearly see at the one year and three year anniversary small upticks in, in the flows. There’s definitely market participants out there, sophisticated ETF users who do want to see minimum one year, and it would be ideally nicer to have longer track records demonstrated.

Now, we all know that past performances know, particular future. And, that, that’s true… But for, it… I think it is a reality that m- many of the target market for these kinds of alt ETFs there, there’s no replacing in their mind the benefit of an actual kind of live track record. So w- you will need to wait, I think, until those kind of windows roll over before you even start to see some fish nibble on those kinds of strategies.

The other reason I think is the COVID crash, right? That kind of derailed a lot of, I think plans and even thinking around investment. I mentioned earlier that it was 2019… I think it was announced in 2018. So it actually goes back quite a number of years now. ‘Cause we are in 2- 2022, right? It… Have… We’ve passed the Blade Runner date, I think, [laughs] [laughs]

[00:47:23] Daniel Straus: This is the future, right? It was 2020.

It’s definitely the future.

It was 2018 when, I don’t want to think about Terminator 2 or something like that. We’re… Because we’re already in a, we’re in a nuclear smoking crater, if that’s the alternate timeline we’re talking about. But it was around 2017, ’18 when the framework around alts was undergoing some regulatory changes in Canada.

We saw a raft of launches around such strategies. Market neutral from, storied hedge fund managers in Canada who are attempting an ETF business of their own around this kind of newly opened up alt space with relaxed rules around concentration, around gross leverage short positions. And and really opening up to investors a kind of a kind of institutional power in asset management that w- had not heretofore been available to them.

And then, a strange new kind of respiratory disease emerges overseas. And nobody’s thinking about it anymore [laughs]. These ETFs chugged along, and they had quite a bit of divergence in their performance. Most of them gave partial participation to the downside because everything went on sale, right? And those few that up performed during the kind of spring 2020 period when the markets were selling off, gave back their gains because they had short positions in high beta stocks and so on, and and I think that that kind of giant [laughs] global macro event pushed the Canadian kind of investor mindset to, into placing the kind of alt idea onto the back burner. But it’s gonna come back. Another example is ESG, right?

[affirmative].

ESG was another massive buzzword. It was… It had a lot of hype and headlines heading into the corona apocalypse. The COVID crash occurred and the ESG conversation disappeared, right? The products were still there, but it’s come back. And it came back faster than I thought it would, right? I thought that that the diminishment and concern around ESGs after, [laughs] after that crash would would scar investors a little bit.

And a lot of people would react the way they did after the 2008 or nine crash, which was “I don’t care what you do with my mind. Just protect my capital.” So many investors had that mindset coming out of 2008 or nine. But now I think with the kind of dramatic and historic interventions and the very surprising bull recovery that occurred in the aftermath, the ESG conversation is back.

Yeah.

It’s back and forth in a way that makes people think, there is a c- a connection. It’s a bit of a logical leap, but there is a connection. There is a tie between ESG and globalization and the spread of pandemics and transparency and awareness of these things. And we live in a connected world and and that part of the conversation has come back and I think it will happen with alts as well.

So Da-

[00:50:14] Adam Butler: And tech also typically ranks highly

ESG-

[00:50:19] Daniel Straus: That’s right. Yeah-

… ranking.

Another coincidence [laughs].

Yeah. Yeah.

Yeah, it is. It’s true. Like a lot… Like Microsoft, Apple all those companies have huge huge footprints in a lot of those indices and high scores from ESG ratings agencies. Because, when you, when your business is in the air, when it’s in the cloud, you can’t despoil the earth as much as as an actual e- extractive traditional industry or oil company. But we know we, we rely on those things.

So we

[00:50:49] Pierre Daillie: had. Daniel, we had an exceptional near two year period there leading up to late last year.

[affirmative]. Yeah.

[00:50:58] Pierre Daillie: And then we’ve had the, the specter of inflation come back. It’s caused some upheaval this month.

[affirmative].

[00:51:07] Pierre Daillie: In the month of January ’22. And what… I’m curious to know, from a macro standpoint because you’re overlooking the entire ETF industry.

[affirmative].

[00:51:21] Pierre Daillie: How did things change from late last year till now? What have you s- what have you witnessed happened this last month with flows-

[affirmative].

… in and out of the market? What are you seeing?

[00:51:33] Daniel Straus: Sure. Yeah, that’s a good question. So I can tell you just when it comes to the macro viewpoint. I’m very fortunate to work for, National Bank. We’re not just an ETF research arm that’s amputated from a larger organization. National Bank has its own chief economist and a really good CIO office and a, and an asset allocation team.

And we very much rely on their outlook and commentary when it comes to, to, to macro calls. And in fact, what we’ll do is we’ll often map it to the right ETFs to align it with their calls. What we found 2021 was a pattern of flows, the likes of which, had not been witnessed in history. And we had previous years of gangbuster ETF flows. But 2021 really blew the roof off the place both in Canada and the US.

And it wasn’t just ETFs. It was also mutual funds, right? So in, in 2021 ETFs had 53 billion in- inflows in Canada, which was like fully one third higher than any prior year. And in the US, the re- the amount of inflows in the us was something like 900 billion. It was almost a trillion, which again was also 20 some percent higher than the past record set in 20 17 or something like that.

I don’t… I’m not exactly sure when the prior record was broken. But suffice to say, 2021 was enormous. It was enormous for mutual funds as well. And why is this happening? We got that question many times, what explains all this? And it’s a post pandemic phenomena, right? There’s this wealth effect going on where unprecedented stimulative action has put enormous amounts of money in the hands of regular investors, or at least a certain tranche of them, which is ma-

Whether… I don’t know if you want to call one percenters, but it is the upper quartiles of the Canadian wealth distribution. Happened to do well financially through this pan- pandemic. It’s hard to say so. And I have to wonder-

Oh, yeah-

… if policy makers are going to look back on it and wonder if they could have done things differently. Because it was a hard pandemic for a lot of people, right? Frontline workers doctors, medical professionals. A lot of restaurateurs and gym owners had a rough go of it. But I feel very fortunate that the demand for ETF research was never higher [laughs].

And aside from, a kind of brief moment period where my emergency deployed laptop wasn’t really fast enough I I, we were able to do our ETF research without an area speed bump through that period. What we saw through 2021 and going into January even with all the volatility that kicked off the year 2022… I keep needing to remind myself that it’s 2022 and astonishing.

I- is that people are still using ETFs to express quick and immediate access, right? When there’s a big sell off, we see inflows into cheap beta, into passive, right? People sell their direct holdings in their stocks. And then when it comes time to get exposure quickly, they don’t know where to allocate. Immediately they’ll do it with the cheap default product. And so we see enormous equity flows at a time when equities are selling off. It’s something we still observe, right?

We often get the question amongst ETF doubters against the Muck Rackers that ETFs are going to disable blows the market when push comes to shove and there’s a giant sell off. There’ll be blood on the streets because these ETF holders are going to dump their products. And it’s… They’re not… They’ve been accustomed to this enormous liquidity. It’s gonna trigger some kind of snowball effect.

I’m not exactly sure how the argument works because not only do I not buy it, but the evidence doesn’t bear it out. There have been massive market disruptions and huge selloffs over and over again in even illiquid markets like high yield bonds, senior loans and so on. And what we saw was, yeah the underlying market can break down as it did in 2020. The underlying bond market in the US especially, and the entire Canadian corporate bond market as well completely froze up.

But the ETFs, they developed onscreen discounts. But they still traded through the day without interruption and provided access and liquidity when nothing else would. And in fact, there’s reason to believe that they pr- created some kind of liquidity release valve into the market. They may have in fact increased the stability of the wider bond market and come to the rescue.

Certainly in the US ETFs came to the rescue of the wider mutual fund complex because the feds started buying them, right? In order to staunch redemptions that were go- going to start happening in, in mutual funds. And that may indeed have been a kind of liquidity do move scenario that we don’t really much wanna think about, right? ETFs are still a small section of the market.

So, Pierre, to your question, they have about 10 to 12% market share relative to mutual funds in Canada. About 20% in the US. That means that the equilibrium point between ETFs and other forms of asset management is still very much a minority. W- ETFs are still very much a minority. And when there’s large shakeups, you’re going to see capital flow to the ETF complex.

Because, in physics, we talk about a diffusion equation. When you have a very large body connect to the smaller vessel through narrow inlet, and there’s turbulence and and exchanges of pressure, particles are just gonna flow from the higher concentration to the lower concentration zones. And the ability and access to do the speed bumps that people encounter are in fact their tax situations, right?

That’s the real limiting factor to why someone might not choose to immediately allocate to a cheaper, better vehicle for exposure to let’s say US equities. So w- we did see significant flows into the landscape of the US equities in the last couple weeks even as the markets were experiencing untold volatility. We saw large outflows from Canada, which I thought was a little surprising given that Canada is traditionally a great inflat- inflation play, right?

Energy, economy the banks as well which are very much correlated [laughs] with the major energy businesses that are their primary clients. Not only that, but being banks, they too could benefit from a steeping of the yield curve if we enter into kind of a rate hiking cycle. So I would say that our macro economist see Canada as a as a kind of natural resting spot for people who are fearful about the kind of inflationary environment we’re heading into.

But we haven’t really seen a lot of flows into Canadian equity ETFs in the near term. I think that should that happen, it will happen over a longer time scale, and we would need to collect a few quarters of data before we really see people using Canadian equity ETFs as the, as a kind of trade vehicle for this kind of inflation environment, which we may or may not be heading into.

So

When you say you saw redemption-

[affirmative].

[00:58:41] Mike Philbrick: … so you’re saying in Canada-

[affirmative].

… on Canadian based ETFs, broadly listed in Canada, you saw redemptions in that space over this period of time. And that money I’m assuming was headed towards the US sort of-

That’s right-

… market cap weighted or tech weighted areas.

Yeah.

[00:58:56] Daniel Straus: Yeah. So w- that’s exactly what we saw. And then the data hasn’t fully come in for the entire month of January. We’re on the last calendar date of January. In the next day or two. If you’re listening to this podcast it’ll probably be out-

Okay-

[00:59:10] Daniel Straus: … A report for January 2022, is that year again. I remember all my checks and so on. [laughs] it’s crazy. But-

[laughs]

You’re still writing checks [laughs]?

[laughs]

That, that’s right. Whatever, I don’t know, right? Just as collectors items, people wanna keep the signature, Yeah.

[laughs] [laughs]

I’m just kidding. The the, w- Yes, we saw ma- major redemptions from Canada, from C- from passive Canadian equity ETFs.

Wow.

The problem is that some of those redemptions can be quite choppy because there are certain ETFs in the Canadian market that have very choppy inflow and outflows on short time scales because there are large international, overseas hedge funds managers and so on who use it very much as a kind of technical petro play, for better for worse.

And in fact, many of the Canadian, some of the Canadian ETFs may be getting employed by international investors that way. And if, the relative performance of Canada versus the US through January was higher, and if there’s some kind of rotations or profit taking or relative profit taking going on-

Rebalancing-

Exactly. Then that, that might have prompted one or two large trades through the month of January. So I think that will have to be a couple of months into the year before we really see whether that ph- that kind of phenomenon is going on. I know that our institutional equities trading desk is very interested to know is Canada for sale via the mechanism of ETFs. It’s something we saw in 2014, ’15, right? Like when oil was for sale, that was one of the…

ET- Canadian equity ETFs were being dumped left and right. But I dunno if that’s the right move for this coming environment and the data remains to be collected.

So it sounds Th-

[01:00:48] Mike Philbrick: that’s where my mind went was, ju- just I wanna follow up on this here.

Yeah. Yeah.

That… My mind went that it was potentially more international flows-

[affirmative].

[01:00:57] Mike Philbrick: … That actually would’ve been coming in to Canada to capitalize on the resource based economy. And, but then you’ve got the counter flows of rebalancing.

Exactly.

And then you’ve got the counter flows of, in- investors who have been waiting to get a spot in the tech correction.

Yeah.

Because they were, they felt underexposed. So you’ve got all kinds of dimensions to the investor decision that you’re trying to-

That’s right-

… suss out of this big pool of capital that has moved around.

[01:01:24] Daniel Straus: Yeah, exactly. And, we talk about ETFs being transparent and being visible, and we can see their activity on the exchanges very clearly. But the actual holders of them are anonymized, right?

We don’t really know who is driving what capital where. If you look at the… For instance, just the month of January, I think there was one particular international ex-Japan ETF that got something like 3 billion of envelopes very suddenly in one day, who on earth… What… It makes sense to think that it was, like, the bank of Japan doing that, right?

‘Cause they have been a massive buyer of Japanese equities. And in fact, probably very overexposed. So if they needed to get some kind of extra brand exposure, it could have been that institution. We don’t know. We don’t know. And we can’t know because the trading is anonymized. And in fact that’s why so many institutions love ETFs, right? They can cover their tracks, so to speak better via the mechanism of ETFs.

Especially if they have large stock positions, they can blend it in with ETFs. They can go long, short, certain positions. They can strip out individual company exposures. And and that is one of the many kind of arrows in the quiver of an institutional manager to, that they can use particularly if they want to transact in large amounts in the marketplace suddenly and on a dime without necessarily telegraphing to the whole street that they’re making a particular company called, right?

How do you deal with

[01:02:47] Mike Philbrick: 3 billion of envelopes? Jesus [laughs].

[01:02:50] Daniel Straus: It’s doable. And it’s not the first time we’ve seen such unbelievable seven flows. But it g- just goes to show that when a basket is incredibly well diversified over thousands and thousands of stocks, the, all the stocks can be individually illiquid. But when an ETF is that diversified, 3 billion, when you spread it… When you thin slice it across many different holdings, you won’t make more than a 10% volume impact in any one of the individual constituents, even in a single day, right?

It’s a way that a, an ETF that holds… Like there… We, we found on certain time scales… It depends when you analyze the volumes. But for instance, Canada has the TSX 60 index, but it also has the TSX composite index. The TSX 60 holds the 60 large cap. The TSX composite goes into like millions and all caps, not really super small, but like 240 some holdings.

Depending on of the time period their liquidity, of the underlying basket, the implied liquidity of the composite can sometimes be higher than TSX 60, even though it holds much smaller, less liquid companies. That’s because the kind of the long… It’s a fat tail of liquidity distribution that occurs as you stretch down the line of smaller companies.

And then when you have more room for your capital to flow into as you’re creating a large trade instantaneously it’s algorithmic, right? Our market makers just… They push a button and it happens automatically in the blink of an eye. And it is somewhat miraculous and it’s something that kind of assumptions, assumptions me every day. We see it in fixed income.

We get clients all the time who say, “Can you prove to me that a fixed income ETF, and can accommodate such volume.” It’s much easier to demonstrate it to them by, really parting the curtain on the portfolio and saying, “This bond can hold this much volume and so on.” it’s something that’s far more doable in the world of equities, and we have a kind of model to simulate on the backend what a market maker would do if they’re creating a basket.

How they can optimize, how they can strip out the bottleneck securities, how they can put in proxies and so on. Fixed income is much harder because the bond trading market isn’t as transparent. But each ETF market banking desk is a bond trading desk in miniature. And they know how illiquid the securities are. And when they’re quoting, they’re competing with one another.

So you’re relying on a competitive mechanism. And we can see in history many times when what should be an illiquid product, actually because it holds hundreds of securities bonds in particular that haven’t traded for days, if not weeks, suddenly accommodate billions of dollars of flow in an instant without… Right there on the bid or on the ask. It’s… It’s something that has been demonstrated historically many times.

And we’ve we saved those examples as snapshots on our Bloomberg just to give some clients comfort that the deep pool of liquidity does indeed underlie this particular fixed income ETF. Not all, but some.

[01:05:42] Mike Philbrick: So that’s a really good point to, to offer some advice to those who are portfolio managers out there who are trading ETFs. How should they… Wh- they’re doing a hundred million dollar order across their book.

[affirmative].

And how should they think about that? What tactics should they take? Should they call their ETF desk?

Yeah.

[01:06:01] Mike Philbrick: How… What are some tips and tricks so that they don’t find themselves with a-

Yeah-

… a fill that’s four or 5%

[01:06:07] Daniel Straus: often asked?

So that’s a great question, Mike. And in fact, when we… We published on this when the Canadian securities authority had amended some of its rules around fact sheet disclosures around effective spreads. Because we wanted to communicate to advisors how to interpret this data point, right? ETFs have a bit spread. But all stock like securities that trade and exchange, they also have an effective spread, which dives into the order book to see how big the order would be at certain notional trade sizes, right?

We find that… We calculate like this figure for ETFs all the time. We used to publish on it very frequently. But it’s difficult to do but we did do that. But now that the every fact sheet has an effective spread on it we published a piece in 2016, which again, seems like ages ago, on how to interpret that.

And in that piece, we had a list of trading hygiene tips. So that answers your question. And I know the I’m not gonna remember all of them right now. I wish I had it in front of me. But one of them of course, is to used. Limit orders and not market orders. And trade. Pat-, I- if you could avoid it aw- away from right after the open and right before the close. Because, s- the risk in hedging increases a little bit for market makers around that time.

For some securities. Particularly those that that have illiquid baskets. The other one is you can check implied liquidity if you know how. The TSX has tools. Bloomberg has tools. Advisors may be able to access those kinds of metrics from third party data vendors. You can come to us if you have access us to our ETF research desk and we will be able to communicate to you the kind of liquidity that actually exists in the ETF.

And, yes if you do have access to an ETF market maker and you can… Your retail training desk can get a line in with them. You can work with your ETF market makers to really understand in real time precisely the kind of liquidity that is available in an ETF. It’s not necessarily the case and this is a drum that we’ve been beating for 12 years as long as I’ve been doing this.

It’s not necessarily the case that an ETF with no volume has no liquidity. I- in fact an ETF with no volume can be just as liquid as the most liquid ETF out there because of that of the creation redemption mechanism. And it’s not necessarily the case that an ETF that is highly liquid is as a liquid, as let’s say a s- that trades a lot with very high volume is as liquid as a stock that trades with that volume.

And what do I mean by that? Sometimes what you’ll get… And this is something we described in our report on the 2020 era bond ETF dis- apparent dislocations and premium discount in F. Sometimes what happens is you’ll have a very tight bid ask spread band around, let’s say, the ask of the basket spread. If the ETF is itself enjoying a lot of demand, right?

But then as soon as there’s a lot of supply, if there’s, if the natural unitals of ETF all start dumping the share simultaneously and the market maker, th- what you’ll see is that ETFs actual trading price on exchange cross the basket spread. And there’ll be a new small bid ask spread around, the bid price of the basket, if there’s herding the behavior in an ETF.

If there’s herding in an ETF that is illiquid, what it will look like is premiums and discounts, big premiums and discounts. Because the nav is in a sense fictitious, right? Nothing has a single price. Everything has two prices. Your house, your car, this pen, your collector’s items, your Bitcoins. I… Everything has two prices. It has a bid and an offer.

And it stems from the liquidity and the supply demand mechanics around the underlying asset. And those prices are passed onto individuals on an exchange. It’s why ETFs are so powerful and efficient. If you’re a long term unit holder, the kind of activity of buyers and sellers doesn’t affect you as much. All those costs are externalized, right? So there are examples of, let’s say, senior loan ETFs, where the underlying basket is 1%. The basket spread is a… The beta spread ratio is 100 basic points.

The ETF apparently has a very narrow spread ’cause it’s a very high volume. But if sentiment around the buying of some of that ETF changes, you will find yourself in price action on the exchange crossing that spread. It’s a bit of a sophisticated topic. I hope I didn’t get too technical and head spinning on it. But we did write a report on it and I have some cartoons and some data to illustrate it.

It is part of our education process when we get into the ETF 301, the grad school material when we’re advising clients, right? And as you can tell from the top of the hour to bring it all back, I love school. I would go back to g- grad school if I could. And maybe I’ll teach a course in this one day.

Is

[01:10:40] Mike Philbrick: there a place where advisors and allocators could find that piece of research that it’s available publicly? Or is that something that is available only directly from your team?

Yeah, so

[01:10:50] Daniel Straus: it’s available through our team. We have something of a unique franchise at National Bank. I’m an analyst just like any other analyst. In our research department I have a coverage universe, right? I’m not making calls, I’m not setting price targets. It’s… And my coverage universe isn’t an industrial sector of, let’s say, like a dozen companies. My coverage universe is the 3000 ETFs between Canada and the US.

We published to research reports that are available to clients of National Bank. If you l- and that could be any client because they’re, the compliance for wide release just like any other analyst report of National Bank. So if you are, even let’s say a discount client of National, you’ll find a little kind of research portal where you can receive our reports on a one to one kind of personal correspondence basis.

Anybody who gets in touch with me, I’m happy to share PDFs of our research reports, especially deep cuts from the back catalog. Because those are, we worked very hard on them and they they may still have a bit of a shelf life. Even though they’re not as current as they once were. But, yeah, anybody is welcome to get in touch with me. And and I’ll share my research directly.

Awesome.

[01:11:56] Pierre Daillie: I’m curious about another thing, Daniel.

Sure.

[01:12:01] Pierre Daillie: Carbon nanotubes [laughs].

[01:12:04] Daniel Straus: Yeah. They’re little tubules of graphing, they’re they’re they have amazing properties. Carbon is a miracle material. We’re carbon based life forms, right? The carbon atom its bond can form unbelievably complex structures. And one of the in fact simplest structures it can form is a perfect hexagonal sheet. Like a honeycomb lattice.

And when you roll it up into a little tube, you get these incredible properties that could be, it could be… They could be semi conducting. They could have optical properties. They have high tensile strength. They’re very absorptive of light. All sorts of incredible technological applications. I don’t think you’ll see massive commercial application even at this time.

But what was amazing is [laughs] right as I was finishing up my thesis the guy who discovered super conductivity in graphene, which is an unrolled sheet of carbon won the Noble Prize. So it was like a… It was a separate… If I had been setting that from the beginning, maybe I would’ve had different academic prospects. But yeah, carbon nanotubes. They’re very cool. You could make a… You could make the cable for a space elevator out of them.

Yeah. I

[01:13:12] Pierre Daillie: was, I-

Oh, yeah.

[laughs] I was curious because, what would motivate you to do your doctoral thesis on that.

[affirmative].

[01:13:21] Pierre Daillie: There had to be a reason. I wanted to ask you at the beginning, but we got to talking about ETFs [laughs].

Sure.

[01:13:28] Daniel Straus: Yeah. Yeah. ETFs-

[crosstalk 01:13:28]. Yeah. I like that, that ETF topic.

I like to think of ETFs as the nanotubes of the financial universe.

I’m not

sure where where Adam went

to. I think according To the, Oh, wait.

[01:13:42] Pierre Daillie: Adam, if… I don’t know if he can see us.

Oh.

But, Adam, if you’re still there, don’t hang

up.

[01:13:47] Mike Philbrick: Okay. The one question I had too. I think we’ve been at this for about an hour.

Yeah.

The conversation has been fantastic. And I think we’ll get back at it too. At some point, we’ll have you back on if you’ve got-

I could do it-

… Grace us with some more time. ‘Cause I think it, it’s been an amazing conversation and wide ranging. You did say you’re a science fiction fan.

Yeah.

And I wondered, what is your you science fiction book or series?

Oh, boy.

[01:14:13] Daniel Straus: I have a lot that are my favorite. Probably one that’s very formative and in fact surprising to me to be in the news again, is Snow Crash by Neal Stephenson, right? And that’s the book that had the term metaverse for, instead of cyberspace. It’s a bit… It was at the time even itself a satire of the emerging cyber punk genre.

He al- he also coined the term, I believe, avatar in there for your kind of digital representation. And and he had to tweet recently that he has no affiliation whatsoever with Facebook’s rebrand to meta platforms. And, but there are several verse ETFs now too. And when I read that book in high school, if you had told me that I’d be an ETF analyst in 20 some years and there will be an ETF [laughs]. Not one, but several-

Yeah-

[01:15:02] Daniel Straus: … With the word metaverse in the name, I would’ve been very surprised. So that’s exciting. But the a recent book I read, l- more of a novella really that I really enjoyed is, it’s called, This Is How You Lose the Time War by Max Gladstone and Amal El-Mohtar. Who’s actually, I believe, in Ottawa right now, my hometown.

A really fun kind of distillery time travel fiction, romance, spy story. They wrote it together as letters between them collaborators. I found that very cool and interesting. I read the science fiction collection of both of them by Ted Chan recently as well. I… The whole world was telling me to read that for a very long time and I finally got to it. And again, it now ranks amongst my favorites. So I can talk about this for a long time.

[laughs]

If you wanted to make this a science fiction podcast-

Yeah, it’s your podcast-

Oh, that’s amazing-

… we

[01:15:49] Mike Philbrick: can start now.

I think we gotta do another podcast on that with Adam ’cause he’s a, Yeah-

… a big fan of that space.

Yeah.

[01:15:54] Mike Philbrick: I’m a tourist and I do enjoy it.

Sure.

But I don’t have quite the depth of knowledge.

Yeah. Yeah.

But, yeah. Amazing to to have you on.

Yeah.

And where can people find you and wh- where can people reach out to you or where would they… Are you on Twitter? Or are you on-

 

[01:16:08] Daniel Straus: I do… I work for bank. I do have a Twitter account. I’m a hardcore looker. Mike, I follow your and Adam’s work. All the resolved guys are, Fintwit participants part- parexelon. It’s, and I have enormous FOMO [laughs]. Seeing the fun you guys have out there.

[laughs]

[01:16:25] Daniel Straus: I was tweeting until 2014 when I was promoted to full analyst. And the social media policy [laughs] at our bank means that most words that come outta my mouth can possibly be construed-

[affirmative].

[01:16:36] Daniel Straus: … As research. So I will… I… That made me a little paranoid. Maybe one day I’ll reenter that world when I get some kind of media policy and public relations clarity around whether I can participate in the social media. I d- so I don’t have a public facing, shall we say. A Twitter profile where we share ETF research.

But you can email me at etfresearch@nbc.ca. It’s the collective ETF research email address for the entire team. And we receive dozens of queries that address the day it goes into a container and we, we take pride in having very fast turnaround, getting back to people very quickly if they have ETF questions. So if you’re a client of National Bank in any capacity, you have access to our full-fledged ETF research desk.

[01:17:26] Mike Philbrick: Awesome.

Love it. Adam you missed the conversation about his favorite science fiction books, bro.

Yeah.

That’s

[01:17:32] Daniel Straus: right. Yeah.

You could say that-

Yeah-

… inevitably.

[laughs] [laughs]

[01:17:36] Mike Philbrick: Just for edification-

Yeah-

… do tell them what they were.

[01:17:39] Daniel Straus: I’ve already forgotten.

Yeah. It goes all the way from Snow Crash by Neal Stephenson to the collections of Ted Chang. And more recently, This Is How You Lose the Time More by Max Gladstone and Amal El-Mohtar which is really fun time travel, epistolary, romance, novel, spy, thriller. A 200 page novel. You’ll finish it in afternoon. It was it was wonderful. More poetry than-

Who’s that by again?

It’s by Max Gladstone and I believe the last name is Amal El-Mohtar. I’m probably mispronouncing it. But it was written as an epistolary correspondence between two science fiction writers not knowing what the other would read would would write to the other. So it was itself something of a social experiment. And it, and it was absolutely delightful.

[crosstalk 01:18:23] I hardly read as many books as I could anymore. I find that this modern internet age has collapsed my attention span. I used to be able to read novels [laughs] ve- very frequently, but now I find that I need to bombard all of my senses with a novel if I am to consume it. So I need to have the audio book playing.

Yeah.

And I need to have the physical book and I need to have the eBook, all three immediately at hand so that I can have a hope of finishing it, right?

[laughs] Yeah. Exactly.

The eBook and the paper version.

That’s right.

And the audio.

[crosstalk 01:18:55] Yeah, that’s right. Publishers love me ’cause I buy their books three times over.

[laughs] Three times.

[01:19:00] Pierre Daillie: But the-

Yeah-

[01:19:00] Pierre Daillie: … The thing that’s the most stimulating is the audio book I find.

[affirmative].

Like, when you listen to audio books-

[01:19:05] Daniel Straus: Yeah. They’re amazing-

… They’re more-

Oh, there’s another one of my favorites.

Yeah.

Gnomon by Nick Harkaway. So that a fantastic book that I bought three times. Nick Harkaway is a British writer. I don’t know how often it’s known or shared. But he’s actually the son of John le Carré.

Wow.

[01:19:22] Daniel Straus: Just coincidence. A fantastic writer in his own right.

[laughs]

[01:19:25] Daniel Straus: And he writes science fiction. His first book called The Gone-Away World. A fantastic, fun, satirical, hilarious, Kung Fu, dystopian ramp. Okay. And then his book Gnomon was like an intricate four part multidimensional puzzle that had to be unlocked in your brain as you read it. And it was by far the most stimulating thing I read in, in, in recent memory. Absolutely fantastic. Gnomon.

Spelled with a G. G-N-O-M-O-N, which is the thing that sticks up from a sundae that casts a shadow. It lets you tell the time. By Nick Harkaway. And the audio book, the reading, the actor is famous. A British voice actor who does the audiobook reading of it. And I read the physical book and the eBook at the same time. I was switching in order to finish it, right?

He does an amazing job. That book is told in multiple voices and it’s just I still think about it. In fact, when I’m, lie awake at night, I find my self automatically going to that book and I do need to reread it again. That, that book itself will would spawn an entire podcast series from me [laughs] if I had a chance to to workshop it.

[01:20:39] Pierre Daillie: Wow.

That sounds amazing.

Yeah.

[01:20:41] Pierre Daillie: Daniel, thank you so much that, thank you so much for your time and for sharing a little sliver of your encyclopedic knowledge. It’s been it’s been a wonderful conversation.

Yeah.

[01:20:54] Daniel Straus: Yeah. Thank you so much, guys. It’s been really fun. And I look forward to a lot of really awesome more episodes from you. I’ve I’ve discovered you on, on, on Spotify. So I know that’s been-

[laughs]-

[01:21:07] Daniel Straus: … Coming in for some controversy in terms of what kind of content it hosts.

Yeah. [laughs]

But but I… It’s definitely one of my, one of my favorite streams now. And we… I gotta find you on some other platforms if I decide to join the boycotts. I don’t know. I’m not saying I will. But, [laughs] We’re on all of them.

But-

So you, you’ll be fine.

All right. Fantastic.

Okay.

 

[01:21:27] Mike Philbrick: And we’re not taking a standing against Rogan. I think Adam’s having a little bit of audio challenges. So he’s remaining silent, but not by, Sure-

… choice. But by design I muted him.

[laughs]

[01:21:39] Mike Philbrick: ‘Cause I wanted to monopolize the conversation as you all might know me. I love my voice.

Mike.

[01:21:44] Daniel Straus: Yeah. Yeah. So thanks so much. Thanks all of you. It’s been a lot of fun for me too.