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  • 01 hr 03 mins 22 secs
The ETF industry has evolved tremendously since its inception back in 1993. This panel dives into common misconceptions and mistakes made by ETF investors, ways that advisors can be smarter about selecting ETFs, the growth of active and ESG funds, and the top ETF trends to watch in 2022.
  • Marc Zeitoun, CFA Chief Operating Officer – North America Distribution, Head of Strategic Beta and Private Client Advisory, Columbia Threadneedle
  • Dodd Kittsley, CFA National Director, Davis Advisors
  • Sean Edkins, CIMA, Head of ETF Strategic Partnerships, DWS

Jenna Dagenhart: Hello everyone, and welcome to this Asset TV, ETF Masterclass. Today we'll cover how the industry has evolved over the past three decades, some of the biggest mistakes that investors make, and ways that advisors can be smarter about selecting ETFs. We'll also look at the Rise of Active, the role of ESG, and the top ETF trends to watch in 2022. Joining us now, we have Sean Edkins, Head of ETF, Strategic Partnerships at DWS Distributors, Dodd Kittsley, National Director at Davis Advisors, and Marc Zeitoun, Chief Operating Officer in North America and Head of Strategic Beta at Columbia Threadneedle Investments. Dodd kicking us off, can you comment on the evolution of ETFs since their inception in the U.S. back in 1993?

Dodd Kittsley: Sure. I'd be glad to. It certainly has been an unbelievable evolution and I'd almost say that it's really been a series of revolutions that we've seen in this industry. It's hard to imagine that ETFs in the U.S. are entering their 30th year, index mutual funds are entering their 50th year, which is pretty amazing as well. But the unique thing about ETF since their launch in 1993 is that they really appeal to such a broad investor base and they do so in such a level playing field. Ranging from the largest institutions in the world, pensions funds, even central banks, certainly financially advisors, and then all the way down to the individual investor and it's a beautiful thing where everyone is sharing the same benefits that ETFs offer.

Dodd Kittsley: There are so many revolutions that happen in ETFs. I'm just going to highlight a few of them. I'm sure Marc and Sean will have others to chime in on as well. But the first was really the ADBE. They really increased in investors toolbox dramatically and put in tools that were arguably a lot more efficient than what were in before and that puts investors and advisors in a position of strength. The first was really indexing. Market cap weight in indexing, really wasn't largely available to investors other than the largest pension funds, which used it indexing pervasively. ETFs really introduced that as an option for folks and did so in a granular way, not just the S&P 500 sure boggles, Vanguard fund has been around since '75 and grew dramatically, but to be able to really target different market segments.

Dodd Kittsley: Then you fast forward 2002, the first fixed income ETFs coming out and that was really profound bringing in over the counter market, that's opaque, that's negotiated, that's discontinuously liquid and putting on in an equity exchange. That's transparent, it's competitive, and the costs are dramatically lower to be able to get exposure, be able to do that really changed our capital markets. Gold in 2004 was really dramatic, I think for a lot of us in the industry because it really signaled the ETFs aren't just about indexing, but they can be a lot more than that. This made instantly, an asset class relevant to a broader investor base. Previously folks had to buy gold miners or try to buy gold bars and worry about storage costs and quality and what have you, change the game and I think that led to Renaissance in product development, where we saw smart beta.

Dodd Kittsley: There was all of a sudden a recognition that ETFs don't have to just be market cap weighted, but we can put a set of rules in place and be able to identify certain things with periodic rebalancing. And then the last chapter, which hopefully will talk a lot about it's near and dear to my heart is recognition that ETFs aren't really just about indexing, whether they be rules based on market cap, but they could be a really effective wrapper for active types of strategies. We've seen the massive amount of growth in ETFs, going from less than 1% of assets back in the nineties, late nineties, if you will, to 31% of all assets of ETFs and mutual funds combined. That largely has been indexing, but when you open it up to Active in arguably a more efficient structure, we're just at the beginning of some of the tremendous growth we've seen.

Jenna Dagenhart: We are, and we'll be talking a lot about Active throughout the panel. But before we really dive into that, Sean, you've been immersed in the ETF industry for more than two decades now, since before people really we're talking about them, when the broad investor base, what are some of the evolutions that you've seen and where are we today?

Sean Edkins: Well, first and foremost, Dodd did a tremendous job walking me down memory lane because we've known each other that long and been involved in that topic. I had hair back then when a lot of those products came out, starting at BGI back in the 1990s and being at State Street with launching the gold ETF. The evolution, Dodd I love how you brought that into the equation, because that's what it's been. The thing that I would add to that, is really the keen necessity of taking the tool set, which exists and then offering in intermediaries investors, an advisory component around it, and in the beginning days of the growth of this having to go door to door and what is an ETF and how does it work and the liquidity behind it.

Sean Edkins: It's been a fascinating ride for sure and I think there's still a number of unfortunately misperceptions that still exist in the industry, given the widespread growth and the adaptation of the other solution sets existing and we touched on a couple of those things. The liquidity, and how does the active ETF work? What is ESG and crypto? The wrapper itself has been so elastic and innovative over time that it just reinforces really the creativity that exists for more and more asset managers and then advisory consultants to provide their expertise in sorting through it all and building portfolios. Those would be a couple additional things that I would add to the opening remarks and to fully encourage investors, to not be overly assuming at first blush on a new idea, but just to be open-minded and engage the vast number of investment professionals that we have on this call and others in the industry to help them figure out how to best use these.

Jenna Dagenhart: Marc, turning to you as an active manager, how are you offering investors different choices?

Marc Zeitoun: It's very interesting in the way that we're talking about ETFs, because one of the things that has evolved is how we actually talk about them and think about them within organizations. For a while there, ETF meant benchmark investing, sort of interchangeable, and you can still catch some of that, but they'll talk about flows into ETFs. I amuse at that because it's like saying flows into mutual funds. I don't know what that means, but it doesn't always mean the same thing to everyone and I think that for a long time, we as an industry got caught up in that jargon of ETFs, passive, passive index, versus, everything is versus. As an active manager, I think the knee jerk reaction when an active manager acquires an ETF firm or builds one it's how will the two coexist?

Marc Zeitoun: I find it interesting that the definition of a structure creates such stress within an organization that we need to know, how are they going to coexist? How will the mutual of fund coexist with the SMA? It's a bit like West Side Story. Where we are today with the advent of semi-transparent and fully transparent, I think people are starting to understand, "Hey, we're just talking about a wrapper now we're not really talking about anything else." What I loved about, Dodd's opening comments, is the 50 years of index mutual fund investing. I spend a lot of energy internally trying to frame a conversation around fundamental active and index solutions. Let's talk about the wrapper after. What are we trying to provide here? And then within index as someone was saying before, he had got benchmarks and smart beta and the thematic, you also have those variations on the fundamental, active side as well.

Marc Zeitoun: Trying to harmonize the offering as an industry, we don't know how to talk about what we do other than being very technical. Well, I know that one of the most compelling ways to market what an asset manager provides is to put anything on an alpha beta continuum and not talk about the packaging yet. On the one hand, you've got pure beta plays, the S&P or the AG, on the other side of that spectrum fully alpha, traditional alternative investments, hedge funds, things that are zero beta, all alpha, and I'm being theoretical for a second. But, if that's the choice, then everything that we offer is somewhere on that continuum and the packaging comes after. Hopefully, we'll get to direct indexing later in the conversation. That's yet another expression of the same thing that we're offering, which is these indexed or non index solutions within an appropriate packaging for the client. The final point on this is, we have to tailor our language to what clients want, and I don't know that they want to hear it in the way that we express it all the time.

Jenna Dagenhart: Those are all great points and I do want to ask you about direct indexing. What's the danger of generalizing preferences of investors and advisors, where do personalization, customization, and direct indexing as you mentioned, come in?

Marc Zeitoun: For us, again, it's on a spectrum. You think about bulk beta as an offering. Some people call that an access offer, let me tap into this, let me provide some exposure to that. There's really zero added value other than our ability to track some index. That's bulk beta at its core. You move into the customization phase, Dodd talked about strategic beta, maybe a yield tilt, equal weighting, all of that right, Factors, RAFI, and I think where we are now is personalization. Interestingly, the pooled vehicle does not permit personalization, it stops at customization. But personalization now, I can open it up. There is no pooled vehicle, I can manage to your taxes. I can manage to your preferences. I can better align that original bulk beta to what you actually need. Again, not versus, and depending on where you are, you're going to want one of those three.

Dodd Kittsley: It's such a strong point. Several things you highlighted, it is definitely not a versus, and we have so much inertia in this business and so much existing structure and folks worried about turf and what have you, and really it should be about the portfolio and the exposures and strategy that you're getting. That's your first question, and your second should be what wrappers write for my clients from a tax perspective, from even an emotional perspective. For some folks, maybe seeing portfolio changes every day in an SMA can make them have bad behavior and sell at the wrong times and buy at the wrong times and what have you, so maybe mutual funds better there. At Davis, we only have five core strategies and we offer the strategies and the different wrappers, but we're talking about the strategy and the high conviction equity portfolios we have.

Dodd Kittsley: It doesn't matter to us whether it's a mutual fund in SMA in ETF, we can add some advice there, but such a great point Marc and the other thing is, there are a lot of structural issues with versus amongst asset managers, particularly bigger shops. We also see that at broker dealers and partner firms. When we entered this road in 2017, who wants to follow our ETFs? Well, you're already following our mutual funds. There are analogs are almost the same, so why would you double up on, but there was just such structural impediment there. It's great to see that the wrapper, not necessarily is being de-emphasized, but is being a secondary or tertiary consideration after, get the exposure you want. That's really what your job is as an investor, an advisor.

Jenna Dagenhart: Strategy first wrapper later. Now Dodd, what are some things that advisors might not know about these different tools and is one approach better than the others for active strategies?

Dodd Kittsley: Yeah. I'm sure we're going to spend a good amount of time. Sean, alluded to a lot of myths and misperceptions. I think one of the things folks make mistakes with is they're just looking at a category and maybe they're diving into the largest. If it's the largest, it's got to be the best, or the one that's the lowest cost or the one that has the highest liquidity. I think it all circles back to use the advantages of transparency if you have it, majority of ETFs do, mutual funds may be not as much, but you still get portfolio holdings from time to time, you understand that strategy. That really within a category, you have a lot of different exposures and you have a lot of different trade offs, and first look at the portfolio, the strategy, the manager. Cost is important, but I find a lot of people spend too much time on that. People spend too much time saying because XYZ fund is the biggest in its category, it's got to be the best, not necessarily the case.

Dodd Kittsley:  Within Active, you have a lot of different choices and again, it goes down to first and foremost the manager, their philosophy, their investment discipline, have they been able to outperform over a period to time before? Are they more likely to be able to do so in the future? There are a lot of different things to take a look at. The structures amongst active, that's more back of the house. It's more the plumbing and certainly semi-transparent is a newer structure, and generally it takes a couple years for folks to become really, really comfortable with it. But at the end of the day, I think that's a tertiary consideration behind, the manager you're buying, the index you're buying, the rules based strategy you're buying, that's what it's all about, and you get a heck of a lot of choices within large cap, within emerging markets, there's just so much out there.

Marc Zeitoun: If I could just build on that, because it's very evocative to what we're going through. Asset managers spend so much energy defining their brand and their voice, and then income and ETF offering, and it goes out the window. It's so important for that strategy, whether it's housing and ETF or not to be part of that competency, that the asset manager is marketing. For us not to drop tickers and I won't, we're big on our research. We should be launching things that use our research. Another firm would be great at emerging market investing. It should launch within that. The point is, we want to go to market with one investment message and lots of different ways to fulfill that, and that's why it's so important to whatever the capabilities that the structures provide, just make it part of what you do centrally as opposed to a satellite tactic or a strategy from a commercial perspective.

Sean Edkins: That's an interesting concept and I guess it depends what hat you have on, what firm you're at, and where you are in the stage of your career, and what that agenda is. I relate to a lot of the comments you guys have made there already, to bring forth a strategy because it is so super saturated and the industry continues to evolve and technology's had a big part of that. Like Marc, brought up direct and we're not in that space yet, but yet I think that's the next iteration of this entire thing based on what each of you said around the customization and what an individual investor wants. Are we at the end of complete saturation of cap, tilt, factor, what have you, thematic? It's getting more and more granular.

Sean Edkins: I don't think that's a bad thing and Dodd, to your point around as a consultant, a fiduciary, you do want to first find what are your needs for yourself, your clients, and then look at the landscape. Marc, to your point around fundamental and we haven't launched any true active ETFs at our shop yet. We haven't got into direct. All those things are in discussion, but one thing I can relate to Marc that you brought up on the customization is like very big trend that we've seen here taking off in the states. But historically, very deep over a number of years has been an ESG and that's not a one-size-fit all. Although, most of the bases are covered in that space now on the beta side. But every day, a lot of the bigger mandates that we get are very specific on how to customize. It's a fascinating industry to be in Jenna. This has been a great opportunity to talk with you and these guys.

Jenna Dagenhart: It's a fascinating industry indeed. But as you mentioned, Sean, there are still are a lot of common misperceptions out there that you mentioned earlier, would you mind walking us through some of those?

Sean Edkins: Yeah, we could go a deeper dive, I've named the few of them. I think first and foremost, based on my experience of all these iterations, it's when an entity is launching a solution. The challenges are first, getting enough assets inside of it, whatever the strategy may be and then again, depending on the sophistication level and knowledge base of the consumer, be it professional or retail, it's can I get in, can I get out, how does it work? In essence, what I continue to find to this day more than what I expect is, it's based on what's inside the liquidity of the solutions or what's inside of itself and there are some best practices to consider on that.

Sean Edkins: First and foremost, look at the strategy. If it is index-based, how long has it been around? A lot of them are rules-based and systematic and that's what the index is. It's a set of rules and a rebalancing schedule. And then each of the asset managers of purveyor are trying to identify different opportunities to invest in it haven't been brought to market yet. Look at what's inside of it, not the ETF itself. Really to engage, the second best practice I would be is after you do that due diligence, is to engage with that firm's capital market's desk, and this varies by firm, what data feeds are you getting to see levels of liquidity, more and more broker deals have cut down the ability to see broader market liquidity sources.

Sean Edkins: That's prevented a lot of great ideas to take off because they get passed over without any additional questioning of how does it work, help me. Those are two ideas that I would throw out, just out of the gate and that works on the way in and the way out. It's not like the Roach Motel, you could get in and get out, so those are other things that I would talk about, just constant communication between the issuer and their internal support systems, I think are really important to engage with.

Marc Zeitoun: I have to agree with so much of what you said and probably some of the stuff you've held back, especially as relates the gate keeping. The fact that the gate keeping requirements vary firm by firm, so significantly speaks to the fact that there's no stand way to look at these things and we try to apply shortcuts. Let's look at the ADTV, let's look at the AUM, and to your point, it's all about the liquidity of the portfolio, not necessarily the liquid of the ETF itself as measured by who's trading.

Sean Edkins: Marc, just to interject that for a second, just sorry to cut you off, but if you want to get a little more controversial, yeah, because that has changed. It used to be extreme open architecture in the beginning, but now to my earlier statement, you need so much in this solution first. It has to have all these metrics before a firm would give an investor access to a great idea that they might not have access to, but they're being held back, and that's if you want to be controversial, Dodd knows I could go down that road too.

Dodd Kittsley: Absolutely. It's a big elephant in the room. The big broker dealers that financial advisors or most of our clients, and it's ironic because some will block either new type of products that aren't controversial or pretty straightforward. We all know liquidity of an ETF is driven by the liquidity of what it owns, so if you own large liquid securities, you should always be able to get in and out and be able to buy a multiple, they're off of the average daily trading volume, unlike a small cap stock, because ETFs are open ended, yet, the irony is individual investors have access to every single ETF. If you can trade a stock, you can trade an ETF. It's really ironic that our financial professionals are more restricted. At least for plain vanilla product, you could go into or you can argue about leveraging inverse and great to step in there, education is totally required. There are a lot of great ideas that have died on the mine and there are a lot of terrible ideas that have been pumped up.

Marc Zeitoun: There are a lot of great ideas that didn't work out either. To speak for them, they have a duty of care, more and more of that business' advisory, higher standard of care, and I completely understand the need to gate keep, and I'm very supportive of that. What I would like to work on is, can we find better measures to identify risk than the simple ADTV, for example. In a way the mutual fund itself has no volume, yet it's okay.

Marc Zeitoun: Again, to remind our listeners or our viewers, that these ETFs they're mutual funds with a little exemptive relief. They're not coming out of nowhere. They're not shares of Ford that we have somehow found a way to populate, they're mutual funds. They're the same regulatory body with an exemptive relief. I appreciate where the gatekeepers are, I love the fact that they're looking out for their clients, the self-directed client always benefits in my opinion, from some professional guidance. But I also say, Hey, maybe we can find another way to get at the risks that you're looking at, and by the way, I haven't figured that out.

Dodd Kittsley:  We've got a long way to go there. You even look at our RFPs, RFIs, that we fill out, there are very few that are tailored specifically to the nuances of the ETF version of the 40 Act mutual fund. There are specific risks to ETFs and we say, look, portfolio's most important and structures tertiary, there is a lot of education and risk involved with an ETF that advisors need to know, and we talked a little bit about that with trading that Sean brought up, in myths around that as well. That's one of the bigger issues I come across with advisors that have never used ETFs before. They've always done mutual funds and they're so used to being able to be like, "All right, I want to invest X dollar amount, end of the day."

Dodd Kittsley: People make a lot of mistakes with the T and ETFs because they haven't become familiar with that. But I 100% agree with you Marc, we got to come up with something more standard that everyone has confidence within the industry on, for coming to an agreement that this is a standard product or this is a higher risk product. We have seen a lot of higher risk products out there, whether it be the exposures they're invested in or how they're structured and folks need to know that.

Sean Edkins: One other thing on that guys, before we go back to you, Jenna, if you don't mind, it's to throw this out since you got my controversy all stirred up now Marc. It's like, if you step back and I've had the privilege to work for a lot of these firms, the beginning part of their launch. Dodd, you probably know this better than me, is it 90% of all the ETFs or at three firms? One of the things that I used to of really advocate in the early days and through my career, working with individual advisors was, do you want to have 100% proprietary solution set given to an investor? In the early part of my career, that was never the case, but it seems now that folks are okay, just offloading a lot of the entire responsibility to build portfolios to a model and then have again, 90% of that at the same firm. I'm just shocked that not more intermediaries are being dis-intermediated by that practice personally.

Dodd Kittsley: It's such a concentrated industry and it's becoming a little bit less, so it's like 79, now last I looked in terms of assets and 40% in the 20 largest. So, it is a little bit top heavy, but you take the flip side of that. Again, Marc's case for the need for gatekeepers, they're some people launching ETF side of a garage these days because of the ETF role and who knows, their experience, their trading desk ability, all the risks involved where the barriers to entry and ETFs have dropped considerably. I think we all agree there is some products that have been out there that really don't have investment merit or I've racked my brain to understand, what rational investor would follow this investment discipline?

Jenna Dagenhart: Marc, you want to add something to that?

Marc Zeitoun: [inaudible] and that will change. I think the constant is, if the advisor is defining the strength of their relationship by what's in the portfolio, there's a larger problem. I think that advisors have understood that the wealth council that they provide, the investment council, that's just one part of the relationship and so when it's tight, they can relax about showing that open architecture so much, especially if there's value add in the allocation from the single manager.

Jenna Dagenhart: There are so many different knowledge levels out there as you mentioned Marc, but Dodd going back to your point about myths and mistakes, myths can of course, lead to mistakes out there, so what are some of the most common mistakes that you see advisors making? I know you touched on a few, but could you elaborate on those and ways to avoid them?

Dodd Kittsley: Yeah. The trading one, again, not to belabor, but always using limit orders. Sometimes people will put market orders in and market order, it doesn't always get executed as best as it could, particularly for less liquid securities, certainly less liquid ETFs that is, so you can solve for a lot of it there. If you're doing a large trade, you absolutely need to work with the capital market's desk, both at the asset manager's firm, as well as your own ETF or block trading desk. A big mistake around that principle is people will look and say, "All right, here's an ETF that's $50 million, I want to do a $200 million allocation."

Dodd Kittsley: It's like, I can't do that. You can at least double the size of an ETF, so long as a liquidity of the underlying ETF is fairly liquid and then it's no different than a program trade. It just creates new shares. Back when I was at a broker-dealer in the early days, late nineties, I remember seeing EFA double in size overnight because an institution came in, they understood that the mechanics and the market impact of doubling the size of the fund more than doubling the size of the fund, was no different than a program trade and instantly they had the shares. I think that's a big mistake people make, is they write off ETFs that aren't past a critical size and there are a lot of ETFs that are less than a hundred million dollars. There are 77 ETF managers that have less than the hundred million in assets. It's a broader industry and some of those have real, real merit and they shouldn't be written off.

Sean Edkins: Dodd on that, I remember that exact trade, all parties involved there and it continues to happen today. I'm so glad you brought that up and when you look for any of our shops or any other asset manager that has a lower traded or more thinly traded ETF, think about what's inside it again. And again, the in-kind creation and redemption and now the evolution in cash or in-kind creates the flexibility of the wrapper. Again, there are large ETFs that have a significant amount of the same underlying just in a different waiting scheme. The liquidity is there and the market makers don't care. It's almost like a warehouse, I'm going to take from this cell. These are the ingredients I need. I'm going to put it into the new wrapper, because that's the rules and methodology of this entity and it's seamless. The depth of market is just, to Dodd's point, it's like an iceberg. You can't just look at the top, you got to look at the entire ecosystem below.

Jenna Dagenhart: Loving all these analogies and examples. Marc, going back to you, what about the common mistakes that asset managers make? How can investors leverage alpha drivers?

Marc Zeitoun: I think riffing on what these gents have been talking about back to the investment strategy is, do you know what's in your index? I think a lot of people don't. I think a lot of people just say, "Oh, it must be the entire market because that's the name of it." There must be 5,000 names in that index or it's a value index. I'm sure everything in that is value. From my perspective, clients probably are expecting their advisors to know what's in the index, if they're going to plow assets into it, and I would urge that we spend a little bit more time understanding who makes the rules, what makes the rules. Some benchmark providers will tell you that there is a little bit of thought, there's a screening process, how different is that from smart beta then? Then there's some name brands that you see crawling on CNBC and all of a sudden there's an ETF around that, but what role does that play in the portfolio?

Marc Zeitoun: I think that asset managers need to spend a little bit more time talking about the strategy itself, back to what we first started with, not putting it as a strategic initiative on the side, not core to the business, because it will never grow. It will never get the support that it needs, and to just say, "Okay, we're bringing an ETF because it permits us to do different things at different prices, and our client base is varied and we want to be able to meet them where they want to be met." Some people want super deluxe, expensive illiquidity premium priced things and some people want bulk, and so long as I'm true to our value proposition and true to what it's good for the client, then I think it's win, win, win. I don't know if I answered exactly, but we're pretty passionate about, know what's in your index. It's a place we're spending a lot of energy.

Jenna Dagenhart: Yeah. That's an excellent point. Go ahead, Sean.

Sean Edkins: Sorry. This has come up a few times and I just wanted to bring this out. It's, we keep talking about cost and cost is important, but there's multiple aspects of that. It is the bit aspect if you're in and out, but Marc, where you were going, I love where you were going. It's really, there are certain investors that are short term traders and they just want in and out, and the internal expense is not going to matter on that. That really materializes over long periods of time, basis points between one solution and another and asset levels.

Sean Edkins: I think the industry in particular has got caught up on that. There is a lot more to that. It's Marc, what you have mentioned around what are the objectives that you have at hand? How long is your high time horizon? Is it a passive core with active satellites? There's just so many different ways these tools, Dodd as you mentioned, in power investment professionals. The total cost for of the portfolio and then is the objective to outperform this and outperform what? What is the goal? What is the goal of the portfolio designed to do? Just a couple other comments on that, I thought we should vet.

Marc Zeitoun: We talk about benchmarks a lot and this is another area of obstinate passion that I have about this. A benchmark doesn't have to be an index, it could just be a number. We're investing in indices, in order to outperform a benchmark. We're not necessarily investing in benchmarks or we shouldn't because those benchmarks may not have been created with a specific goal in mind.

Sean Edkins: Well, that point, it gets to the beginning of the industry again. The initial benchmark indexes were there to measure active managers' success. I have a number of clients that are more catered to the individual investor and it's a goal. Like this money that is being invested is for a purpose and a time horizon. What's important and got a consideration is, what do you make measure that against? The success of achieving that goal versus I think where you were going with this benchmark talk is again, we've empowered investors to own the benchmark and slice and dice and put their own rebalancing schedule. But at the end of the day, what is the objective of the portfolio meant to do? I think that's really key.

Jenna Dagenhart: Looking at ESG objective, Sean, what are the most common missteps that you see within ESG, ETF investing?

Sean Edkins: Wow. The first and foremost, the most prevalent is that there's a trade off in risk and return based on using a lens that looks at the non-financial materiality of a corporation, which is a big part of the ESG movement. I don't think that's really spoken about at length. Which also, there's a couple things there that need to be talked about is that quality and that information set, if you will, is data at its core and it's becoming more and more prevalent as we all know. Because we traditionally have looked at any investment, looking through traditional financial metrics, price to earning sales, we turn on equity, et cetera, and that gives us a really great picture of the corporation's financial materiality. Now, if they're poor at governance or they don't have good kind of a social interaction or representation or they're in an environmentally unstable business segment that their cost of capital is going higher and higher.

Sean Edkins: These aspects will bleed into the financial materiality that most investors look to. Throughout a couple different things there, but ESG really is a very, very broad topic that these guys could also chime in on, because what happened in the beginning part of our careers with traditional non ESG benchmarks and tilts, the same thing is happening now with an ESG lens. It's like a very familiar run for me, again here at DWS because we've done the core, the same ESG benchmarks that started in the early nineties and now we continue to evolve to value growth splits and muni, and high yield and corporate credits and then I'm sure Active at some point too. Those are a couple thoughts there, it's not just measured the sustainability of the impact of the portfolio, which is there and you have to be able to measure that actually that's a key importance, but the misperceptions is, I'm going to lose something by using an ESG lens and it's not the case. Dodd, you might have some insight there.

Dodd Kittsley: I think it's a great point because long term companies aren't going to be successful by screwing their employees or dumping oil in the ocean. There are fines, it's bad business, and it's a great thing to have some guardrails in place for index based. That's a great thing to see with ESG because it's not only just like values based, but it actually has an investment process to it long term or investment outcome that companies that are better environmentally, socially, a better governance are longer term going to be better run companies, more successful companies, able to grow earnings.

Dodd Kittsley:  I'll give a different angle for this, because we get the question all the time. They're like, "All right, you got these Davis actively managed funds, why don't you do an ESG?" Our answer to them is, "Within our active management approach, we take that into account." There were a lot of qualitative things that, again, I admire the way screening out ESG and there's no perfect way to do it, but there's really good ways to do it. But with us, our products are already ESG, because we firmly believe we're into for the long term. We don't want companies that are going to have earnings that are just going to beat this quarter or this year, we're looking for long term compounding machines and that's embedded in our process. But they're just different flavors of accessing the same thing I think in pursuit of not just doing right, but doing better as an investor.

Marc Zeitoun:  There's so much to say on this, I resist the temptation of going down this whole long path. But I will agree with both Sean and Dodd from Columbus Threadneedles's perspective, we look at it as Dodd was described. It's just, it's part of research. Someone recently told me, "Think of ESG as the word audited." Audited financials are always better. You're not going to necessarily build a fund of audited companies, but if you had a choice between audited and unaudited, you would go audited.

Marc Zeitoun: ESG for us responsible in investing, it's just part of our research fabric. Now, what is difficult is, do you label it as such? And if you do, how do you report on it? We are an industry that is really good at reporting on excess return. I think our European colleagues are being told how to report on certain ESG outputs, so that's one framework, but back to John Q. Public and the advisor, I don't know that our entire ecosystem is yet set up to say, "Here's your alpha, and here's your carbon footprint, and here's your net and these are the three measures that we concern ourselves with, for your portfolio."

Sean Edkins: On that, thanks for chiming in guys. I do work for a European firm and due to that landscape, been at the forefront of not only, Marc to your point, the regulatory aspect, but also Dodd as you know, it's client driven. Generally, foreign pension plans and institutions, this is the way they invest and they have done for years and there are certain things that are expected. Marc to your point, it is like, so if I... Again, it's a lens that both of you all said, your firms use the non-financial materiality is what I like to call it of the sustainability of the company.

Sean Edkins:  How do I measure that is really key? That's probably one of the greatest things, where I work, at DWS, because we've been doing it for so long and invested a lot of money and time into the data aspect of not just one data provider, but really because each one has and unique access point and expertise in gathering either social, environmental, or labor aspects of it. How do you then combine that and then report it back to the investor. I was able to remove 100 cars off the road by investing in this some emerging markets ETF and oh, by the way, compared to the traditional market cap, I was able to demonstrate 200 basis points of excess return for a lower risk profile. You're not giving up return or risk and you're doing well, as well as doing good in the investment experience. Measurements really, really important, but being able to provide that back, we should and guys just as an offer, we work with other firms too, so if you want to go down that road, we have this pretty unique engine we can talk about.

Jenna Dagenhart: Maybe, we'll take that one offline. Following up with you, Sean, are there any additional best practices that advisors and investors should deploy as they either build these ESG models or communicate to potential investors?

Sean Edkins: Same ones Dodd said earlier, it's again, it's an index based, and Marc, you said the same thing earlier, I'm glad you did. Each index provider has their own ability and methodology. How much market cap do you want to catch? What exclusions do you expect? That comes back to your point Marc, am I giving up alpha for tracking? What is my outcome? And just full disclosure, where we are now in the building blocks of ESG asset allocation, it looks just like the building blocks of non ESG.

Sean Edkins: You'll get similar outcomes, but that's going to evolve and I would just say there's becoming different shades of green. So light green, medium green, dark green, and that has to do with the amount of exclusions, which really is a personal taste and objective, and then that relates directly to the tracking error, to what standard non ESG benchmark. But tracking error, liquidity, don't let a small ETF fool you. You got to look at the index provider, how long that track error's been around and then it's a little bit of work up front, but hopefully people don't just look at the largest ETFs that are out there, that are getting all the traction. To Marc's point, look at what's inside and what is your overall objective I would say.

Marc Zeitoun: I will just add that, I think that we're a little behind in explaining it to the public. We're using words right now. We're just, sustainable, ESG, RI. The more we weave this into our every day, the more we're going to have to find another way to describe what we're talking about because it's not going to be accessible and it's going to be versus. Dodd as you were saying, "Oh, you've got regular Davis. Let me get Davis with ESG." It's a versus conversation once again.

Jenna Dagenhart: Turning to the current market environment, we kicked off 2022 with a lot of volatility. Marc, during times of uncertainty, like right now, what are the biggest mistakes that you see people making?

Marc Zeitoun: The good news is, it's not just ETF users, it's everybody. Everybody makes the same mistake at times like this and they overreact to whatever it is that they believe. I'm not saying that they should, or shouldn't fly into risk free assets or risky assets or bottom feed or find opportunities but, we tend to double down on impulse during times like this. For example, money markets, we're at the highest level of money market AUM in the last four years. The fourth quarter was like the second or third biggest net inflow of money market. And I understand it, it's a visceral investing, can be emotional, back to every do-it-yourself investors, better off with a professional guidance. I do believe that and I follow my own advice, but it's the feeling of the need that have to do something, let me react right now. That long term person is going to feel it, but needs to resist against it. If you look at the flows, it's always the wrong place at the wrong time.

Dodd Kittsley: We couldn't agree more. It's such a strong point. I think it's one of the greatest things that financial advisors add to the many services that they provide their clients, is they help control emotions. We've all seen the Dalbar study that looks at the average mutual fund return and the average asset weighted investor return. Regardless of what time period you're looking at, and some are bigger than others, more volatile at times it's much bigger, but there is a behavioral penalty that is pervasive in this market due to just that. Its human nature and you can understand why. Its human nature, but then you can go to an example of, look, if you went to the grocery store and melts $5 a cartoon, and then you go back next week and it's seven, do you want to buy that milk when it's seven? But with stocks, it tends to have the opposite effect. Flip it around, same thing.

Dodd Kittsley: One of our sayings here, and one of the reasons why we admire and love partnering with financial advisors is, it's a very simple equation that advisors add value. It's volatility minus emotion equals opportunity, and to be able to control that and most of us can't do it on our own. Even those of us in the biz, you need that to talk you off the ledge on these short term emotional decisions, can wreck returns.

Sean Edkins: Guys, I love that. I would've normally said the same thing, but listening to your views brings me to maybe an opportunistic idea right now, because what have we been talking about? We've been talking about, do you know what you own, is it the right mix, right composition? We talk about fees. We know that small ETFs really don't matter. One of the things I've learned many times in my career is, to evaluate that during points of distress and that, gains go to losses quickly, but capital losses are carried forward. I'd encourage investors to look to do capital loss swaps at this point. If you're at a loss, take it, look at what you own. Is it the right mix? Go look at the landscape again, capture able loss right now, carry it forward because you'll have gains later in your portfolio, and these could be offset. Not that of a tax advice, that's no tax advice disclosure, but that's a common practice that we use in the early days of advisory over ETFs, is the control aspect of that, so just a reminder there for everybody, I would say,

Dodd Kittsley: Because you have so many options within a category, you can find very similar exposures that are likely not subject to wash-sale rules. There's truly economic value in positions at losses and they add tremendous amount of value that way. I think the other thing that advisors help people out a lot in is, look, we know bad things are going to happen. We know there's going to be a sell off. We don't know when, but on average you get a 5% sell off every three times a year. You get a 10% sell off every year and you get a 20% sell off every three and a half years.

Dodd Kittsley: It happens consistently. But you look at downturns in the S&P 500 and we've seen double digit returns more often than double digit drops, more often than we haven't. But the majority of the time, the majority of the years, the returns are positive for the year. In more than half, they end up being double digit positives. We're not saying blindly stay the course, but control emotions in terms of your investments into your exposures when the rest of the market is losing their head.

Jenna Dagenhart: Yeah. Cutting out the emotional component is definitely key there. Another thing that a lot of advisors are getting questions about right now is the fed. Are rates going up and by how much? On that note Marc, how can ETF investors respond to the rising rate environment and where should they be looking for income? I won't ask you to predict the dot plot or anything, but just broadly speaking, how should investors be thinking?

Marc Zeitoun: I like the way you asked the question, you said, "What should ETF investors do, not investors writ large?" I'm going to say, I'm going to stick with that because ETF investors love to buy broad benchmarks right now, or they just like to shorten their duration on that. They're still buying broad. I think that there's so much more dynamic levers in the fixed income world than simply where you are in duration. That it's worth looking at ETFs that invest in strategies, cautiously, in other areas of the spectrum.

Marc Zeitoun: There is a lot to be had with mortgages. There is a lot to do with portions of the high yield market, not all of them. It's that dicing and slicing that Sean was talking about, but you know what, it doesn't really exist on the fixed income side, as much as it does on the equity side. That slicing and dicing, you might have to buy something that is specialized in that or is much more diversified. We built something that was diversified specific as a foil to benchmark investing and fixed income. But I think it's an opportunistic time. I'm obviously going to rely on research intensity to help find those because that's what our call is, but either way it's not just, "Oh, well, I'll just buy the market."

Sean Edkins: Marc, thanks for bringing that up. I think first and foremost, identifying the market conditions, so there have been no rate raises yet. There's been verbalization and expectations in the markets have moved dramatically, which again, creates opportunity or not. If we're assuming liquidity is being drained, and rates are rising, a lot of investors I think were positioned with short duration and I'm glad you brought up high yield Marc, because that is one of the asset classes that's been quite resilient with loans historically in an environment where liquidity is being drained and rates are being risen. To your point also, are there solutions that exist? And there are, where you could separate that broad based high yield asset class into a high quality and low quality, if you could. High beta, low beta and with shorter durations.

Sean Edkins: There are at least one solution that I'm aware of that provides that, if that's your view. Loans were the other thing that would be thought about that we see, but really we haven't seen the execution. Did the markets basically do the Fed's job for them already? And is that, may or may not be off the table? So inflation is definitely a key concern across every organization right now, we'll have papers on it, I'm sure. But back to my earlier comment, the market has sold off. There's opportunity. Do you know what you own? Can you take repositioning based on your own views because there's a lot amount of tools to implement that view. Those are a couple things that I would suggest and we have a couple of those solutions.

Jenna Dagenhart: Now that we've touched on, all that investors are thinking about right now, specifically ETF investors, let's talk a little bit more, before we wrap up about where ETFs are going in the rest of 2022. Dodd, what do you think will be the biggest trends for ETFs in 2022?

Dodd Kittsley: Gosh, a few things. I think the trend from last year of a lot more asset managers getting into the game, a lot more big asset managers finally deploying their internal ETF strategy on the active side. I think we're going to see that continue. The ETF industry is maturing and it's still this lightning in a bottle for innovation, but at the same time, I think we're going to be seeing less viable strategies, less competitive strategies, certainly close, and there's nothing wrong with that. We see mutual funds close all the time. ETFs sometimes do as well for a variety of reasons, but it's primarily if they're meeting true investor demand. But I think the entrance of both high quality managers, as well as new managers with maybe not the track record or the expertise will happen, and you're going to see it from a lot of different standpoints.

Dodd Kittsley: The exciting thing is, there's going to be lot more choice. We saw two thirds of all issuance last year, be actively managed equity ETFs, they've come of age. The growth I think is going to continue over the next decade because active ETFs, both fixed income and equities are only 4%, yet a 4% of the overall industry and they're one of the fastest growing in an industry that continues to have record flows, taking in almost a trillion dollars last year, writ large in ETFs is amazing. Particularly, we felt pretty good the year before taking in over 500. But those are the areas I think you're really going to see grow and some consolidate and there's nothing wrong with that.

Sean Edkins: I'd echo those comments exactly where each of your firms already into the active space and there are a lot of other big names that are now coming into that channel. Yes, that will continue for a number of reasons. The wrapper we talked about in the tax efficiency, the choice I would say in wrapper is also key, so that will continue to happen. Self-serving with the ESG is going to continue on in this country to catch up with Europe. Be it just from individual investor interest and demand, but possibly Marc, to your point, there's a very loose goosey interpretation of regulation. What is it? What is it not? Can you say, if you are truly an ESG manager.

Sean Edkins:  All those things are going to I think, the regulators love to get involved in these opportunities, so that's going to be a big thing to continue out. To tee you up Marc, your comments about direct, we're not in that space yet either, but the technology's there. Some major competitors that we all have, we've already invested. I think that's going to be the next iteration of customization to consume as you want it, how you want it, with those baskets would be my contribution there.

Marc Zeitoun:  Yeah. I think it's the continued proliferation of this stuff, and the semi-transparent we'll eventually see, so there other asset classes, I think the commission is very favorable to the ETF business in general. Obviously, there's some concerns around crypto right now, but that too will work out in whatever format it ultimately ends up with, because that's an investment issue, not an ETF issue. The industry will want to solve that generally. I think it's great that Dodd kicked us off on the call because he's doing such a nice job of closing it up with Sean. But I do agree more choice, which with education is more empowering. I'm excited about the future.

Jenna Dagenhart: Well, should be a big 2022. Everyone, thank you so much for joining us.

Dodd Kittsley:  Thanks so much for having us.

Sean Edkins: Janet, it was great. Dodd great seeing you again and Marc, nice meeting you, so have a great the rest of 2022, everybody.

Marc Zeitoun: Thanks for having us on this was great. Thanks.

Jenna Dagenhart: Thank you to everyone out there watching this ETF Masterclass. Once again, I was joined by Sean Edkins, a Head of ETF Strategic Partnerships at DWS Distributors, Dodd Kittsley, National Director at Davis Advisors, and Marc Zeitoun, Chief Operating Officer in North America and Head of Strategic Beta at Columbia Threadneedle Investments. I'm Jenna Dagenhart with Asset TV.


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