MASTERCLASS: ETFs Into 2023

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  • 51 mins 15 secs
Four experts from ETF issuers and services providers discuss some of the key trends and product developments in the marketplace, ETF construction, ESG in the space, and what the landscape for ETFs looks like in 2023.
  • Dodd Kittsley, CFA®, National Director - Davis Advisors
  • Chad Miller, CFA®, Senior Portfolio Manager - Thrivent Asset Management
  • Amanda Rebello, CFA®, CESGA®, Head of Passive Sales, US Onshore - DWS
  • Mike Prendergast, ETF Product Specialist, Head of ETF Products - Ultimus Fund Solutions

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Jonathan Forsgren: Welcome to this Asset TV ETF masterclass. We'll unpack some of the key trends and product developments in the ETF space, discuss ETF construction, and ESG considerations, and what the landscape for ETFs look like in 2023. Joining us now, we have Amanda Rebello, Head of Passive Sales, US Onshore at DWS. Chad Miller, Senior Portfolio Manager at Thrivent Asset Management, Dodd Kittsley, National Director at Davis Advisors, and Mike Prendergast, ETF Product Specialist and Head of ETF Product Management at Ultimus Fund Solutions. Thank you for joining us, everyone. Dodd, can you kick us off by sharing a little bit about the evolution of ETFs over the last 25 years, and can you give us a little perspective into the growth, and what are the key drivers that led to that development?

Dodd Kittsley: Well, thanks first of all for having us here, and love to start with that, I've been fortunate to be involved in ETFs for over 25 years, and we're about to hit 30 years in the industry, which is ironic because a lot of folks think that these are still new products or they're just becoming familiar with ETFs, but January, we'll mark our are 30 year history, at least in the United States, and even longer outside the US. The growth has been nothing short of amazing, it really has changed the way people invest, changed the way that money is being managed. To put it in context, starting the year 2000 even, because not much happened from 93' to 2000, we had less than a hundred billion dollars in the industry. You fast forward a decade, you're talking over three trillion dollars another decade, you four fast forwarded to do 2020, we're talking over five and a half trillion dollars just in the United States, and here we are just under seven right now with a little bit of the market selloff and what have you.

                                    To also put it in context on a relative basis, ETFs in 2000 were about 1% of the combined ETF and mutual fund industry, today that's 35%. Think about a disruptor in the way that people get diversified exposure, and really what's driving it I think are three things. One is just a diverse investor base, I mean anyone who can access and invest in a stock market can buy an ETF, and that ranges, and the ETF users range from self-directed putting in hundred share trades to central banks and major institutions, and they're all big, big players in that. The advantages certainly are driving the growth and the awareness of that but I think perhaps what's really, really driving this growth is the compelling exposures that ETFs have instantly made relevant to all investors. Whether it was indexing beginning in the early days, to factor-based investing and smart beta, to today, being able to leverage efficiently strategies that are actively managed.So this toolbox amongst investors has grown enormously and it's done so providing efficiency, lower costs, more tax efficiency, transparency, all of those benefits is what really attracted people in the first place.

Jonathan Forsgren: And Mike we're going to come to you. You're representing a service provider in the ETF space, what role does a firm like Ultimus play in the ETF ecosystem?

Mike Prendergast: So Ultimus, we're one of the largest independent non-bank fund administrators in the industry. So what we do is we basically service to back office work, core functionality around fund accounting, fund administration, so call it the plumbing, the back office plumbing if you will, of to maintain daily operations, efficient operations, to make sure that we have efficiency and straight through processing as it relates to processing the data affecting transactions in the marketplace. So what we typically offer is our core benefit really is around the fund accounting fund administration, we offer services that the funds need. Each fund has to have a trust, a board of directors, so there's from a risk and compliance perspective, there's offices of the trust.Ultimus can assist in that process.

We also have a unique view within the industry of where we sit because we are not a bank, so therefore our operating model really is we provide some core services around fund administration, clients can choose a custodian they want, audit firms they want. We help make industry introductions to key market participants within the industry, whether it be the authorized participants, the lead market makers, we make introductions to the exchanges. We have experience with, we've launched over of probably 40, 50 products in the last two years, so we have a lot of institutional knowledge as it relates to getting to the market quick, efficiently, training our clients or educating our clients who are new to the space. So we offer solutions that basically enable our clients to get to market fairly quickly and typically at a lower cost.

Jonathan Forsgren: Mike, I'm going to stay with you. You mentioned that you've got institutional clients abreast, and so this gives you a unique perspective into what clients are looking for and what ETF issuers are looking for. So what are some of the trends that you've seen develop over the last year and that you'll think will carry over into 2023?

Mike Prendergast: We've seen a lot of clients actually enter into the space for the first time. About two years ago, maybe a little more than two years ago, Rule 6c-11 was passed by the SEC, also known as the ETF rule. What that did was streamline the process actually for ETFs to come to market, no longer did you have to go to exemptive relief. Very, very similar to the amount of time it would take to bring a mutual fund to market, 75 day filing period if you have an established trust. So what we've seen in the space is the fact that, Dodd mentioned that the significant interest in ETFs due to the tax efficiencies and typically it's thought as being a lower cost vehicle for investors, but what we've seen now is clients coming to market that might have been sitting on the sidelines, whether it be a mutual fund, there were mutual fund asset managers wanting to get into the ETF space.

                                    We're also seeing a lot of registered investment advisors typically managing SMA assets or strategies that now want to put that into an ETF because it's operationally more efficient for them to manage the strategy in one portfolio versus separately managed accounts, and also there's tax benefits for their end shareholders being in a structure like an ETF. So we've seen a lot of folks looking to come to market that are new to the marketplace, existing managers who are looking to get into the ETF space, and we're also seeing a lot of interest in converting existing asset structures and trying to do a tax-free exchange to what they call 351 exchange, where they're able to move the assets from a mutual fund or from separately managed accounts into an ETF and do that in a tax-free nature.

                                    So we've been spending a lot of times with clients educating them on the marketplace. We have a pretty robust, what we call onboarding project management process where we actually manage, we look at is as we give you the chassis and you sort of build your services around that. Our core technology allows folks that flexibility, that they're not tied into one provider for all their services so offering them the flexibility, I'll say more of a boutique with industrial strength technology but hands-on management, consultativeness, working with our clients, making the right industry introductions, and many times just educating clients on what has worked well in the past and make sure that our clients don't sort of fall into any situations that we may have seen or we can see coming. So we like to think of it as being very proactive and working very closely, but clearly there's been tremendous demand within the marketplace for new products and we have developed a very flexible operating model that allows our clients to bring that to market.

                                    We're also seeing, from a trend perspective, we're seeing a lot of folks obviously actively managed ETFs continue to grow, it's about 60% of our new launches for the last couple of years, both on the sort of domestic international equity fixed income. We're also seeing a lot of clients actually look to sort of expand the risk exposure of the funds, seeing more of funds looking to create alpha through derivatives, swaps, and then assisting our clients sort on the regulatory and the compliance issues around sort of diversifying or I should say, extending yourself into those risky areas where you need to make sure you have more support from a compliance and regulatory standpoint, and offering additional services around that.

Dodd Kittsley: I'd love to just put a point out what Mike had just said in an addendum to my last response, what's fueling growth in the ETF industry, and what Mike and his firm are doing, along with the ETF rule that he mentioned is really reduced the barriers to entry into this space, and we've seen, as you mentioned, a lot more entrance that maybe were hesitant, didn't quite have the scale, didn't have the expertise that they can provide them now. So we're seeing more and more players in the space, more and more strategies, particularly on the active side.

Jonathan Forsgren: So Dodd, who are the big users of ETFs and how are they leveraging the advantages of the product?

Dodd Kittsley: There are a couple great things about ETFs. First is, again, if you have access to transacting on a stock exchange, you can buy ETFs, and that really opens it up to just a very, very broad investor base, ranging from, again, self-directed investors, financial advisors, both at wirehouses, brokerage firms, registered investment advisors, insurance companies are huge users of ETFs, and then institutions, whether it's hedge funds, central banks, a whole host of user base. So I would say ETFs probably have the broadest user base of any financial product that is out there. The other great thing about that is that everyone's on a level playing field, right? They're not break points with ETFs, if you're a big player, you don't get advantages over the guy at home putting in a hundred share trade. And the neat thing about that is it's a symbiotic relationship where long-term smaller investors actually benefit from huge short-term investors because their activity helps create more efficiencies in trading, reduces trading costs, and creates a lot more efficiency to get exposure that they're looking for.

                                    So the more activity, the more players within a particular ETF, actually the better it is for all involved. They're using it for a host of different purposes, it could be an alternative to futures, a quick market exposure. Mutual fund managers are using ETFs to equitize cash and be able to have their cash position actually be in line with the benchmark, which is pretty neat, but we're seeing the most of is people using ETFs to create scalable business models for their clients through asset allocation models. So I can let others kind of chime in, but the uses I think are absolutely unlimited because of the flexibility of the product, the ease of access, the transparency, and the number of products you have out today.

Amanda Rebello: I think this year especially, they've definitely come into their own, it's been one of the most volatile years across all asset classes in memory, and what you've seen is that there's also been an evolution of fixed income ETFs. So historically, the equity ETFs were used a lot more as delta one alternatives to swaps, to futures, and so forth, but we see now as well the fixed income instruments are also being used very heavily from that perspective as well. Quick execution, anonymity in terms of position as well, that's been leveraged quite a lot by hedge funds, other asset managers, and then also large institutions like Sovereign wealth too.

Jonathan Forsgren: So Chad, can you discuss why Thrivent decided to create the recently launched small mid-cap ESG ETF, and can you discuss the unique process which Thrivent has created in your new product?

Chad Miller: Yeah, happy to Jonathan, and thanks for having us here today. So Thrivent's mission is to provide our clients with financial clarity so that they can live lives of meaning and gratitude, and with that mission in mind, we saw an opportunity in the marketplace that combines three of the most attractive areas of asset management today, those being the small and mid-cap space. If we look back over the past 30 years, small and mid-cap companies have been the top performing publicly traded asset class, returning roughly 11% per annum. The second part being ESG, where we've seen tremendous interest from investors on products that consider various ESG factors, and for us, we've started with a successful fundamental research process and we're adding into that our proprietary ESG process. And then finally is the ETF structure to give our clients these elements in a lower cost and also more tax efficient structure. So combining those three elements into one product is why we're so excited to launch the new fund.

Jonathan Forsgren: And Amanda DWS has also launched an ESG ETF recently, what are some considerations that DWS takes into account before deciding to launch an ETF, and then why this ESG fund right now?

Amanda Rebello: So we've got a core range of ESG ETFs, so we're covering all of the different asset classes within US equities, we've got large, mid, and small cap, we've also got dividend, growth, and value. Then we also offer international equities as well, and then we also in fact have ESG fixed income too. And for us, we always do a due diligence in terms of ascertaining which benchmark we're going to track, that's quite in depth, so we think about the different index providers, what are their nuances and their expertise in each of the kind of parent asset classes. And then we have to think as well about the quality of the data that they can embed into the ESG indices. So that's really important because it's not just about putting a label on a fund, it's also about making sure that the fund is really going to deliver the aims that you want for the product.

                                    And so we partner a lot with different index providers like MSEI, like S&P, like JP Morgan for example on and the fixed income side. All of them are very good to work with, what we think about often is that at the end of the day, most of the investors, they're still benchmark aware, so they're still aligned to the S&P500 for example, and so really it's about how do we deliver ESG version of those benchmarks that they're still having to adhere to within portfolios? We then work with the index provider, and it's actually usually very consultative. So often the index doesn't exist to start off with, we help them with that journey, and we have an ESG engine at DWS, so it's based on five different data sources, so we can actually be quite pernickety when it comes to having a conversation with the index provider, be very demanding clients to them, and we have our own ESG leaders as well who can have views on the future of ESG, different components of that.

                                    So we always look for high quality data, that means long track record, long history of having different data points on different constituents across the world because we're always looking to think about global exposures as well. And then what we also think about as well is the rebalancing too, so how often are you going to look at this data, and then integrate it into the index constituents into the recipe for the index. We also think about there's a lot of criticism about ESG, so you're not going to be exposed to the full market. We typically try to have sector neutral approaches because energy for example, it's important to think that actually whether you buy equities or bonds, this is a deployment of capital, and so actually you are helping the situation by picking the companies that you want to invest in. So maybe some of the larger energy names are also the ones which have higher CapEx towards green technologies, for example. Agreed, they are still drilling for oil and so forth, but they're also part of the solution, and it is important that you are also including them in the allocations as well.

Chad Miller: I just wanted to dive into our ESG process in a little more detail to talk about the proprietary ESG process that we've built into this new product and a few areas that I think are important to touch on. First, we start with our stakeholder analysis, and this is the portion where we're trying to analyze if companies can sustainably and successfully serve the primary stakeholders within their business ecosystem. We break it down into six primary stakeholders, being the environment, employees, customers, suppliers, communities, and then effective corporate governance over the top to make sure the company is run properly. And what we're doing is stepping through each of those stakeholders and trying to make a determination is that company successfully serving that stakeholder? What might be the risk in there, the opportunity? What do they need to change or potentially invest in their business over time?

                                    And after we're done with that portion of our analysis, we move on to try and focus on financial materiality. So we're really trying to key in on the top two to three or so what we believe are financially material ESG topics that this company needs to address and ultimately get right to be successful as we look forward. And after we've done those two elements of our process, we're able to take that, and as long-term investors that are really focused on owning the company for three to five years or beyond, we can then take that and engage with the management teams to understand what are their perspective on the issues, what are they investing in, what are they doing to try and address the various issues that they're facing and how are they positioning that company to be over the next three to five years? And ultimately, after we complete that picture of the company in our process, we think that helps us make better investment decisions.

                                    And I also think it's important just to touch on for a second, a couple of the things that we do not do in our ESG process, and one of those which Amanda talked about a little bit but is exclusions. And for us, we don't have any sector exclusions that we look at for the product, but rather we put each company through the exact same fundamental and ESG process, and then we're left with companies that have a strategy to address their material ESG topics and then also outperform their peers. And the other topic that has come up a little bit is any type of moral, social, or political angle, and for us, we have none of that in our product. We are simply looking at these factors to help us achieve attractive risk adjustive returns for our clients.

Amanda Rebello: I think this governance piece in particular is so important because actually this is something that all portfolio managers should be looking at, and the ESG data can provide us with so much guidance on this. It's not subjective, it's objective, so the governance piece can eliminate quite a lot of RepRisk, and especially in tough markets like this year, we saw a lot of ESG strategies outperform. It's not to say that ESG is always going to outperform, but a lot of it is actually quite attributable to the fact that you already kicked out some bad governance names in the portfolio.

Dodd Kittsley: I got to say just that at a high level, this is really an illustration of why ETF space is so exciting, it's about choice. And I might like mint chocolate chip, and you might like peanut butter fudge, it's great to have choice, you don't want just to have vanilla all the time, and one's not better than the other. Both of their firms do a tremendous amount of time, spend a tremendous amount of resources educating on what are the trade offs, and it's really the job of the advisor or the investor to kind of decide amongst what approach is right for them, and to have that toolbox with more choices rather than less is really why we're seeing so much growth.

                                    Our approach to ESG is a little bit different, we don't have an ESG labeled product, but we are benchmark agnostic, bottom up, research driven shop, and ESG is something that is embedded in our very qualitative process, where we'll spend years understanding management teams, companies, the competitive landscape, how management treats their employees, how they treat the environment. And our going thesis is that if you're not treating your employees well, you're not being fair, if you're hurting the environment, that's not good for the long term, and we buy businesses, we don't rent stocks. So that's kind of our view on ESG. While we won't fit for somebody who's probably looking for something that's an ESG mandate, it is something that's really important to us in our investment process.

Jonathan Forsgren: And Mike, how are your clients coming to you with ESG needs?

Mike Prendergast: I mean what we see in the ESG space is from a servicing perspective, for the most part ESG funds fit pretty well into an ETF wrapper, as far as the investment mix and the investment type, but what we are seeing though is as regulatory requirements change, disclosure requirements change, we need to be flexible understanding what those changes are so that from a reporting perspective we understand what we would need to do for on behalf of our clients as it relates to our fund administration role. Also, as it relates to filing, filing of the ETF if this question's about the name. And I will say being able to account for new instruments as they come to market, whether it be the carbon credit futures, and so there are some new investment types coming out into the marketplace to support them, and just making sure that we do any kind of new type of investment, making sure that it's going to fit into an ETF wrapper properly, having conversations with the marketplace so that folks know how to interpret the data, and basically price the basket to make sure that they can maintain reasonable spreads in the secondary market as it relates to pricing the ETF.

Jonathan Forsgren: Mike, this question's for you, but I'm going to allude to one of Dodd's questions there. He was talking about the differences in ice cream, and he might like mint, I might like peanut butter. So let's say somebody wants to open up their own ETF, can you explain the options an investment advisor has in setting up their own exchange traded fund?

Mike Prendergast: Typically, they say either you build it or you buy it, and what we mean by that is obviously in ETF you need to establish a trust, and the question is how do you go about establishing that trust? Do you want to go about doing that yourself or would you go to a third party white label or what we call a series trust? So if you were to go to the series trust route, it's an established trust and it's a turnkey solution. You utilize an established board and typically established trust council, and you would come into the trust in all as you would need to do since it's an existing trust, it's a 75 day period of doing your filing. So typically that solution will get you to market quicker, typically you can get to market within four to five months if you utilize this series trust.

                                    You get some economies of scale, you are utilizing it's established board, and there's trust offices, CCO, and those offices are required under the SEC and they have certain roles and responsibilities from a compliance and regulatory standpoint. So you're able to leverage that, and typically it's a cheaper product for clients because you're able to take the expenses of that board in those various functions and they're shared amongst all the other funds that are part of that series trust. And you also then leverage, from an economic standpoint, there are typically due to the scale of the trust, you are able to leverage contracts that they may have with other service providers, whether it be for insurance, custody, audit firms, so there's additional sort of economies of scale of entering into the series trust process. And you're able to take advantage of even trust level agreements with the authorized participants. And typically, again, you're able to then just focus, we like to see some of our clients coming into this space, they're then able to focus on managing money and raising assets, and it provides them a white labeling opportunity. So they have their brand but they don't have to deal with the infrastructure, and the risk, and the day-to-day operations of the fund.

                                    On the other hand, if client wants to open up their own trust, obviously they might want to have control over the board or have more say in the selection process of who the board members are and maybe some additional service providers, they would potentially do that route if I was opening up their own series trust. Hire a council, establish the trust, hire a board in that process and basically establish the infrastructure to support that. And it depends upon what a client, maybe their long-term view is, how quickly do they want to come to market.

Dodd Kittsley: We've come a long way. It's like you said, months to come to market. Obviously variable options, but one of my good friends helped to launch the first gold ETF and that was measured in years, in multiple years, so maybe different product, but it's again, the efficiencies here are going to continue to expand that toolbox in a great way.

Mike Prendergast: It's a good point, and I will say service providers like Ultimus now, we used to have a year to be ready, now it is three to four months. So there are multiple work streams working concurrently during the filing process to make sure we're hitting dates, and the efficiencies in the technology that's supporting the straight through processing is definitely something that is needed, and making sure that your service providers have the technology to support the infrastructure and basically have the technology that's flexible enough that allows the connections into the ETF ecosystem and allows you the flexibility. So if a client wants to deal with multiple providers, the technology is there to support it and it's very agile so that the fact that it's plug and play. So it's key to have that flexible infrastructure to support, I will say a rapidly changing marketplace, especially from a regulatory standpoint, and the ideas that are now coming out into the marketplace and making sure that you can support them in an ETF structure.

Jonathan Forsgren: Speaking of marketplace, Dodd, where is Davis finding opportunity in the marketplace today? What are your research teams looking for when they're rating and analyzing ETFs?

Dodd Kittsley: We're finding tremendous amount of opportunity in the market today, particularly because the environment has undoubtedly shifted pretty dramatically coming out of a very abnormal period of free money. Gosh, our chairman put together a chart, it looked at levels of interest rates going back historically, and we're coming out of a period of the lowest interest rates since 3000 BC. So long, long time, and that created very divergence of performance over the last decade, and as active managers, we seek to take advantage of that opportunity and obviously we have seen a big sell off over the course of the last six, six to eight months. So there's a lot of fear out there as well, and that has created, I think dislocations in the business results of companies versus the stock prices of companies. So there are areas like financials we think that are still being painted with a brush during the global financial crisis.

                                    This time is very, very different. Their balance sheets are better than they've ever been, they're one of the few segments of the market that's poised to benefit from higher interest rates. They're very well-managed companies. Being selective, we can choose, but companies that have been around not just for decades, but for centuries, often multiple centuries in some of the companies that we own, so they are dominant players. There's so many opportunities out there both within segments and in specific sectors. We certainly think that e-commerce, especially global e-commerce companies, have really been discounted, unfairly so. To see dominant companies in end markets where the growth is happening at 20 to 30% revenue growth on trading at single digit multiples, wow, huge, huge opportunities. Great opportunities overseas too, it's unpopular but we have a saying at Davis, that where people feel comfortable often lurks the biggest risk, and where people are scared of often has the greatest opportunity. So for folks using us, we're not for everyone, we pair very well with broad-based kind of market types of exposure, but we're very differentiated and we're very comfortable being so because that's what we do and we're really built for these kind of times.

Amanda Rebello: We're also quite keen as well on international exposures. I think that European, we're a European asset manager, we ourselves felt a lot of pain, we saw that through the eyes of our colleagues as well living in the region, but I think that Europe at the moment and international more broadly is not the case that it's looking cheap, it's looking like it has value, so we're also very much on the same page there as well. I think as well, just thinking about where to go with international as well, if it is unnerving, then you can think about other ways in which you can reduce your volatility, like having less of a view on the currency for example, and just hedging back into dollars too. So even for those who kind of want to make a play in the space but less familiar with it, there are lots of tools in the market which can help.

Jonathan Forsgren: And Amanda, staying with you, are you seeing good reentry points in 2023 for investors who might've withdrawn from the ETF space in the last year?

Amanda Rebello: Well I think that 60/40 didn't work this year, so a lot of us have to rethink our as asset delegation, not just for the last year but for the last 10 years maybe, and Dodd, you're absolutely right, we're entering into a new era. So I think there's a lot of reconsiderations that all investors should be making for 2023, all of the asset classes kind of performed like unanimously downwards, so I think in every asset class or sub asset class, there are some opportunities. We think that high yield is something quite interesting. Fixed income more broadly is interesting because now there's actually income and fixed income, we haven't seen this for over a decade pretty much. And so high yield in particular we think is quite nice because, Dodd, you mentioned it as well, there's actually a lot of corporate strength, so default rates even in the lower quality names as well, within high yield actually been quite low versus historically. So high yield is something that can help there, especially when you're kind of competing against bank deposit rates. And then we also think as well, thinking about some other asset classes as well, moving away from just having a US equity portfolio, but also thinking about having more kind of liquid real assets as well, for example, through REITs, through infrastructure securities as well, is something that clients can be considering as well for next year too.

Jonathan Forsgren: Chad, back to you. How can ETF managers deliver in small and mid-cap asset classes given the projected outlook and where we are in the market cycle?

Chad Miller: Sure. So I think that at Thrivent we don't engage in any type market forecast or macroeconomic forecast, but what we are aware of is where we are at the current time and taking stock of where the opportunities might be in the marketplace. And so I think if you look right now, for our products specifically, in the small and mid-sized companies, we know that over the long term that is a good place to look for great companies with a long runway for future growth and improvement in financial results. I think if you look at the other side of that, the valuation set up we're seeing today in small and mid-cap companies relative to their larger cap peers is really compelling. And the last point is just that we know coming into a potential rebound at some point in the marketplace, the small and mid-cap companies, they have a stronger bounce off of the bottom and ultimately a stronger return relative to their large cap peers. So with that backdrop of those three attractive elements, we're seeing opportunities now in the marketplace in the areas where we're looking and I think as people are out there looking and thinking about great deals and doing some holiday shopping, perhaps now is the time to do a bit of holiday shopping in the market,

Jonathan Forsgren: Continuing to look forward for a different type of opportunity. Amanda, with tax season not so far in the future, how does DWS help its clients with tax loss harvesting?

Amanda Rebello: So we're not giving any tax advice ever, but I think this year a lot of portfolios across the different asset classes have seen some losses, maybe there are more opportunities this year than in previous years just because you can crystallize a loss in your portfolio in pretty much all of the asset classes across equities and fixed income. We are seeing a lot of clients looking to reengage again on some kind of similar exposures, so they might have the broad base benchmark, but now looking to think about a lower volatility or less draw down exposure of the same asset class. So we're helping clients a lot with that and I think a lot of clients are also expecting a Santa Rally as well, we've already had a couple of days of that, so just thinking about doing this pivot sooner rather than later.

Dodd Kittsley: I can add on that too. ETFs are very, because again of choice and having a lot of choices within each category, they are used by advisors and investors in a huge way to tax lost harvest. You're going to find very similar exposure in a different product, not subject to the wash sale rule, be able to maintain market exposure, don't miss the Santa Rally, and then either rotate back into your preferred investment or maybe you like where you rotated back into. But having that choice in many choices for similar exposure yet nuances, we see tremendous amount of unlocking of that economic value of positions held at losses, and that's where advisors are really earning a tremendous amount of the fees that they're charging outside of their investment decisions and outside of helping their clients control emotions and keep fear and greed at bay.

Jonathan Forsgren: So coming to you, Chad, 2022 was a solid year for active management. What are some of the pros and cons of active management, and how do you think the investment style will fare in 2023?

Chad Miller: Yeah, great question. So I think probably the most positive element of active management is that you can create a structure and a process to take advantage of opportunities when they arise in the marketplace that you can use through market cycles, and I think the important elements to have so that you can capitalize on those opportunities is first of all the team. We're lucky at Thrivent that we have a large investment in our equity analysts, and our equity PMs, and all of our support infrastructure over the years to have that in place. The second element is you need a process that is tried and tested that you can leverage and build off of, and in our case, we have a fundamental process that has been used out in the marketplace specifically in our small and mid-size funds successfully for a long time now, and we integrate into that our ESG process.

                                    And then finally is the ability to have patience in a long-term investment horizon as you are crafting that process and structure, and we're lucky at Thrivent to have the mandate that we should look out at the next three to five years and beyond for our clients who create value, so that gets us out of the day-to-day, the week to week, the quarterly results, and we can focus on the things that are actually financially material over the long term. So as I think about active management, the biggest advantage is creating those structures to let the market give you opportunities, and when it's down, you use try and capitalize on those and when it's up, perhaps at times you get more defensive and you lean back on that structure and that process you have in place as a company.

Dodd Kittsley: We couldn't agree more, Davis is an active shop, we've been doing it for 53 years, and you high highlighted all of the very, very important characteristics if you're going to go active, and that's a mistake a lot of people make with ETFs, they think it's just about indexing, and it's not anymore. And the fastest growing space is the actively managed space most of the entrance, or 67% of the entrance, last year were active strategies going in, but the due diligence bar is a lot higher and there's a lot of lousy active out there, and one thing that really gets me frustrated is people just dive into this SPIVA report, and they're looking at the average active manager, and most of the time the average active manager doesn't outperform. Well, who wants to choose active average? It's like you don't want to choose average, you want to choose above average, and looking at things like you highlighted, a long-term investment horizon. Have you done it before? Do you have a strong track record? What's your experience?

                                    A few other things I'll throw in there is you got to look different than the index too. You should be only charging a few basis points or single digit basis points if you're giving S&P500 exposure, so you've got to be different. You got to have high active share and long-term horizon, and I think skin in the game is really, really important, we don't see enough managers doing this. Morningstar did a study where more than 85% of managers have less than a million dollars invested alongside their clients, that's something really important to us at Davis. And 2 billion out of the 20 we manage is firm and family money, our PMs are compensated in shares over a five year period. So there are a lot of due diligence questions to ask, it can be daunting and that's where advisors come in, but you really can separate the wheat from the chaff by just asking some of those very basic questions.

Amanda Rebello: Dodd raises a very interesting point, so I think as well for this year, I'm at DWS, we have active and passive exposures in mutual funds and ETFs, so I can be agnostic from that sense. This year has thrown the cat amongst the pigeons really, US equities, the go-to way to do that, especially on the large cap side, was with index, but at the end of the day they have been very heavy in tech names with the fangs and they've suffered a lot of trouble this year, obviously doesn't look like they're coming back for at least a decade really, so I think kind of re-tabling active again in cheaper formats, more transparent formats like ETFs, I think there's a great opportunity for investors there.

Mike Prendergast: And even as it relates to expenses from an active perspective, it's not necessarily a race to the bottom. I think what we've seen from the flows is that investors will pay for alpha, and so your average active strategy is coming in a lot higher than an index fund, and so it's not necessarily a significance switch from a management fee if you had a mutual fund strategy and ETF strategy. Shareholders are definitely paying for that now, obviously we'll see how things go over time and how their performance will be once they hit their three and their five year track records, but it's as long as the investment manager is comfortable in a transparent strategy, in running that strategy, there's definitely benefits.

Amanda Rebello: Agreed. I think on this price piece, even a lot of clients we're seeing and investors are actually willing to pay for access that's been provided by ETFs, so in thematics in particular, also in some geographical regions where they haven't been able to gain exposure as well, just as we step away from this home bias, because it has been so skew towards tech names. So it's interesting that investors also understand as well that there's intrinsic value in outsourcing effectively to a manager through an ETF.

Jonathan Forsgren: All right, Mike, what area do you think Ultimus will be servicing its clients related to ETFs most in 2023?

Mike Prendergast: So in 2023, we're very bullish on the prospects from a market perspective. What we've seen over the last two years is significant growth, our business has almost doubled year over year, and we expect that to continue. Three, four years ago, we made a significant investment in technology and people, developing a scalable operating model for basically when this day comes. So we are ready for the business to come in, but as far as trends from 2023, we as I said, expect a lot of the same to continue. This actively managed seems to be a big draw for clients, although we are seeing some more indexing pop in here and there, and also more of the same sort of continue as it relates to mutual funds to ETF conversions, separately managed accounts, we expect that process or that trend to continue and probably pick up more so than what we've seen in the past year, which past year, there's been a decent amount to make that change.

                                    Also, we again see new clients coming into that space and we're pretty bullish, as I said, with that prospect, but where we look to help our clients to come in is making sure that we can educate them, provide that sort of consultive nature. Our onboarding team now is equipped with, we have the project plan, we have the master plan that we've been using for the last few years, but able to leverage that, help clients come to market quicker, making sure they're providing the right industry introductions to any new players in the industry and continue with the education mean. This business is all about educating clients and educating folks in the process, and we've been doing it now for 25, almost 30 years, but there is a whole new generation coming to market that requires basically the same type of education that we've been providing to clients in to and to shareholders the last 20 years, but I would say it's definitely renewed interest and enthusiasm in the marketplace.

Jonathan Forsgren: And then Davis offers many resources related to investor behavior. What do you want investors to understand heading into a very murky 2023?

Dodd Kittsley: Yeah, there's certainly uncertainty out there, but I think what really changes is our awareness of the uncertainty, not the uncertainty itself, and I think it's I important, and this is where advisors really come in, and Davis was founded 53 years ago based on partnerships with financial advisors. But recognizing that how you behave is as important as what you own, and when I say how you behave, it's like timing your buys and sales and not succumbing to human nature and selling when there's a lot of fear and buying when there's a lot of euphoria. Peter Lynch said the most important organ in an investor's body isn't his brain is, it's his or her stomach. So it's really, you do your work ahead of time, you and your advisor plan, and you're planning long term, right? Bad things happen all the time, we've had a lot of bad things happen, Covid, Ukraine and what's going on in the tragedies over there, but we all know that these things will eventually resolve. And if you look back on this kind of the last even two decades, what have we been through? 9/11, global financial crisis. Chicken Little always has his day but he is not a good investor, so don't be a Chicken Little is what we would say.

Chad Miller: Yeah, no, I think that's a great point as you think about just the kind of nuts and bolts of what that means from a portfolio management perspective, is one of the things we keep in mind is there are limits to how bad it can get, just like there are limits to how good it can get, and so if you go in stress test your model, and your valuation, risk reward analysis, and you're layering on bad assumption after bad assumption, after bad assumption, and you go back and see what that spits out, and it's the market price, well ultimately those are the opportunities that you need to be ready for.

Dodd Kittsley: If I could just highlight one thing too, because I've forgotten, I'd be remiss not to say this and I think it's a value to everyone listening. We partnered with Morgan Housel, who is the author of The Psychology of Money. If you haven't read that book, it is the best book I've read in the last two decades plus, and it's an easy read. It's written kind of like each chapter is almost a blog, so very digestible. I loved it so much, I gave it to my high school graduate son last year and all of his friends. And they actually read it, or most of them did anyways, but we have a video series with our chairman, Chris Davis, along with Morgan just kind of sharing, which may seem just very logical conclusions, but it's where, again, we as humans and being succumbed by emotion continually on average make bad decisions. So raising your awareness of those tenants is very, very valuable.

                                    We have a series of those videos that are already out and we're going to continue to do that, and it's really interesting to see more of an academic author's perspective, sharing the stage with a seasoned investor, a legendary investor if you will, three generations of a practitioner. So encourage folks to check that out, but the book, at least read, because that's fantastic.

Chad Miller: And that's where, to your point, the financial advisory is so important, to help with that type of journey, that even if someone who's in the market and tries to practice it every day, it's difficult, and so you need someone there to acknowledge that and help you walk through that process. I couldn't agree more.

Jonathan Forsgren: All right, Amanda, I'm going to give you the opportunity, what would you like viewers to come away with looking into 2023 here,

Amanda Rebello: I would say be brave enough to dip your toe back into the market, rethink your assumptions. We've had a lot of changes over the last couple of years in terms of markets, asset classes and so forth. I think there's a real resetting, we're seeing de-globalization, for example, whereas all of us, we've been investing thinking that globalization is here, it is a stay, and I would say be open-minded to what your asset allocation looks like. So what worked in the past doesn't work any more maybe there's more opportunity for TAA and less reliance on SAA.

Jonathan Forsgren: Well, thank you all for joining us today and sharing your insights on ETFs.

Mike Prendergast: Thank you.

Chad Miller: Thank you.

Dodd Kittsley: Thank you, John, for having us.

Amanda Rebello: Thank you.

Jonathan Forsgren: And to our viewers, thank you for watching. For Asset TV, I'm Jonathan Forsgren, we'll see you next time.

 

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