MASTERCLASS: Fixed Income - February 2021
February 10, 2021
Jenna Dagenhart: Welcome to Asset TV's ETF Masterclass. We'll look at how the industry is evolving the growth of active ETFs and the ways that these new strategies add value in fixed income and equity ETFs. Joining us now are three expert panelists. Dan Noonan, the Head of U.S. Global Wealth Management ETF Sales at PIMCO, Dodd Kittsley, Director, Davis ETFs at Davis Advisors, and Scott Livingston, Heat of ETF Strategy at T. Rowe Price.
Jenna Dagenhart: Everyone, thank you for being with us, and setting the scene, Dodd, what big trends in the ETF industry are you seeing? How is the market different than, say, 10 years ago?
Dodd Kittsley: Well, the industry has changed just so dramatically over the last 10 years. Certainly, gotten a lot bigger. There's been much more widespread use and the advantages that ETFs offer are really delivering value in a much, much greater way. Investors are voting with their dollars, so when we entered 2010, there were about a trillion dollars in assets in ETFs. Today, we're closing in on almost $5 trillion.
Dodd Kittsley: To put in context, in 2010, ETFs compromised about 10% of all fund assets, including both mutual funds and ETFs. Today, that's 26%, so more than one out of every four dollars invested in funds are in ETFs, which is nothing short of amazing and the growth and the innovation continues. The bottom line for investors is now there's never been a more exciting time to invest in ETFs. There's never been a more compelling reason to not use exchange-traded funds. They are delivering so much value in terms of lowering costs, increasing transparency, trading efficiencies have improved pretty dramatically, but in my opinion, the greatest change that we've seen, the most dramatic change has been in an investor's toolbox, which has got so much broader.
Dodd Kittsley: It encompasses now not just index-based strategies but rules-based strategies to try to isolate characteristics in the marketplace, and very important thing that I know we're going to talk a lot about today is it gives investors access to some very talented managers that are able to really add value in very unique and differentiated ways. We've come a long way.
Jenna Dagenhart: We certainly have, and we'll talk a lot about some of the topics that you mentioned, Dodd, but before we get there, Dan, how would you describe the current landscape for ETF investors?
Daniel Noonan: I think the current landscape, I would characterize it as it's an exciting time, as Dodd mentioned. A lot has transpired over the last 10, 15 years in the ETF business, and the ability for investors to access such a range of choices is better now than it's ever been in the ETF industry. As Dodd mentioned, we know have the ability to through the ETF wrapper access active management to access commodities, to access fixed income. There's so many different ways that investors can now access the capital markets using exchange-traded funds.
Daniel Noonan: I think the other thing to note is that even just this year, ETFs faced a pretty significant test in terms of their resilience in very, very volatile markets. I think the conclusion is that ETFs exceeded expectations in terms of their ability to withstand significant stress in the capital markets and provided investors a real-time access to liquidity and to prices that were difficult to obtain via other instruments. During the COVID volatility, watching CNBC, I couldn't believe my eyes to see ETFs actually being used as the market indicator oftentimes because they were really truly representing price performance in a variety of different asset classes.
Daniel Noonan: For those of us that have been in the ETF industry for a while, these are exciting times and I think the resilience of the vehicle really came through this year in a meaningful way.
Jenna Dagenhart: You get that intraday liquidity as well, especially during times of crisis like you mentioned, Dan.
Daniel Noonan: Yeah, that's right, and I think when we look at difficult-to-access markets or markets that don't price the same way that equities do like fixed income, the ability to access on an intraday basis that liquidity, the ability to express an opinion as either a buyer or a seller of exposure on an intraday basis, periods of volatility bring that to light. Again, the ETF vehicle came through, I think, as a really resilient structure.
Jenna Dagenhart: Yeah, Scott. Funds really seem to be pouring into ETFs, and we're nearing that $5 trillion mark, as Dodd mentioned. Why do you think ETFs have grown so much?
Scott Livingston: I echo the comments that both Dodd and Dan made. Looking back at ETFs when they first launched here in 1993, there's been really an extraordinary growth since that time period. As Dodd said, nearly 5 trillion in AUM here in the U.S. Over 2100 different products that are now in the ETF wrapper. 300 billion implodes really just year to date thus far in 2020. I'd say the growth has partially been a function of the constant innovation. You think about the evolution of ETFs. 2002, we had the first mixed income ETFs come to market. 2003, we saw a smart data product.
Scott Livingston.: Finally, 2008, we'd seen active ETFs come to light. I think 2020 is also an important marker for ETFs as this is a year where we've seen the first active equity ETFs come to market and have the ability to shield their IP to essentially protect investors' performance. I think it's a big development for the industry as a whole. Certainly, for investors who now have the ability to access some great investment strategies that weren't previously offered in the ETF wrapper.
Scott Livingston: With that said, the growth of the ETF format, at least in my view, primarily has been fueled by the benefits of the structure. For many years, ETFs were synonymous with low-cost passive products, and I think low-cost is certainly a big benefit of the ETF structure, but I'd say ETFs certainly aren't limited to only passive strategies. The cost savings have really come from the streamlined operational structure from an ETF, so differently many of the costs inherit in the mutual fund structure, for example, are eliminated in their format
Scott Livingston: Many issuers, including Seymour Price, choose to pass on this cost savings to the young investor. It's important note that the management being a different strategy may not be lower, but really the total expense ratio for an ETF investor can be and that's important, second to tax efficiency, the increased tax efficiency that comes through an ETF through the creation redemption mechanism. Why most of the trading or a majority of the trading for an ETF happens in the secondary market between investors, when there's excess supply or demand and they get into an ETF, APs create a redeem shares directed at the issuer. This mitigates the recognition of cap gains purely from investors exiting the products. There's also several other vehicle features that ETF users use to manage essentially gains in an ETF wrapper.
Scott Livingston: Over time, I'd say this tax efficiency has resonated with investors, particularly in years that the market's been down. Another vehicle is a [inaudible 00:07:33] cap gains distributions. Obviously, as an active manager, our role's still to buy low and sell high, so clearly, it'll be cap gains recognize that periods, but the ETF structure definitely puts the recognition of most cap gains back in the hands of the investor.
Scott Livingston: Finally, as Dan mentioned, really the versatility of the product, the liquidity and the convenience. Investors can quickly gain access or exit investment strategies, intraday even the trading. I think particularly this year, as Dan said, they've proven to be a versatile product structure through periods of volatility, and that's again really resonated with investors. In closing, I'd say it's really the aggregation of all of these benefits that we think led to the growth of ETFs. To date, it's been primarily passive. 5 trillion, we'd between 150 and 200 billion are in active products, but I think all of us on this meeting really believe that active ETFs will be the next leg of ETF growth.
Scott Livingston: At T. Rowe, we don't think they'll entirely replace mutual funds. We think our ETFs are complementary to our other vehicle structures, but we also believe that giving investors choice is a good thing. Some investors may prefer existing vehicles, and others will choose to access our investment strategies through the ETF wrapper.
Jenna Dagenhart: A lot of benefits across the board, tax efficiency, low cost, as you mentioned. Dan, why fixed income ETFs to them?
Daniel Noonan: Yeah, in terms of fixed income, it's an interesting asset class because you're taking bonds, which still trade in kind of this archaic analog world. They trade over the counter; they trade in large blocks. They sometimes trade by appointment. Single CUSIPs may not trade for days or even weeks at a time, so it's a very, very different market than the equity market. What the ETF structure allows investors to do is to electronify to some extend the bond market and to trade with a similar type of efficiency that you would trade in equities, but to trade fixed income in that manner.
Daniel Noonan: Fixed-income ETFs, I think, really democratize access to fixed income. They lower costs for investors. The ability as an example to buy an actively managed municipal bond ETF that has hundreds of different issuers inside of it in a single ticker and to be able to trade that instrument the same way you would trade an equity is enormously efficient for investors and allows them to build diversified portfolios at all different sizes.
Daniel Noonan: Fixed-income ETFs are really a solution for a lot of investors as they look to diversify their portfolios, as they look to increase the liquidity of their portfolios and, in some cases, they seek to obtain active management of their fixed-income assets. Where maybe they just bought individual bonds previously, they can now use ETFs to access different parts of the bond market and choose active management if they prefer that.
Jenna Dagenhart: Dodd, why did Davis enter the ETF market in 2017? What makes Davis ETFs unique in the marketplace?
Dodd Kittsley: It's a great question and I think Scott already hit on this. We have a very similar philosophy where our decision to enter the ETF space is all about choice and it's all about being able to meet the wants and needs of our clients, whether they be end investors or financial advisors. Some prefer mutual funds, some prefer ETFs. There's a host of advantages that we talked about and covered. Maybe not all resonate to all types of investors, but 27 years, this industry has really proven that the benefits that it offers are very, very, very strong.
Dodd Kittsley: I like to highlight a parallel from our firm's history of why we got into ETFs as well. We started out really back in the 1940s, but formally we're incorporated in 1969, and that decision was really a shift from leader of our firm at the time, Shelby Davis, who was an institutional money manager. He was approached by folks saying, "Why don't you make your strategies available in a mutual fund format?" The knee-jerk reaction at the time in the late '60s was, "Well, we don't do that. We're an institutional money manager", but lo and behold, he ended up doing that. Then, we transitioned to separately managed accounts in the '90s. ETFs philosophically are absolutely no different. We want to be able to provide our strategies in the wrapper that meets the wants and needs of our clients, and that was really the motivation to get into the business.
Jenna Dagenhart: Spending a little bit more time on active ETFs here, I know a lot of people are talking about them. Scott, what makes this ETF format different than standard ETFs? How do they look to improve on traditional mutual funds?
Scott Livingston: I think the biggest difference in any of the products we're discussing is really the ability to add alpha to investor portfolios. We know that even a little bit of alpha can have a substantial impact on investor outcomes 2020 has certainly been an interesting time in the world and putting in the markets. We've seen the volatility; we've seen indices have a greater concentration risk than at any other point in the equity space.
Scott Livingston: We've seen innovation really fuel returns and active managers have the ability to navigate those factors, the ability to look for pockets of opportunity in the market, whether it be caused by shifting consumer behavior or increased liquidity in financial markets, sectors that are well-positioned or challenged. While we think that both active and passive strategies can play a role in investor portfolios, passive strategies can't take advantage of the types of opportunities I just discussed and tend to invest in things that worked in the past.
Scott Livingston: The last thing I'll say is active management is certainly important, not only on the upside but also the downside. Limiting losses in down markets makes the road to recovery much easier. Structurally active ETFs are not different capacity ETFs. The same benefits we discussed earlier about the ETF format offered in both passive and active products. The new structures that were approved in 2020 allow active managers to shield investment IP to protect investor performance, which I think is a good thing, but these structures also work the same way typically ETFs have since 1993 with the same beneficial features.
Scott Livingston: I think ETFs will continue to grow in popularity. We think that these new structures will only accelerate that growth on the equity side and if we look at what's happened in the market in 2020, there's been 230-plus ETFs call it that have come to market. Over 50% have been active, but I think that's notable. We're going to continue to see that trend.
Jenna Dagenhart: Dodd, can you comment on the evolution of ETFs? Passive, smart data, now active in these new products?
Dodd Kittsley: Sure. Yeah, yeah. At a high level, we really started ETFs back in 1993 where it was exposure to broad markets. I would say that's version 1.0 and most of those indexes that the ETFs were based upon were market cap weighted. If you had a version 1.5, it was began to see ETFs get more granular and make cuts in those market cap-weighted indexes to, say, sectors or different market capitalization-type spectrums. There was a bit of a kind of catalyst to growth where folks looked at beyond just broad equity exposure but building blocks to put together asset allocation models and be able to asset allocate in a more efficient way.
Dodd Kittsley: Then, we began to see a lot of innovation, which we call version 2.0, which was a recognition that it doesn't have to be market cap weighted. There could be rules-based indexes that can give and isolate exposure to characteristics, to themes, different types of thematics, if you will. Could be something as simple as growth and value, it could be water companies, a whole host of different things that follow a set rules-based index still. Most recently, it started with fixed income and it's really accelerated over the last year in particular, but really the last three years and a half years has been going to full-blown active, which is a recognition that there doesn't have to be a set of rules that are prescribed.
Dodd Kittsley: It's not a stock screen. It is something that leverages a manager's experience, judgment, qualitative types of characteristics that are very, very important when deciding which businesses, you want to invest in, particularly if you're being very, very selective. Things like management's ability to allocate capital, things like the culture, those sort of things that can't be captured in a stock screen or a rules-based type of approach. One is not more valid than another.
Dodd Kittsley: I think all three add a tremendous amount of value to the marketplace, but to date, there hasn't been a lot on the active side and that's why I think the three of us are so bullish on this really being the next catalyst for growth in the ETF industry because it's been underserved. It's been an underused tool amongst ETF investors and the best portfolios in the world blend really all three types of approaches together.
Jenna Dagenhart: Dan, why do active strategies make sense for fixed income specifically?
Daniel Noonan: Yeah. When you look at active management and fixed income in the ETF wrapper, PIMCO is actually an innovator in the space. Back in 2009, we launched one of the first actively managed ETFs, our actively managed MINT strategy. When we look at the environment then and we look at the environment today, it's quite similar. You've got a major disruption to the economic environment. You've got a huge amount of uncertainty. You've got low interest rates and you've got investors that are trying to contend with those low interest rates and low yields on their savings and looking for alternatives. Active management provides that. It extends the tool kit that portfolio managers can utilize to access different parts of the market and increase return relative to some of the benchmarks that traditional indexes invest in.
Daniel Noonan: When you think about fixed income broadly, though, active management in general has outperformed the indexes over long periods of time by quite a significant margin. Unlike equities, where it's quite challenging for an equity manager to beat the benchmark and oftentimes they're unable to, in fixed outcome, active management has proven an ability to increase returns relative to those benchmarks over time and often do so with less risks. We fundamentally believe in active management and fixed income here at PIMCO and we believe that the ETF wrapper is a tool that will allow additional investors to access not only the benefits of the ETF vehicle, but also active management.
Jenna Dagenhart: Scott, can you explain the new processes approved by the SEC for active equity ETFs?
Scott Livingston: Sure, so 2020 saw the approval of essentially five different ways to bring active ETFs to market on the equity side, including a proprietary model from T. Rowe Price. I'd say for all of these models, or for many of them, it was over a 10-year process to get SEC approval, so definitely a long date to endeavor. The objective collectively of the models really is to shield active issuers' IP in order to protect investors' performance. What I mean by that is historically the SEC has required ETF issuers to disclose a holdings basket each day as a condition for if we're going to launch an ETF.
Scott Livingston: At T.Rowe Price and many other active managers on the equity side, we were concerned that this holdings disclosure could really lead to the frontrunning of our trading strategies, increase our transaction costs, and ultimately hurt our investors' performance. We manage over 1.3 trillion of investor assets and we're a bottom-up fundamental-driven active manager. The key differentiator for us is our robust global research platform and our analysts put in the work to identify these investment opportunities. Our PMs buy and sell based on those recommendations and their own insights. Many times, we have several investment strategies involved in a particular strategy.
Scott Livingston: Publishing what we're doing each day for an active fund can certainly be harmful for our performance and our investment strategies. We really want to seek best execution for our trades for our clients so that they can maximize their performance. The daily holdings requirement by the SEC really would prevent us from doing that by disclosing our holdings, but at the same time, we understood what the intent of the SEC was. They believe that the holdings were needed by market makers to actively price ETFs intraday and essentially ensure that investors were able to transact near the true value of a product.
Scott Livingston: We understood the concern around having effective arbitrage mechanism in ETFs. At the same time, we believed it was possible to design a successful ETF that did not require that daily holdings disclosure. In order to do that, we worked closely with ETF market makers on our process and ultimately, excuse me, ultimately designed something that mirrors the way that ETFs have traded in the U.S. since their launch in '93. Instead of providing a holdings basket each day for pricing purposes, we're giving them a proxy basket and the proxy basket is designed to closely track the performance of our fund, but also gives us the ability to shield security names where we're particularly sensitive, names are working into or out of.
Scott Livingston: Market makers use this basket just like they would for identity disclosed holdings basket in the passive product. The other key point is it also serves the proxy basket as our pressure redemption basket, so we didn't make any changes to the important pressure redemption ETF process. The proxy basket's essentially our primary pricing signal.
Scott Livingston: Finally, we also risk metrics via our website to quantify the close relationship between the proxy basket and the fund holdings. This really gives market makers a snapshot of how closely aligned our proxy basket is with our current fund holdings and gives them comfort to maintain orderly markets. We've really had a ton of support for our products and markets since launch and I think at least partly it's due to the comfort market makers have with these signals and the design of our process.
Scott Livingston: One final step we took was just in order to ensure that our pricing signals remain strong for our market makers, we built custom technology and systems around this process. We're able to monitor our pricing signal intraday to ensure their strength. If we were to see any deterioration, for example, in our proxy basket, we have the ability to update that and give a new cut of that. This is an important extra step we took just to ensure the nice quality trading markets in our product. I should also note from a client standpoint, our process doesn't change anything. Investors still get the same disclosure they get four our active mutual funds, including holdings disclosure quarterly on a 15-day lag, top ten holdings for quality characteristics monthly, in addition to the pricing signals I just described.
Scott Livingston: To summarize, our process gives market makers all the information they need to facilitate early trading markets, allows us to package some of our best investment strategies in an ETF wrapper, extending the benefits of the wrapper to certain types of investors. We've seen these processes described as nontransparent or semitransparent. We're referring to them as active ETFs. We don't think it's true to say they're nontransparent. Market makers and investors get plenty of information as I described. It's true that we stop short of showing our holdings each day, but this really comes from a good place to protect our investors' performance.
Scott Livingston: The SEC didn't require us to call them anything different like they have with some of the other product structures, so we're calling them active ETFs and we're hopeful that the industry will embrace them as active ETFs.
Jenna Dagenhart: Dodd, what are your thoughts on transparency?
Dodd Kittsley: At Davis, we didn't have as many challenges because of the way that we manage money. We launched our ETFs in a fully transparent format because we didn't need to go with the other structures. We were completely comfortable disclosing our holdings like a traditional ETF has always done. The short answer for the reasons there is we took a very long-term approach. We invest in large liquid securities. It's a very low-turnover portfolios, much lower than a lot of indexes out there, so the concerns with frontrunning, the concerns with anything eating into client alpha didn't exist in our instance, again, because of the way we manage money.
Dodd Kittsley: For the three and a half to four years our ETFs have been out in the marketplace, we haven't had any concerns. We haven't had any bad execution or bad trades. We've been able to manage big inflows and have good volume and very good performance. Our ETFs performed as they were designed. It was not a necessary next step for us, but we're very excited to see other entrants who have higher turnovers, have more concern about disclosure of IP entering into the ETF space. As Scott mentioned, they're all active ETFs and we're really, really excited to have the space grow and give more credibility to active ETFs as a bonafide category.
Jenna Dagenhart: Yeah, I'm sure it must feel great for all of you to be on the other side of that SEC approval. Certainly, a long time coming, as Scott mentioned, and Scott, T. Rowe Price recently came to market with active ETFs for the first time in August. I want to ask you the same question that I asked Dan. Why active for equity? Why now?
Scott Livingston: Yeah, sure, so for us it was really the approval. This is the first time we had a format that we were comfortable with, offering our active equity strategy. Really, as a firm, and Dodd mentioned this earlier, T. Rowe is very similar. We've really adopted a vehicle of gnostic approach at our firm. We believe our role is to generate alpha, improve investor outcomes, and from there we want to offer our strategies in whichever vehicle or format works best for investors.
Scott Livingston: As we discussed earlier, we've seen a tremendous growth in ETFs and we really wanted to offer our investors ETFs. It's something that they've long wanted from us, but it's take us well over a decade to get to this point. Our first filling was actually in 2013, but conversations extended for several years prior to that with private [inaudible 00:26:55] letters, paper filings, conversations. We certainly appreciated the collaboration we had with the SEC during this process. We're definitely very excited to receive the approvals late in 2019 and mid-2020. From there, we launched our first four active ETFs on August 5th, so we Blue Chip Growth, TCHP, Dividend Growth, TDVG, Equity Income, TEQI, and Growth Stock, TGRW, on August 5th.
Scott Livingston: At the same time we were working through that exempt of relief and approval process, we're also working internally and externally to build the infrastructure needed to support our ETFs, so the capabilities, the technology, the infrastructure. That really put us in a strong position to launch once regulatory approval was received, so we did get to market pretty quickly.
Scott Livingston: As far as now for equity, I think we discussed some of this previously, but really, it's always a good time for equity, or excuse me, for active, but we think now with the increased volatility, it's certainly so. As we look at 2021, I think investors, this is a really good development for them in that they have really good active strategies that'll be coming to market as ETFs and they can now access them through the ETF wrapper.
Jenna Dagenhart: An exciting time to be an ETF investor, certainly. Dan, going back to bonds, why is active management in fixed-income ETFs more important than ever?
Daniel Noonan: I think it's more important than ever because the indexes, quite frankly, are riskier than ever. When you look and compare the aggregate fixed-income index now versus 10 years ago, it's changed quite dramatically. It's gotten increasingly risky. When you look at the credit component of the aggregate index, it has gone up by over 50% over the past 10 years. When you drill into the credit exposure within the index and you look at the BBB segment of the market, the riskiest part of the credit market, that has doubled its exposure over the past 10 years within the index. You're taking significantly more risk when you invest in the index today than you did 10 years ago.
Daniel Noonan: In terms of being compensated for that risk, it's been reduced dramatically. If you look at the yield on the index now versus 10 years ago, it's down by over 60%, so the index has gotten dramatically riskier and the compensation that you're receiving when you invest in the index via yield has gone down dramatically. Active managers are able to, as I said earlier, extend outside of the index, look to areas of the market we find attractive and reduce risk and be selective with where we take risk and be selective with the bonds that are purchased within a portfolio. We believe now more than ever active management is critical in an investor's tool kit as they look to make fixed-income allocations.
Jenna Dagenhart: Building off of that, Dan, why is credit selection so critical?
Daniel Noonan: Credit selection is critical now, again, more than ever. If you look at the issuance that we've seen this year, corporate credit issuance, there's been enormous, enormous amounts of issuance in the marketplace. Indexes, by definition, need to purchase this paper regardless of whether the credit work has been done on those various different issuers. Here at PIMCO, we independently evaluate every one of those CUSIPs. We've got over 250 portfolio managers, 75 credit analysts that are looking through the market in understanding what paper looks attractive and what doesn't look attractive. That independent credit analysis and the ability to invest outside the benchmarks and invest outside the indices we believe to be critical to investors' long-term success.
Jenna Dagenhart: Dodd, turning to you, how can active add value in client portfolios? What are the characteristics investors should look for when selecting an active manager?
Dodd Kittsley: Yes. Active can add a tremendous amount of value in terms of compounding wealth, and not just relative returns but absolute returns. Dan mentioned this a little bit earlier and the numbers are correct. The average active manager certainly has a much harder time outperforming the benchmarks compared to fixed income, but we think that looking at the average active manager is really missing the forest for the trees.
Dodd Kittsley: Jenna, what you asked, what are the characteristics to look for? I think if investors just tick through this list of three or four considerations, they put them at a position to really identify managers that truly can and will add value. There is a lot of bad active out there in the marketplace, so sifting through and finding the right characteristics is so very important. The first is really just a track record and history of doing and delivering the outperformance. Experience certainly helps in this business and helps with your judgment and decision-making process.
Dodd Kittsley: Having reasonable fees is very, very important, too, but certainly I think a lot of investors in the ETF space are still focused on uber low fees that they're also missing the boat on understanding that a lot of active equity ETFs are priced very, very reasonably. Having a differentiated portfolio is so very important. You can't do what everyone else is doing and expect a different result. If you are a closet indexer, then you should go right with a beta product that's going to be very, very low cost. Having high conviction portfolios puts you in a position to succeed.
Dodd Kittsley: Then, finally, eating your own cooking is so very important. It's something that's not talked about enough these days. About 50% of long mutual funds have zero dollars invested alongside their shareholders, and over 80% have less than a million dollars. At Davis, we do cook our own cooking. We have over $2 billion of firm and family money invested alongside our investor base in the products that we offer. We think that is very, very important from an alignment perspective. Checking those puts you way beyond trying to solve between the average active manager. It puts you in a position to succeed in a much better way.
Jenna Dagenhart: Scott, how are the ETFs using these new processes been trading in the market?
Scott Livingston: The early results look great and I think it's really because of the collaboration and partnership that we've seen with key ETF industry participants like market makers during the design phase and essentially the build of these products. It's really led to consistent tight trading spreads, impressive depth of book, and really just overall market quality, the type of quality you'd want to see in an ETF. I tell you; these early data points are extremely important. Investors are watching these new products as they come to market and we believe these good results will lead to future sales and scale on the active ETF side.
Scott Livingston: Currently, there are over $600 million according to the current numbers at 15 different funds that have come to market with these different active equity processes. It's still very early on, but again, across the board I think spreads have been impressive and really have confirmed the thesis that market makers don't need holdings per se, but instead have made really strong pricing signals in order to facilitate orderly ETF markets.
Scott Livingston: From a T. Rowe standpoint, this is a strategic initiative for us, and we think it could be a significant business over time, so we're really pleased to look at these early results. As we talked a little bit earlier, ETFs have grown exceptionally well over the years, but it's also important to note it didn't happen overnight. ETFs launched in '93. We're 27 years later and each stage of ETF innovation, and that's where I think we are today, it took time for investors to get comfortable with the new products.
Scott Livingston: Ultimately, once they did it led to scale and I really believe the same story will play out here. I think it's going to happen in fixed income. I think it'll happen in these new equity products. There's definitely a ton of interest from clients, advisors, media, ETF, personalities and participants. We've seen solid growth in our products over the last couple of weeks, particularly in volume and AUM. Over the last week or two, we've set some highs. We do expect this to continue and, again, we're very pleased, but very early innings here. We think this has high potential as a new category within ETFs.
Jenna Dagenhart: Yeah. Early innings definitely. What do you think about 27 years compared to the grand scheme of things with the history of financial markets? Dodd, how would you say advisors are using your ETFs?
Dodd Kittsley: Advisors are using our ETFs in a variety of ways. Some are using our ETFs as core holdings, whether it be for large cap exposure, international, global. Others are using our DFNL or financial ETF, to take advantage of arguably a very attractively valued, unloved segment in the market that's underweight in a lot of their other investments, whether they be mutual funds or the overall index.
Dodd Kittsley: We look at financials, for example, representing that 20% of S&P earnings, it only being 12% of the S&P's market cap, so folks are using that to kind of true-up, but more often than not, we're seeing a lot of advisors pairing active and passive together within their asset allocation models, understanding that a blend between the two puts them in a position to outperform. Creates a blend of lower fee. Ensures that they're very well-diversified. Blending has been a real popular strategy amongst a lot of financial advisors in using our active ETFs
Jenna Dagenhart: Dan, how would you say advisors should be talking to their clients about how to use your ETFs?
Daniel Noonan: I think when they're speaking with our clients, there's a couple of things to consider. One, I think Dodd mentioned it earlier. Focusing purely on the lowest possible cost could be to the detriment. The ability to access active management, the ability to diversify into different exposures using actively managed fixed-income ETFs will allow their end clients to receive incremental returns in their portfolios and reduce risks.
Daniel Noonan: I think the other thing that they can talk to their clients about is liquidity and thinking about cash balances that they may have on the sidelines. A lot of investors during volatile periods de-risk their portfolios and move money to cash, for right or for wrong. As a result of that in the current environment, you've got a lot of cash sitting on the sidelines earning very little yield in bank deposit programs or money market accounts.
Daniel Noonan: I would encourage advisors to talk to their clients about thinking about how quickly they need those funds. Is there an opportunity for them to receive some incremental yield and return on those cash balances. Using actively managed ETFs would allow for that. You can tear out your liquidity needs and earn some incremental return relative to those money market investments.
Daniel Noonan: The other thing we would encourage advisors to talk to their clients about is the role of fixed income. I think there's a question out there in the industry right now as to, "Is the 60-40 portfolio dead? Do I need fixed income when rates are this low?" Here at PIMCO, we think emphatically that investors significantly benefit from having a structural long-term strategic allocation to fixed income and that it plays a critical role in an investor's portfolio in dampening periods of volatility and offering ballast when equity returns are volatile or negative. The role of a core fixed-income manager is critical in terms of investors' overall asset allocation.
Daniel Noonan: We would encourage advisors to seek out true core managers that are able to provide that ballast during periods of volatility and allow their end investors and their end clients to stay invested during those periods of volatility due to their fixed-income allocation. While interest rates are low, we still believe that fixed income provides a critical element in an investor's portfolio and we would encourage advisors to stress that with their clients.
Jenna Dagenhart: Scott, going back to you, why did you bring cloned mutual fund strategies to market as ETFs?
Scott Livingston: Yeah, so for us, the reason we undertook this journey and said, "It's been a long time coming," is we're really wanted to bring our flagship funds to market, some of our best investment strategies to investors before we brought our large retail franchises, well-tenured PMs, impressive track records of performance. Again, these are the types of strategies that we wanted to bring and offer in the ETF format.
Scott Livingston: Over time, we do want to build out a robust suite of ETFs. For sure, we're not stopping at four and that includes across asset classes. I'd echo a lot of the comments that Dan made earlier around the attractiveness of active fixed-income ETFs. I think that's very much in T. Rowe's future. In fixed income, there aren't typically the same concerns with disclosing holdings due to the way the bonds trade, so we're comfortable offering our investment strategies without creating a new process like the one I described in equity. On the equity side, where we've been very busy evaluating investment strategies to offer as ETFs as well as considering new strategies that may resonate with ETF investors.
Scott Livingston: Then, finally, I'd say we're also continuing our work with the SEC. We're hoping that over time they'll expand the types of equity strategies that can be offered under these new processes. Certainly, more to do there, but to date, it's really been constrained to the active equity space and we're hoping to get future flexibility to offer different types of strategies.
Jenna Dagenhart: Dodd, spending a little bit more time on your outlook here, where are the opportunities and risks in today's market?
Dodd Kittsley: At Davis, we see enormous opportunity in the U.S. equity markets and the global equity markets, but with an asterisk that we think selectivity is more important today than ever before and a strategy that's just broadly invested in equities is not going to be as effective as it has been over the last decade that's benefited from largely an 11-plus year momentum-based bull market. We believe what you don't own is as important as what you own. What we've seen year to date through October has truly been a tale of two markets. If you look at the S&P 500, up 4%, if you just took five of the high-performing names out of the index, Amazon, Apple, Nvidia, Facebook, you take those out, Microsoft was the other, the return would be -3.5%.
Dodd Kittsley: Then, you look at kind of the difference between growth and value, and we're seeing a 35-percentage point difference there between growth and value, with growth up 20 or so percent in value, down about 12%. You're seeing this huge spread, but the answer there isn't necessarily to go all in value. We think a balance of both is very, very important and being selective in both is incredibly important. Where we're putting a lot of investments in is in durable growth, in growth stalwarts, big companies in E-commerce, big companies in cloud computing and in chips.
Dodd Kittsley: Then, we're also seeing in the value category, there's certainly a lot of value traps, but there's also an immense amount of value in subsectors like select industrials, select financials. They're looking incredibly attractive, so we truly believe whether you're investing in the broad market or you're investing more granular in growth and value, selectivity is really going to play out in the decade to come.
Jenna Dagenhart: Yeah. Dan, I know you talked about selectivity, too, and I like that point, what you don't own is just as important as what you do own. Dan, what do you think ETF investors should be keeping a close eye on in 2021?
Daniel Noonan: Well, I think along that theme, Jenna, being selective is going to be critical and active managers are going to be able to be selective relative to the indices. We've seen actively managed fixed-income ETFs grow at I think about four times the rate of passive income ETFs. We would anticipate that continuing and I think investors that have benefited and acclimated and transitioned to the ETF vehicle and maybe have defaulted to passive investments as a result of that, might wake up to the idea that active management can really provide a benefit, particularly in fixed income.
Daniel Noonan: As we look to a low return, low interest rate environment, I think investors in 2021 may look at their index-based fixed-income exposures and be disappointed in the returns and look to active management to improve their portfolio. I would anticipate investors in 2021 are increasingly going to adopt actively managed ETFs. We think that the growth rates in actively managed fixed income are going to continue to accelerate as investors realized that they have a choice, that when they use an ETF it doesn't mean that they're just by default going to be in a passively managed indexed exposure, that they can access active managers like PIMCO, like T. Rowe Price, like Davis, and other market entrants as they come online.
Daniel Noonan: We're incredibly enthusiastic about the active ETF marketplace. We look forward to continuing innovation there and we think investors are ultimately going to benefit from that.
Jenna Dagenhart: I wonder, what about stocks? Scott, what comes next in active equity ETFs? What should active equity managers think about before entering the ETF space?
Scott Livingston: I think there's going to be more innovation. I mentioned a little bit earlier that the new ETF processes approved by the SEC are so far only restrained to U.S. equity strategies, and the thought behind that has really been the SEC wanted to make sure that all of the underlying securities in a given strategy were trading concurrently with the ETF. That essentially has blocked international global equity from using these new processes. Certainly, we can use ADR as an exchange traded to replicate some of that exposure, but a good portion of the ADR market is non exchange less and so it's difficult.
Scott Livingston: From an SEC standpoint, I think they really wanted to crawl-walk-run on these new product structures. As I mentioned before, their early day has been really encouraging. We were okay with kind of starting slow, realizing that once we got to market and were able to prove that these structures work well, the hope was that the SEC would essentially give us more flexibility. We're continuing to have construction dialogue, excuse me, constructive dialogue with them on that. I am hopeful that we will get approval to consider international securities, which I think will be a big deal, opening up the ability to offer international global strategies.
Scott Livingston: As far as active managers, I think it's just really imperative that firms have an ETF strategy. Giving investors choice is a good thing. I think we're going to continue to see the scale, as Dad said, in ETFs in active ETFs and both fixed income and equity. Anecdotally, I can tell you that we've even seen a growth in some of our other vehicle structures because investors that weren't considering us because they were primarily ETF users have put us up in their platform. By doing so, they realized, "Oh, well, maybe we'll look at some of their other product structures upon some of our models."
Scott Livingston: It is important. I think investors are going to increasingly use ETFs. We're hearing more and more from other active managers of asking us questions about what we've done to build our process and for our perspective in building that. I really believe we're going to see more active managers come to market, whether in the fixed income or in equity over the next couple of years. Investors will have an increasing amount of different active products that they can access through the ETF wrapper.
Jenna Dagenhart: Dan, I see you nodding your head. Anything you would add?
Daniel Noonan: No. I would echo a lot of Scott's comments and agree. I think one of the things we found here at PIMCO in speaking with ETF-centric advisors and investors is that it does open up the doors to other conversations regarding other strategies that PIMCO manages in different formats. That's exciting for us to bring new clients into the firm and to introduce them to our capabilities, and if ETF's going to help do that, then that's fantastic.
Daniel Noonan: I think in terms of innovation, we are also keenly interested in the ability to launch fixed-income ETFs that don't disclose their holdings on a daily basis. As that market continues to evolve, as there continues to be or make regulatory changes there, we're excited to be part of that conversation so we can bring additional strategies online here at PIMCO.
Daniel Noonan: I also think that ESG is something we haven't talked a lot about today, but the ability to access fixed-income ESG strategies is one that's growing quite quickly. We're seeing a lot of interest from investors and I think that that's an area where you'll continue to see some innovation in the marketplace, hopefully. Here at PIMCO, we've launched a few strategies, but we're looking to that space from an innovation standpoint as well.
Jenna Dagenhart: Yeah, and Dodd, anything you would add?
Dodd Kittsley: No. I echo both of the gentlemen's comments. I think we will reach a fever pitch within the next couple of years, and as Scott said, every asset manager has an ETF strategy. I think as proof of concept on some of the new SEC-approved structures gain a little bit more time, investors are going to become much more comfortable with that, and very excited for the future.
Jenna Dagenhart: Dan mentioned protecting IP. Scott, over time, do you expect many more different ways to deliver active ETFs while protecting IP? Or do you think that there'll be some consolidation?
Scott Livingston: Well, I think that's really an interesting question. Similarly, I should have mentioned earlier, Dan hit on it, we're also interested in fixed-income processes that shield IPs. I think that does open up the types of strategies you can put in a fixed-income ETF wrapper. To your question, we've seen several other applications in the queue at the SEC. I can tell you a lot of discussions we're having both in the industry and with clients, there's some confusion about the different ways to deliver this. I think it's important to understand that this is really the delivery mechanism. The end result for a client is essentially he or she is buying an ETF and buying the strategy. I hope over time there are some best practices
Scott Livingston: The proof's in the pudding. We can see some trading’s spreads for these different processes now. We're really proud of what we've done at T. Rowe Price. I hope and sense that there'll be some consolidation amongst the models. I don't think it's necessarily a good thing if all of us are talking and comparing and contrasting different models in a couple of years. I think the focus really should be on alpha generation and the merits of the underlying investment strategy. Today, I don't have an answer for you. I think it'll be an interesting thing to monitor and to watch, but there are definitely some good ways to do it now, and I'm not sure if we need other ways to then get approved and add to the mix.
Jenna Dagenhart: Dan, any final thoughts on your end? How do you think active fixed-income ETFs will continue to evolve?
Daniel Noonan: I think you're going to continue to see innovation from on the traditional transparent side, so as managers look to the fixed-income ETF market and they see the growth and they see the ability to offer their strategies via that wrapper and offer that choice for investors, I think you're going to continue to see growth there. Also, as Scott mentioned, as there are potentially structures that allow for protecting IP, I think that that could dramatically increase the adoption rate of fixed-income ETFs because a lot of investors and advisors recognize that active management's important in fixed income. As a result of that, use structure like the mutual fund or other vehicles because there's just not that much choice right now on the active fixed-income ETF front.
Daniel Noonan: If we can increase choice, if we can increase competition there, I think that that will be a benefit to investors and to the industry as a whole. We're excited about the growth rates. We think it's an attractive space and we think that we're excited to see how the industry continues to evolve and innovate in fixed-income ETFs.
Jenna Dagenhart: Dodd, any final thoughts on your end about trends coming down the pipeline in 2021 and beyond?
Dodd Kittsley: Well, I think our topic and our area of focus today is absolutely spot-on. If the ETF industry's still in the early innings, which I wholeheartedly believe it is, active ETFs are really in the first inning. We're just getting started. You've seen assets double since the end of 2018, albeit off of a low base. Scott highlighted that we've seen a vast majority of the new products coming to market this year being active. We've talked about a lot of asset managers being in the sideline. The category as a whole hasn't been recognized by a lot of investors. Now, it will be as we're all getting very much involved.
Dodd Kittsley: I felt like a big myth in the ETF industry is. "ETF's are just about indexing." I think we're all doing a great job to dispel that myth, but it still does exist amongst a lot of investors, so I am so optimistic. I'm so excited that we've got great company in the active ETF space and I think it's a very bright future and the right thing for any investors.
Jenna Dagenhart: Yeah. It's definitely an exciting time for ETFs and active ETFs. Well, everyone, thank you so much for joining us. Great to have you.
Scott Livingston: Thanks, Jenna.
Daniel Noonan: Thank you.
Dodd Kittsley: Thanks, Jenna.
Jenna Dagenhart: Thank you for watching this ETF Masterclass. I was joined by Dan Noonan, Head of U.S. Global Wealth Management ETF Sales at PIMCO, Dodd Kittsley, a Director of Davis ETFs and Davis Advisors, and Scott Livingston, Head of ETF Strategy at T. Rowe Price. I'm Jenna Dagenhart with Asset TV.