MASTERCLASS: ETFs - October 2021

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  • 01 hr 01 mins 57 secs
The Exchange-Traded Fund industry has evolved tremendously since its inception in the U.S. in 1993. Two experts discuss the growing adoption of ETFs, the recent rise of actively managed funds, and some of the top trends to watch in 2022.
  • Dodd Kittsley, CFA®, Davis ETF Director - Davis Advisors
  • Rich Koerner, SVP, Sector & ETF Strategist Manager - Fidelity Investments
Channel: MASTERCLASS

Jenna Dagenhart: Welcome to Asset TV's ETF Masterclass. The exchange traded fund industry has evolved tremendously since its inception in the US in 1993. Joining us now to weigh in on the growing adoption of ETFs, the recent rise of actively managed funds, some of the top trends to watch in 2022, we have Rich Koerner as VP, sector and ETF strategist manager at Fidelity Investments and Dodd Kittsley director Davis ETFs at Davis Advisors. Dodd and Rich, great to have you both with us. And Dodd starting with you, what big trends in the ETF industry are you seeing and how's the market different than say 10 years ago?

Dodd Kittsley: Well, thanks very much for having us, Jenna. There are some really positive trends that continue in the ETF industry. A couple I'd like to highlight is really just an increased adoption. We are now at $6.7 trillion ETFs account for 29% of all mutual fund in ETF assets. And that's really amazing when you think back at 2010, that number was 10%. If you go back to 2000, it was less than 1%. So, we've come really a long way in a relatively short period of time if you can say a ETF industry has been around 28 years. I think the growth is going to continue and it's going to be fueled by two real big trends.

Dodd Kittsley: One is the continued accessibility of inexpensive beta, meaning just market exposure. And we've seen that in terms of assets and flows, where over 60% of both categories fall into funds that are 15 basis points or lower. That being said, the other kind of twin engine to this growth is the entrance of active into the ETF industry. And you look back 2019, there were less than three dozen active strategies available on the equity side. We've seen over 60% of new products launched over the last 12 months be active equity strategies. So, it's been really exciting that the toolbox for investors is only getting bigger and bigger. It's democratizing the way people are managing their portfolios and their investments. And it's a great thing to see.

Jenna Dagenhart: It really is. We're going to talk more about that toolbox throughout the program. But first, Rich, could you help introduce our viewers to Fidelity and your ETF initiative?

Rich Koerner: Yeah. Thanks, Jenna. I mean today Fidelity has 42 different ETFs out in the marketplace, a little bit over $32 billion in assets under management. We really came back to the ETF marketplace in 2013 with the launch of our passive sector ETFs. We launched 10 products and with the GIC changes add an 11th. The real estate sector, it's really we're at the bulk of our assets are right now, a little bit over $25 billion in assets under management.

Rich Koerner: But since then we followed the sector launch the following year with three active fixed income ETFs, which really speak to Fidelity's heritage on the fixed income side, core bond offerings. And since then, we've really added to what I think are Fidelity's strengths. Today we've got 13 different factor strategies on the equity side, we've got nine active equity ETFs out there, and we've also expanded the fixed income lineup as well with three new launches this year. So, feel really good about Fidelity's positioning in the marketplace and really bringing the very best of the firm in the ETF wrapper.

Jenna Dagenhart: Dodd, I have to put you on the spot here now, why did Davis enter the ETF market in 2017? And what makes Davis ETFs unique in the marketplace?

Dodd Kittsley: Yeah, we entered the marketplace for a couple of reasons. The first was it really met client demand. We had a lot of clients asking if we could deliver the strategies that we previously have had in mutual funds in SMAs and in ETF wrapper, many advisors transition their book of business to be more heavily weighted in ETFs and began to really understand the compelling advantages that ETFs offer. So, with that ask, to the firm's credit, we did a lot of due diligence in terms of is it even feasible and that the stars really aligned. So, we view ETFs as a choice for investors, don't have a preference, whether it's a mutual fund, an SMA, or an ETF. But we want to be able to deliver our strategies in the wrapper and the vehicle that is most appropriate for clients and for advisors.

Dodd Kittsley: And we were able to get into the ETF business now almost five years ago, 2017, because of the way we manage money. And we were able to launch in our strategies, which are fullblown active, no benchmark, totally benchmark agnostic, in a traditional ETF wrapper because we invest primarily in large liquid securities. We have relatively low turnover. We take a very long-term approach and try to own businesses, not rent stocks. So, we were really uniquely suited to have the strategies and, again, that have existed for decades in mutual funds and SMAs, and just port them over and port that strategy over to an ETF. So, we're very unique in that we're very focused portfolios. We have four ETFs. They're very, very differentiated than the benchmark and they reflect good old stock picking and really roll your sleeves up and do your research and understand the management teams, the competitive advantages, the competition, and really select the best businesses within a category that investors are seeking. Whether that be large cap, financials, international or global.

Jenna Dagenhart: Why did you choose transparent as opposed to the semi-transparent approaches that we've seen a lot of in the new products this year?

Dodd Kittsley: Yeah. That's what I meant by the stars aligned. It was a added technology that in our opinion, wasn't necessary for the way we manage money. Now we're very excited that other managers that might have higher turnover, may be more concerned with talking about changes within their portfolios and releasing their edge or their secret sauce. We're excited that more will be able to enter the space. But we essentially didn't need to because a lot of folks are concerned about two things when it comes to transparency inactive. One is front running, which is not been an issue for us in our four and a half years because we invest, again, in large liquid stocks.

Dodd Kittsley: So, we're making a change that's not telegraphing or panelizing any folks in terms of trying to front run future trades. The other is just, Davis has a wonderful culture of transparency. We, again, are very focused. But we believe that investors should understand what they own within their portfolios and the investment thesis behind it. So, it was really an alignment of the stars and the moon, and we didn't necessarily need a semi-transparent. So, we were really fortunate to kind of get a headstart and be really amongst the first actively managed equity ETFs based on strategies that have been around for decades.

Jenna Dagenhart: Looking at technology Rich, you also licensed the technology. Could you talk about that?

Rich Koerner: Yeah, sure. I mean, I agree with Dodd's comments. I think it depends on the individual asset manager and how they manage portfolios, the size of their portfolios. But we do have a focused effort on licensing and servicing the new technology. And we've signed up eight asset managers at this point. And we're in discussions with many others. We've got a couple of those managers out already in the marketplace with their products. Some of these managers are, this is our very first foray into the ETF marketplace. And so we really want to be a leader inside the active, what we call active equity or the market sometimes calls active non-transparent space. And we're excited about our offering.

Rich Koerner: Like I mentioned earlier, we've got now nine of these products out there in the marketplace. We've got the largest in the market with the Fidelity blue-chip growth ETF, and just think it's a great way to get, another point that Dodd alluded to earlier, choice. What's the vehicle wrapper that fits best for the advisor and their client. It could be a mutual fund. It could be an active equity ETF. It could be an SMA and that's a really exciting development for us here at Fidelity to be able to offer a number of our strategies now in all three of those wrappers.

Jenna Dagenhart: Yeah. A ton of choice out there. Dodd, I see you nodding your head. Dodd Kittsley: Yeah. We applaud what Fidelity and others have done. The technology really has made this a reality to grow the category of actively managed strategies in a very, very efficient wrapper. And it's just, it's been amazing to see. I mean, that's really been the story of 2021 is ETFs are not just about indexing. ETFs are about exposures, whether they be index, whether they be a rules-based type of strategy or the incredible value that experience in human judgment can bring to the table. And I think folks forget that sometimes, and particularly folks that use primarily ETFs, you get so enamored with the advantages they have that unfortunately many have written off active management and just use kind of index building blocks or market cap weighted strategies. The playing field has been leveled again. And it's really a beautiful thing.

Jenna Dagenhart: Rich, I see you nodding your head as well.

Rich Koerner: Yeah. I mean, I just think about recent pieces in the news, as it relates to just maybe the cap, the top heavy [inaudible] of a market like the S&P 500, or even down in the small cap space with the meme stocks dominating the returns for the Russell 2000 or the Russell 2000 Value Index. So, we clearly think this is a great opportunity right now for active managers to add value in this environment. And you've got the ability, as I said, depending on your style and your comfort level, you can do it in a fully transparent, active equity. We've seen a lot of success with that and a lot of new entrance coming into the marketplace in that wrapper. And then we've also seen folks using the Fidelity as well as other methodologies to hide a little bit of the portfolio disclosure. But again, just bringing some of your best strategies to marketplace now in the ETF wrapper, we think is really the early innings of active equity or active non transparent ETFs.

Jenna Dagenhart: Going back to both of your points about choice. There are so many different flavors out there, so many different choices, thousands of ETFs. Dodd, can you comment on the evolution of ETFs since their inception in the US back in 1993? We really have no shortage of options.

Dodd Kittsley: Yeah. I break it down into a few, possibly four chapters. The first was 93 to 2000. And I look at that as ETFs in their infancy. We ended the year 2000 with less than 40 products, about $40 billion in assets under management. And then the next phase really was a coming of age for ETFs. And it really is bookends by two really watershed types of moments and catalysts. The first was in 2000. A gentleman by the name of Lee Kranefuss formerly launched iShares in the brand iShares. 40 products in his vision was, look, these are portfolio building blocks. I'm going to roll this out to retail, broker dealers, financial advisors. And it took a while for folks to really recognize the power of that expanded toolbox again. But prior to that, before 2000, it was mostly an institutional market, highly sophisticated investors.

Dodd Kittsley: ETFs were almost used as kind of alternatives to program trading. So, we got to thank Lee in iShares for really bringing this more mainstream in broadening the investor base. Then in 2004, the first gold ETF was launched. And to me, that was such an important moment for two reasons. It really made an asset class instantly relevant to a broader investor base. Prior to that, you couldn't invest in gold in a brokerage account. You'd have to actually get the bars and store them or use derivative products. Here you had fully allocated gold. But the more profound thing of that moment was, I think it's signaled to the marketplace that ETFs, again, are not just about tracking indexes, but they can be applied to entire asset classes. And then folks became really creative. And we began to see this renaissance stage where product development was a huge thing on some of the best minds in the indexing business.

Dodd Kittsley: Some of the best investment minds were trying to devise smart beta. And that was kind of the birth of smart beta in non-market cap weighted rules-based type of strategies. And then the last kind of chapter, which we're in ironically began coming out of the financial crisis 2008, 2009. And that was the launch of the first active ETFs, which were fixed income and eventually with technology with the ETF rule that came out. We've seen this now being applied to equity ETFs as well. But PIMCO getting into the game shortly after a fall started. Bear Stearns' first active ETF back in 2008. But PIMCO getting into it, launching their very popular mutual fund strategy, short duration in an ETF format, kind of blew everyone's mind.

Dodd Kittsley: And I think began those of us in the industry, in the asset management industry, to really start building on an ETF strategy, whatever it was. But people started kicking the tires, being like, look, we've seen market cap weighted, we've gone to kind of rules-based smart beta.  Wow. This can be really applied to active as well. And that's so exciting. So, I think we've gotten kind of the full range of strategy types. So, again, that's just so exciting, which I think ETFs began almost as a serendipitous trial in providing an alternative to program trading and futures to an institutional, to a retail, to now everything under the sun in terms of asset management. So, it's, again, very exciting.

Rich Koerner: Jen, I think the evolution of the industry has certainly been beneficial. I think it has also put more pressure and responsibility for due diligence on advisors to just really understand how to conduct due diligence. I mean, just with the explosion, I think it goes without saying that an advisor understands that an active equity ETF is going to look different than the index. But with all the factor and smart beta products out there, and even just how the various index providers construct an index and changes that take place to those indices, I think when it comes to ETF due diligence, it's incredibly important that advisors are taking the time to understand and know what goes into the index and make sure the ETF that they select reflects the view that they have.

Rich Koerner: If they want to have a more, in the case of value, do they want to have a more cyclical bent? Do they want to have a cap tilt to it. There's just so many products out there that it's just big takeaway. It's just a really big sure that you understand the differences and folks like us, and Davis, and as well as third-party providers have a lot of good tools out there that folks can take a look at to make sure they do understand the ETF that they're thinking about including in their client's portfolios.

Dodd Kittsley: Yeah. Rich, it's such a great point. The ETF research and just manager research in general is really, really picked up because there are so many choices out there, different flavors within the category. And often you see folks just defer to the largest or most liquid ETF and call it a day. And that's often very short-sighted, because there can be more appropriate solution out there, whether it be active, smart beta or passive. So, the need for advice has grown ironically not strong with the growth in indexing. The other thing I'll say, Rich, you just tickled my mind on this one.

Dodd Kittsley: But I think it's really raised the bar for the quality of products that are out there. As an actively managed shop, we'll be the first to admit that there is a lot of bad active out there. There's high priced. There's those that look very much like the index. There're folks that are not co-invested with their shareholders and aligned it that way. So, what ETFs have done, I think is really raised the bar where a lot of the dead wood that was our industry on the active side of things is going to be weeded out. You've really got to deliver over sustained periods, improve your value to be a going concern as an active manager. And that's a good thing.

Jenna Dagenhart: Yeah. That competition really helps doesn't it?

Dodd Kittsley: It does. It really does. It's important. I mean, it keeps everybody accountable. And you know what? It's hard to find a good active manager out there. But if you can't in a particular  category or exposure going to a diversified low cost index solution makes a heck of a lot of sense.

Rich Koerner: Yeah. And Dodd. I mean, I know it goes without saying, but time horizon matters too. I mean, if it's more of a tactical trade that advisors looking to put on, then the low cost passive is probably the best solution for something that's maybe three or six months, because many times it's going to take an idea 6, 12, 18, 24 months in some cases, and you talk about low turnover with your strategies. I mean, it sometimes takes that long for the market to recognize the idea that perhaps an active portfolio manager saw much earlier than the market and those differences can we do a meaningful outperformance in the long run. But there are short-term periods where it tends to lag.

Jenna Dagenhart: So, Dodd, what are the characteristics that investors should look for when selecting an active manager? Dodd Kittsley: Yeah. This is a cross delivery vehicle too, this is really just doing your due diligence on the people behind managing your money. I think there are really four key ones and certainly a lot of secondary and tertiary ones. But first is experience and just a very straightforward investment discipline. Something that is cohesive, easy to understand, but an experienced team behind running your money. Second is just reasonable fees. And I'm not saying lowest fees around because good management in alpha should be paid for. But it should be reasonable. Below average fees is certainly something to look for as an investor. I think differentiated portfolio is really important. Sometimes folks will say fancy terms like active share.

Dodd Kittsley: But bottom line what we're saying here is looking different than the benchmark. Because if you can get a benchmark at three basis points and you don't look that much different, you certainly shouldn't be charging more than three basis points or much more than that. But reasonable fees are really important and looking different than the index. And finally, I think this isn't talked about as much, but alignment with your shareholders and having skin in the game. Morningstar did a study a few years ago. 49% of all mutual funds have zero money alongside their investors and over 80% have less than a million. And certainly there are some restrictions in place for some managers where they can't, I get it. But for most, it's very important to have kind of alignment of interests and skin in the game to really ensure that your actions as a manager are in the best interest long-term for creating wealth for your clients.

Jenna Dagenhart: Eating your own cooking.

Dodd Kittsley: Absolutely. Yeah. And again, it's shocking how few do. Compensation structure can be related to that as well. Certainly talking a little bit of our own books here, because Davis is the largest shareholder in virtually all of our strategies, at least amongst the largest. We're uniquely structured that way. We're able to do it because we're kind of across between a family office and a boutique asset manager. So, we're managing a lot of from money and family money as well. But as an investor on the other side, that's peace of mind. That every action you're taking, you're feeling the pain and you're feeling the benefit when you're you're right and you're making decisions for the right reasons.

Jenna Dagenhart: And Rich, what are you hearing from clients? What's resonating with them right now?

Rich Koerner: Yeah, I think after living through 2020, when there was just so much market turmoil early in the year, and then you had the fed coming into the marketplace, I would say for most of last year. And then certainly after the vaccine news and the election it seemed most conversations in 2020 were all about the market and what's happening in the market, and what should we be looking for, and what should be happening. And I'm not saying those conversations have subsided. I think right now we're still having a lot of conversations on the question of where are we in the business cycle? What are our concerns around inflation? How do you position a portfolio for maybe slower growth, maybe slower growth with higher inflation.

Rich Koerner: And so there's still a lot of conversations around those topics. And at the beginning of the year it was hard to have a conversation without talking about innovation and a lot of the thematic portfolios that were going on. But I also think advisors have sort of started getting back to business. And so we're having a lot of practice management conversations with advisors and trying to help them work in this environment, trying to help them refine their sales process and using technology like Zoom and making sure they're being the most efficient, increasing their referral base, working with centers of influence. So, really refreshing to have a lot of those conversations. And I think along those same lines advisors are interested in more customized solutions, whether that's from models.

Rich Koerner: And then certainly a lot of conversations around ESG. And ESG I think is really impactful. There's a lot of client portfolios that that want to understand how they're positioned as it relates to ESG. And I think that's going to pick up again here as we move through this budget season in Congress. There's a lot of the legislation is around clean energy. And I think that's going to increase, again, more client conversations around thematics as well as ESG.

Jenna Dagenhart: Dodd, what are some of the things that advisors might not necessarily know about these different tools and is one approach better than the others for active strategies?

Dodd Kittsley: Jen, in terms of the wrappers and the different technologies? Yeah, gosh, I mean, you have active transparent, that's traditional ETF, not really much different than the ETF structure that we've seen and known for 28 years now. But real catalyst for the growth this year has been the technology that Rich was talking about earlier. And there are a couple of different flavors to it. There are some that are a blind trust structure. There are others that are proxy portfolio. There are some that are shielded alpha. They're all trying to accomplish the same thing and that's to protect a firm's intellectual property if they feel it needs to be protected and to protect shareholders in strategies where there's more turnover, less liquid securities, those sort of things. All of those structures are being tested.

Dodd Kittsley: And I think they've all passed with flying colors. It's going to take a while for investors to become completely comfortable and familiar with products in innovations that haven't been out for a long time. But frankly in conversations with advisors they don't really see the inner workings of the sausage factory. I mean, they want to buy their food. It gets delivered to them in a quality way. But the inner workings I think, are stuff that they work, they're slightly different and no real red flags that I've seen. So it's really, it's got to be a good match between the asset manager, the portfolio manager in terms of what approach they take. And then for the advisor, I don't think they're really going to notice or feel much of a difference between the different ones.

Rich Koerner: Jen, I would just say, I mean, I think Dodd's point out all the structures that are out in the marketplace are working very well, very comparable bid-ask spreads between it. Where people really want to understand how the sausage is made. I would say for all those advisors out there is with your home offices. So, with your ETF research team, with your trading teams, with your platform due diligence teams, they are really going deep and understanding how the strategies work, what the differences between the various approaches as they look to onboard these strategies on their various platforms. In the conversations I've had with advisors surrounding the Fidelity structure, where it is available on the Fidelity platform, very few conversations around, to Dodd's point, how the sausage is made.

Rich Koerner: I'm interested in the Fidelity growth opportunities ETF. Tell me about that strategy. I'm familiar with the mutual fund. Tell me how it might be different than the mutual fund. Tell me where it's going to look the same and what I can expect in terms of performance, and holdings, and positioning inside the ETF vehicle. So, I think when it comes down to looking at the number of products that are out there, it's really just looking at it like you would a mutual thought or an SMA. That's what advisors really want to understand. How's positioned? What we can expect in terms of performance moving forward based on that positioning.

Dodd Kittsley: And if I could just add on to two points, Rich has made a right then. And then earlier, the manager research teams, the ETF research teams and so many of the broker dealers have really ramped up their efforts. And they're the ones kicking the tires. There are a lot of nuances to different structures. But if an advisor wants to spend time, to Rich's point, understanding the strategies, the investments and servicing their clients. You could spend literally months, if not years, going into the real nuances of different approaches.

Jenna Dagenhart: And what are some of the most common mistakes, Dodd, that you see advisors making with ETFs?  

Dodd Kittsley: Oh gosh, there are a lot over the years. I'm sure Rich has some on his list he's seen too. We get so many calls, and we're all about education in this industry and making sure people have their correct answers. I think the biggest mistake that investors make is they forget about the T in ETF. Particularly for those that have run a business investing primarily in mutual funds, where they're used to just putting a dollar amount and in the end of the day that dollar amount goes into the fund at NAV. ETFs have an extra step. You have to trade them. For some that's kind of a pain in the neck for others it's, hey, this is an added thing I need to do. So, there are a few rules of the road that as an investor, you can protect yourself in the unlikely but possible instance where market volatility picks up and you can get a bad execution.

Dodd Kittsley: So, what we tell people and others do as well, is to generally put in a limit order that gives you control over the price that you're paying. That's actually a benefit, not a hindrance. Though some people see it again as a pain in the neck and an extra step. And then other quick things like the value of an ETF is driven by the value of the stocks, or bonds, or securities that it owns. So, one of the things you don't want to do is buy right at the open. And I know a lot of anxious people want to get their trades in and be able to go on about their day.

Dodd Kittsley: But when you think about it at 9:30 New York time, the value of an ETF, it's really hard to know what the value is going to be until the majority, if not all of those stocks or bonds that owns have opened up and have shown true value. So, little things like that, it's a little extra steps. But those are kind of where people I think get tripped up and it's not rocket science. It's not super complicated. But it does take a little extra care and attention on the part of an investor and advisor.

Rich Koerner: Yeah. I echo Dodd's comments. We always suggest limit orders. We always suggest avoiding the first half hour as well as the last half hour of trading, if you can avoid it. And then finally we would just encourage you to reach out to your ETF provider, reach out to the contact you have with that asset management firm, because we all have ETF trading desks. We all work very closely with your ETF trading desks. So, there could be a strategy that you're interested in after you've done the due diligence, you might think this is exactly what my portfolio needs. But I'm a little concerned about the volume associated with it. I'm little concerned about the AUM maybe associated with it. That's where the ETF trading desks can really help you execute on a trade, both entering and leaving the ETF.

Rich Koerner: And so I would just encourage everyone to make sure you take advantage of those resources. And, Jen, to your question, I think one of the biggest mistakes we see is in terms of portfolio construction, it's just not understanding exactly what you own, because there are such differences in index construction on the passive side, we talk about it with value. But I would say dividend ETFs are another area where there's a lot of different components that go into those strategies. Some are higher yielding than others. Some lean more into higher yielding sectors. There's a lot of just different approaches that you need to be mindful of because putting one of those strategies can alter the dynamics of your portfolio construction.

Dodd Kittsley: Yeah. I'd love to build on something Rich said, because it's really, really important. And it's related to a mistake or a myth out there where investors will look at average daily volume and think that's a proxy for liquidity, a proxy for the amount or size of a trade that he or she can execute. And remember, ETFs are open-ended, shares can be created at will. They're very different than say small cap stocks with only so much in shares outstanding. Shares outstanding can double or triple with an ETF overnight. And Rich's advices is really, really good advice if you're somebody saying like, look, here's a small ETF that doesn't trade a lot, but it's got the right exposure for me and my clients. So, if that's the case, as Rich suggests, you reach out to, we call them capital markets desks, of the issuer.

Dodd Kittsley: And you also reach out to your trading desk as well, and say, look, I to do a $20 million trade, a $30 million trade. The ETF might only trade less than a million dollars notional per day. But you can get executed because the liquidity of an ETF is driven by the liquidity of what it owns. So, if you own a basket of very large cap, highly liquid stocks, your ETF should be able to be executed in huge size without really any material market impact in a great, great spreads and great, great costs. But to do that, that is also an extra step. Reach out to the capital markets, reach out to your trading desks. There are a lot of people here to help you. But that should not ever be a reason to not invest in a small ETF. Rich Koerner: And all the ETF capital market desks and providers, we have examples we can share with you to show you cases of execution. Like I said, both buying and selling that's greater than the average daily volume the Dodd talked about. So again, please, don't hesitate to take advantage of it. It's a really important resource.

Jenna Dagenhart: Yeah. That's an important reminder. And Dodd, how are advisors using your ETFs and how can active add value in client portfolios? Dodd Kittsley: Yeah. Gosh, there are so many different ways to use our ETFs and ETFs at large. But what we're seeing at Davis with our portfolios being high active share very different than indexes is they're often using us in conjunction with a low cost, very diversified market cap weighted exposure. And what we offer is the opportunity to outperform. Our stocks hold anywhere between 23 to say 40 different stocks. So, what we own is very strategic. What we don't own is also very intentional as well. So, we see a lot of people using ours in conjunction with broader exposure, lower cost beta ETFs. Whether that's international, more in the US for financial exposure. But investors realizing that look, if you just have building blocks that are market cap weighted, you can play the asset allocation game all day and add value, and that there's nothing wrong with it.

Dodd Kittsley: But to really take advantage of all of the powerful tools at your disposal, you're going to use a little bit of different strategies throughout. And we are very differentiated. I mean, you look back at some of the most arguably, most sophisticated portfolios in the world, the pension funds P&I would do an annual survey and they'd look at what percent of pensions, 200 largest pensions in the country, what percent was active, what percent was passive. And they broke it down by asset class. There was no discernible trend other than in most instances, it was about 50% active and 50% passive. So, to be able to deliver that down to the individual investor today, which was previously tools only accessible for very, very large institutions is really gratifying.

Jenna Dagenhart: Rich, can you share a little bit more about your lineup and some of your different strategies?

Rich Koerner: As I said, we're really excited about the 42 products that we have. We have a lot of discussions with advisors around sectors, and we think there's such an important tool that you can use in portfolio construction. We always encourage the folks that we work with to do what we call a PQC. It's just a portfolio quick check. And that is just a, it's a tool that we have, it's now online, that advisors can access. And we can then really have a customized discussion just around their views around this market, their firms views and what sector is their overweight, what sector is their underweight. And just make sure they're comfortable with those over and underweights. And then provide them with ideas based on where we think we are in the business cycle and historically what sectors have outperformed.

Rich Koerner: So, we still have a lot of conversations around sectors, because I think it ties into the active side of Fidelity still, just right now in the mutual fund wrapper for sectors. And then the other conversations we're having is I know flows this year have been dominated by equities. But listen, fixed income and fixed income in the ETF wrapper, still an important part again, to the portfolio construction process. We still believe that there's always a place for core bonds inside your portfolio. Our flagship total bond offering is now over five years old, and it just continues to do what we think advisors expect for a core bond offering. But Dodd talked about it earlier with one of the first launches in the fixed income space with a short duration, I think in this interest rate environment and with the potential for higher rates advisors are always interested in short or low duration products. Rich Koerner: And so we have a lot of conversations coming in on the curve when it relates to fixed income products. Now, I think this year one of the more interesting resurgence is the discussion around factors or smart beta. They got left behind in 2020. I think maybe some advisors were disappointed that maybe some of their low volatility strategies just didn't hold up as well as they would have anticipated in the first quarter of 2020. But now this year, especially earlier in the year with the rotation to value, you're starting to see a lot more interest I believe. And we're seeing a lot more interest in factors, whether that just be a value factor, whether it'd be a dividend strategy. So, a lot of conversations in that area.

Rich Koerner: And then, like I said, we spent a lot of time here today talking about active equity. The availability is for the active non-transparent is still somewhat limited at this point. But in those areas where it is available the conversation is really just around the manager, the philosophy, the process, and most of the strategies that we have put into that come from existing managers that manage an existing mutual funds. So, the advisors are familiar with the name, familiar with the strategy, and just wanting to understand the portfolio construction differences.

Jenna Dagenhart: And I know this is an ETF Masterclass and not a mutual fund masterclass. But let's talk about mutual funds for a moment. Dodd, what are some of the advantages and disadvantages that ETFs possess relative to mutual funds, and then how organizationally do you think about both mutual funds and ETFs? Because one isn't necessarily the enemy of the other just like active and passive ETFs and mutual funds can also coexist.

Dodd Kittsley: Absolutely. And it has to do with the client needs. It has to do with sometimes the ability of clients to control their emotion. It depends really on a lot of different factors in terms of which vehicle is right for each and every individual. And we view, again, ETFs and mutual funds on a level playing field. Some are more appropriate for certain types of clients than others and SMAs as well. So, again, not choosing our favorite child here, we offer mutual funds, SMAs, ETFs. And I think each brings its own advantages and sometimes challenges to the table. It's interesting because we've been around 51 years and our firm actually started as an institutional shop that Chris Davis's grandfather was running. And his father, rather based on his grandfather's investment discipline.

odd Kittsley: And one day before Davis even existed, folks came up to him and asked why don't you issue your institutional strategies in a mutual fund? And his initial reaction was we don't do that. We're an institutional shop. But lo and behold, that's how Davis had its start. And that's why we got into SMAs. And that's why we're into ETFs now as well, and been real fortunate to offer all three. Quickly a couple of different it advantages disadvantages. I mean, on the tax perspective, I think ETFs offer tremendous amount of efficiency, giving advisors control over their tax liability. It's not a loop hole, it's control in terms of when they realize their gains within the portfolio and they protect them from other shareholder activity, which I think mutual funds do have challenges there structurally.

Dodd Kittsley: Where ETFs, I think are clear winner. But mutual funds to take the other side can be better for folks at a dollar cost averaging, folks that don't want to really allocate time to good execution and trading, fractional shares has been an issue for a long time and that's why ETS really aren't in the 401k space. But several broker dealers have some solves for that as well. So, we'll see. But rambling here. But big back, it's amazing how much ETFs have grown and not have had the primary platform where most savings in the US goes and that's into retirement accounts.

Jenna Dagenhart: Now I know this is an ETF masterclass and not a mutual fund masterclass, but I do want to touch on mutual funds in the context of ETFs for a moment. Dodd, what are some of the advantages and disadvantages that ETFs possess relative to mutual funds? And how organizationally do you think about both mutual funds and ETFs, because one is not necessarily the enemy of the other and to your point about active versus passive, they can both coexist.

Dodd Kittsley: They certainly can. And I think they certainly will. So, I'll start with our firm's overall view of mutual funds, ETFs and we'll throw SMAs in the mix as well as kind of a different way to deliver your investment discipline or a particular strategy to clients. And we view all three structures really on a level playing field. And there are certainly trade offs based on client needs, tax positions, their disposition in ability to control emotions in the market can often drive that as well. So, certainly a mutual fund can be appropriate for a certain type of investor, ETF for another, maybe SMAs for others. So, again, we view them on a level playing field and with minimal but important trade-offs. So, with mutual funds it may be more appropriate for folks at a dollar cost averaging for tax advantage accounts where you don't get the extra advantage that ETFs offer in terms of enhanced tax efficiency or potential for a higher tax efficiency, flip side ETFs, maybe better in taxable accounts, offering similar types of exposure.

Dodd Kittsley: So, it really just kind of depends on the individual circumstance across a lot of different areas, but generally they're pretty close. At Davis, we have five strategies, we've got ETFs and mutual funds on four of them. And the performance is pretty darn close in tends to mean revert quarter over quarter. So, not too much of a difference there. It reminds me of the founding of our firm where Chris's father was an institutional money manager along with a few other gentlemen. And somebody had come up to them prior to 1969 and asked the question, hey, why don't you offer your strategies in a mutual fund? And their gut reaction, initial reaction was we don't do that. We're an institutional money manager. Well, they realized how silly it was. And it really led to the start of Davis Advisors the mutual fund shop that then evolved into offering SMAs, and in 2017 ETFs. They're on the same strategy. They own largely the same amount of same names, roughly the same weights, same economic exposure. But again, depending on a variety of factors will depend on which one is right for the advisor or the client. Rich Koerner: Yeah. Jen, I would just add. I think with active equity ETFs, with more asset managers becoming comfortable based on their style to go fully transparent on the equity side, we're seeing more and more traditional asset managers come into the ETF space, which we think is great for the industry. And I think it's great for advisors. It allows them to select, as we talked about earlier, the best vehicle for their client. Is it a mutual fund? Is it an SMA? Or is it in the ETF wrapper?

Jenna Dagenhart: And are there any undiscovered ETFs out there or hidden gems that you'd like to highlight, Rich?

Rich Koerner: Yeah. We've had a lot of success this year. It's still by ETF industry standards, a smaller product. But we have a Fidelity stocks for inflation. I think it's got one of the better tickers out there, it's FCPI. And it just uses a multi-factor approach to overweight sectors and industries that historically perform better in a rising inflationary environment. Maybe it was a strategy we launched over two years ago when no one was talking about inflation. We just wanted to have it in the lineup. And it certainly attracted advisor's attention and is performing quite well in this environment where we're starting to see more inflationary pressures.

Jenna Dagenhart: Yeah, can't get through a conversation about the markets without inflation coming up these days. Now, Dodd, where are the opportunities and risks that you see in today's market?

Dodd Kittsley: There are a lot of great opportunities today. And I think a lot of people are surprised when you say that, given that markets are still close to their all time highs and something that Rich said at the beginning of the session really resonated with me. I do think it is very much a stock pickers market when you dig in a little bit and really understand what's been driving the market over the last 10 years, which a lot of it has been momentum based. We saw so much dispersion over the last year, year and a half between growth and value and within growth and value, those two categories. Where we see opportunity is really in growth companies that are undervalued and undervalued, not based on necessarily next quarter's earnings, but looking out for the ability to kind of grow earnings over sustained 5, 10, 15 year period.

Dodd Kittsley: So, we're finding some great dominant companies in e-commerce, in technology that have these sustainable competitive advantages, have shown their ability to grow earnings over a long period of time. And really, if you look past the PE based on just the next 12 months and you make it go out a lot further, they're trading at unbelievably attractive valuations. But that being said, there's some unproven new companies that look like, the growth is it's not proven yet. They've unproven business models. They might have great ideas, but the longterm sustainability of those earnings is at the very least very uncertain. And then we go into the value category and we really like value companies that have the ability to grow their earnings. It's kind of flipping growth and value, which are tied on its head.

Dodd Kittsley: But a great example there would be financials. And financials have made a great rebound and now paused. But we think this is the beginning of a multi-decade revaluation of some great financial companies, large banks that are poised to benefit from inflation, that are more durable and have more cash on the balance sheets than they've ever had before. But yet are kind of under this cloud coming out of the financial crisis of being overly risky, being boring. That couldn't be further from the case. They're coming out of the COVID crisis. They're part of the solution, not part of the problem, unlike the financial crisis.

Dodd Kittsley: And I think folks are beginning to realize that. They're still the cheapest valuation of any sector in the US market and on a historical basis as well, which is absolutely amazing with the runs you've seen in some of these financial stocks. So, very compelling opportunity within financials. But we think categories can be dangerous. The entire market could be dangerous at some point. We've had a great run overall in the market. But we're finding more pockets of opportunity as stock pickers today than really we have in quite a long time.

Rich Koerner: Yeah. It's nice to hear maybe a similar outlook from Dodd. I mean, we tell clients all the time right now that we think balance is key. I mean, I think there's a case for clearly GDP growth is slowing and where do you want to be when growth is scarce? You want to be with the most innovative companies who can grow their earnings regardless of what's happening in the economy. But certainly the cyclicals like financials, like energy and materials and industrials have certainly shored up their balance sheets. They've cut CapEx. And if we see a reacceleration, all you have to do is just look at the fourth quarter performance last year and know that you need to have that value, that cyclical exposure. Probably too hard to time when that economy turns, you see it sporadically on any given day in the market, any given week. There's a pretty strong cyclical turn. Now that's why I think balance is really important for client portfolios right now, between growth and value, between cyclicals and more the longer duration equity sector assets.

Dodd Kittsley: Yeah. I mean, if you're fortunate to have a longer term time horizon talking to like a market cycle being selective can add a tremendous amount of value in this type of market, putting an emphasis and durability, on companies trading at attractive valuations and those that can grow their earnings long-term in a great rate. And that's kind of the way we've, in a nutshell, how Davis is positioning our portfolios.

Jenna Dagenhart: And, Dodd going back to your book analogy earlier in the program, we're still reading a lot of really thick chapters in the ETF industry, but the book is still being written. What comes next in active equity ETFs, and what should active equity managers think about before entering the ETF space?

Dodd Kittsley: I think what's next is a continuation of what we've seen this year and that's both more asset managers getting into the game and offering in ETF solution because the market has clearly spoken, and this is a vehicle that continues to grow really greater than any other investment delivery vehicle in history. So, certainly we're going to see more and more get into the game. I think as an asset manager, you can't afford at least not to have a strong ETF strategy from a business perspective. But I go even further to say, you should have an ETF offering in most instances as well, because you're going to reach a broader investor base. Dodd Kittsley: And that's the second thing. I think the category while it's become much more validated with the entrance of some of the bigger players, it's still a small part of the overall ETF industry at about 4% of assets. But it has grown tremendously. And I think we're not even in the end of the first inning here. So, more to come on that for sure. But the category is not going to be a rounding error. And because of that, it's going to get a lot of attention. More adoption, more research being done on these and more information for people to make great decisions in terms of which managers are appropriate for them and their clients.

Jenna Dagenhart: Rich. Anything you'd like to add, any final thoughts?

Rich Koerner: Yeah. No, I agree with Dodd. I think we're going to continue to see this growth. I think we're going to continue to see new larger and traditional mutual fund asset managers enter the ETF space. And then I think we're going to continue to see the interest around ESG and also thematic. Because I mean, we have as an industry covered pretty much all the basic building blocks. We've covered a lot of the factor strategies to alter some of those basic building blocks. And now we're bringing out active strategies in transparent and semi-transparent strategies. So, I still think there's a lot of interest around ESG and a lot of interest around thematic as they can certainly help enhance portfolio returns on the thematic side and then a lot of client interest surrounding ESG. So, I think all those trends, you just continue to point to more and more growth in the ETF industry.

Jenna Dagenhart: Dodd, in a nutshell here, could you sum up the big trends for ETFs in 2022? Dodd Kittsley: I think it's really coming of age for active ETFs in terms of a category and increased adoption, more players in the space for sure. And that's really going to, I think be the most exciting part of the story. I think on the other side, the other engine that's going to continue to grow is a recognition that beta exposure, market exposure can be done in a very, very cost-effective way. So, that should remain part of folks' toolbox and we'll continue to see the growth. Do I think it's going to be 60% of the flows and very low cost market cap weighted benchmarks? Maybe not. I think we're going to see things swing a little bit more to other types of strategies. And the industry become less concentrated, a lot of knock ETFs as being a very concentrated industry.

Dodd Kittsley: And it is in the top 20 or 30 products. But it's becoming less so, because so many great minds, so many great firms are coming out with compelling solutions in a structure that offers a tremendous amount of added advantage to the marketplace. So, I guess long winded way of saying the growth continues. And gosh, I remember 15 years ago, people saying like ETFs are going to slow because all the good indexes are taken. And how short-sighted is that? I mean, we continue to work in the invest business and it's to be amongst so many innovative people that are willing to try something new in the serendipity to happen, to be like, wow, I didn't know that was going to be such an advantage. It's a great story. And it's going to continue.

Jenna Dagenhart: We continue to grow and the industry keeps surprising us. Well, Dodd, Rich thank you both for joining us.

Dodd Kittsley: Thank you.

Rich Koerner: Thanks Jenna.

Jenna Dagenhart: And thank you for watching this ETF Masterclass. I was joined by Rich Koerner, senior vice president, sector and ETF strategists manager at Fidelity Investments and Dodd Kittsley, a director at Davis ETFs at Davis Advisors. And I'm Jenna Dagenhart with Asset TV. 

Important Information about Active Equity ETFs: These ETFs are different from traditional ETFs. Traditional ETFs tell the public what assets they hold each day. These ETFs will not. This may create additional risks for your investment. For example: You may have to pay more money to trade the ETF’s shares. These ETFs will provide less information to traders, who tend to charge more for trades when they have less information. The price you pay to buy ETF shares on an exchange may not match the value of the ETF’s portfolio. The same is true when you sell shares. These price differences may be greater for these ETFs compared to other ETFs because they provide less information to traders. These additional risks may be even greater in bad or uncertain market conditions. The ETFs will publish on its website each day a “Tracking Basket” designed to help trading in shares of the ETFs. While the Tracking Basket includes some of the ETF’s holdings, it is not the ETF’s actual portfolio. The differences between these ETFs and other ETFs may also have advantages. By keeping certain information about the ETFs secret, these ETFs may face less risk that other traders can predict or copy its investment strategy. This may improve the ETF’s performance. If other traders are able to copy or predict the ETF’s investment strategy, however, this may hurt the ETF’s performance. For additional information regarding the unique attributes and risks of these ETFs, see below. Additional information for Active Equity ETFs: The objective of the actively managed ETF Tracking Basket is to construct a portfolio of stocks and representative index ETFs that tracks the daily performance of an actively managed ETF without exposing current holdings, trading activities, or internal equity research. The Tracking Basket is designed to conceal any nonpublic information about the underlying portfolio and only uses the Fund's latest publicly disclosed holdings, representative ETFs, and the publicly known daily performance in its construction. You can gain access to the Tracking Basket and the Tracking Basket Weight overlap on Fidelity.com or i.Fidelity.com. 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