Gillian Kemmerer:
Welcome to Asset TV. I'm Gillian Kemmerer. In today's ETF Masterclass, three experts will discuss the latest trends and opportunities in exchange traded funds today, from thematics and strategic beta to actively managed. Joining me today in studio are Tony Rochte, managing director and global head of ETFs at Morgan Stanley Investment Management, Rob Bush, senior research analyst at the DWS Research Institute, and Marc Zeitoun, chief operating officer at Columbia Threadneedle.
It's great to have you here today. It's a set of familiar faces from Asset TV. We love having you back. I think I'd like to start with a view from the top or a macro perspective before we dive into the granulars and the opportunities. So, Tony, kicking off with you, what are some of the global trends you're seeing in ETFs today?

Anthony Rochte:
Yeah, thank you for having me here. Great to see you. Just a bit of background on Morgan Stanley Investment Management, and I'll highlight three trends. But MSIM actually entered the ETF market publicly about a year and a half ago, post-acquisition of Eaton Vance. MSIM is about $1.5 trillion in assets under management, with brands like Eaton Vance, Parametric, Calvert, and certainly Morgan Stanley Investment Management.
We launched our first set of ETFs just six months ago. We've just surpassed $400 million in assets. These were Calvert ETFs, so very focused on ESG. But we have plans to expand with Parametric ETFs, Eaton Vance ETFs, and beyond.
Three of the trends that we're seeing that really drive our strategy, number one, is actively managed ETFs. We saw in the middle of this year, 2023, over half of net new inflows into the ETF market in the US were active ETFs. So that's definitely more than a cyclical trend we're following.
I think the second thing is growth in fixed income ETFs. It's almost $2 trillion in assets. It's a fast growing part of a $7.5 trillion US ETF market. So that's a key input to our strategy.
Then I know all three of us are going to talk about distribution, but when we look at distribution, it's intermediary. It's certainly the self-directed investor, but also institutional investors. We've seen quickly demand from institutions in the US and Europe for ETFs growth. So those three macro trends are really where we're focused as we build out this new global ETF platform.

Gillian Kemmerer:
Well, welcome to the party, so to speak. I know we're going to dive a little bit more into active and fixed income later in the conversation. Marc, what about you? What are some of the global trends that you're tracking at Columbia Threadneedle?

Marc Zeitoun:
First of all, thanks for having me here and great to be with my colleagues. I think, first and foremost, the ubiquity of these, of ETFs. Everyone is using them more and more. I don't think that there's a segmentation of advisors that can be based on a product chassis as there once was, "I'm an ETF producer," "I'm a mutual fund producer." I think wealth management has leveled all that playing field.
I think that what we see from our clients and our prospects is this need for research and insight. I think that ETFs have begun to migrate away from just that bulk exposure to a market into something insightful. Whether it's active or whether it's thematic or whether it's incorporated in an enhanced benchmarking framework, the need for guidance and insight, I think, is finding its way more and more in ETFs.

Gillian Kemmerer:
Well, I look forward to diving a little further into strategic beta with you later in the conversation. Rob, lastly, what are you tracking at DWS?

Rob Bush:
Yeah. Gillian, great to see you again and thank you for having me. It's really nice to be back here. I agree with the comments that Marc and Tony made. I think that when I think about trends in the ETF industry, I think about the evolution of the industry. I mean I'm sure that like me, many of us have been in this almost from the get-go.
It started, of course, with market cap exposures and we segued into sector exposures, international exposures. But for a long time it was regular beta exposures. Nothing too clever or fancy going on. Then we moved into factor exposures, multifactor exposures, currency hedged.
I think what the market has come to realize is that the only thing that's really limiting you is your imagination. It's really that and the client demand for the product. Obviously the market will always test new ETFs and new innovations to see that they are actually viable and wanted.
But you think about where we are today, we're looking at a huge amount of interest in more niche exposures, structured exposures, active exposures. And so, really it's a fantastic industry from that perspective to be involved in because the innovation is really exciting.
I think the other trend, of course, that's probably less exciting for us as firms that offer ETFs is the competition and the ... Not that we don't welcome competition of course, but what it's done for the fees is great for the end investor and it's something that all of us who work in the industry have to think about, the compression of the fees. But that's a natural result of, I think, the popularity of the ETF as a wrapper.
And so, I think that the three guiding words that have always driven us at DWS is access, value, and innovation. So we won't launch a product unless it ticks one of those boxes. We want to give people exposure to something they couldn't get before.
Sorry, I hope I said access, value, and innovation, not active. But I meant access, value, and innovation. Access to something they didn't have before, value is something that is at a competitive price, and innovation is doing something in a new and interesting way. So taking a traditionally vanilla exposure and changing something about it, tailor-making a component of it.

Gillian Kemmerer:
Well, I look forward to diving into some of those innovations at DWS a little bit later on. Marc, coming to you, discussions about passive ETFs often include benchmarks and custom indices under the same passive umbrella. What do you think investors need to know about this?

Marc Zeitoun:
I think investors need to ... Or advisors and investors need to understand that there is a world of passive, there's a world of active, and then there's the bridge in between. Whether it's an ETF, a mutual fund, a separately managed account, it doesn't really matter. The conversation in my opinion, or our opinion, needs to be about what is the client trying to achieve. If there's a pursuit of alpha, at what price? We can't make the mistake that every client and every advisor has the same value principles across the entire wealth management spectrum.
And so, we see strategic beta as an expression of active, insights and research that I was referring to before, at a different price point in a slightly different expectation. I think clients who have migrated to a benchmark exposure, pure and natural without any enhancements, are throwing in the towel, giving up, eliminating a source of alpha.
So in a way, we at Columbia Threadneedle are trying to show that there is value add, there is alpha, even in a passive setting, if it's designed, back to the innovation point, around trying to achieve that. And so, in that way, we're rejecting passive versus active and thinking more in terms of insight or not insightful.

Gillian Kemmerer:
Tony, you referenced the inflows to active. I'd like to talk a little bit about some of the trends you're seeing specifically in active ETFs.

Anthony Rochte:
Yeah. Again, if you look at the data, active ETFs have really taken hold just in the last three to four years. So ETFs have been around for 30 years, celebrated their 30th year anniversary. But really two things have happened.
Number one, the SEC enacted Rule 6c-11 or the ETF rule in 2019. That enabled traditional active managers to enter the market in as short as 75 days. Prior to that, it would take two, sometimes three years to launch an ETF.
So I think the regulatory change has really enabled new entrants like Capital Group, like American Century-Avantis, like DFA. I think that's good. To your point, Rob, about competition, that's a good thing, and we're focused on expanding choice.
I think the second thing is just performance. We looked at ... There was a study from Barron's in July of this year. If you looked in the first seven months of the year, of the 230-plus ETFs launched in '23, 68% are actually outperforming their benchmark.
So I'm not here to say active is better than passive. I spent most of my career launching ETFs. So I think there's room for both. What I will say, though, is the next decade we believe will be focused on active alongside passive and certainly smart beta. So I think that's good for the investor alongside increased competition and lowering fees. That's a win for the investor.

Gillian Kemmerer:
Rob, how should we be thinking about thematic investing in broad terms?

Rob Bush:
Well, I'm still trying to figure that out myself, but I'll tell you where I'm coming out on it at the moment. I think to the point about evolution, thematic was a natural evolution. We went from market cap to sector to thematic.
In the research institute, we've published on this recently, and where we came out on it is that we're all operating in the securities kitchen, as I like to call it. We're slicing and dicing markets in different ways, and these ways are all very valid as long as they're done sensibly and properly. Thematic is another way of carving up the equity market, which I think can make a lot of sense.
But I compare it a little bit to ... I draw the contrast to sector investing and factor investing with thematic. So I think about sector investing as being probably the most ... The stretch that most of us are very familiar with. You've got this very clean, delineated, mutually exclusive way of carving up equities.
Then on the other hand, on the other side of the spectrum, you've got factor investing, which looks across securities as not mutually exclusive and carves the market up in, I would argue, a more quantitative way. Very interesting as well.
The thematics, I think, sits a little bit in the middle in the sense that you're also carving up across and within sectors. So you're looking at different economic drivers and revenue streams that tie to a particular theme. But there's also quite a quantitative aspect to it in terms of figuring out how much of the revenue of a company actually aligns with that theme.
And so, I think that it's really about putting it somewhere between those two. That's the way I like to currently think about it.
I'll risk a hockey analogy since you just said you're a hockey fan. And so, you'll be well-placed to correct me if I get this wrong. But I believe there's a very famous hockey player, Wayne Gretzky, who I think said part of his success was, "I don't skate to where the puck is. I skate to where it's going to be." I like that analogy for thematic because I think what you're trying to do as a thematic investor is skate to where the economic puck is going to be.
If you believe that today's world fully encapsulate all information and that the stock market ... And it does a pretty good job of that. We have to be honest, it does do a very good job of that. But if you believe that it doesn't do a perfect job of that, if you believe that actually there are themes that you can align with which are going to be more successful in the future than maybe is currently priced in, that's the economic park, then skating to it through thematics is, I think, pretty interesting.

Gillian Kemmerer:
Wow. I was not expecting the Wayne Gretzky reference, but I enjoyed it very much. Hopefully we'll see a few more of those throughout the conversation.

Marc Zeitoun:
Can I just add that-

Gillian Kemmerer:
Of course.

Marc Zeitoun:
... I think it's wonderful ... We've been in the ETF business for quite some time. I think it's wonderful that the choice has evolved from cap weighting, non-cap weighting to insight and theory and thesis and all of the different ways that we slice and dice. That's part of that innovation that you were talking about that our constituents are looking for when we talk to them, whether it's the home office or the end advisor. They know what's possible and how much more it's evolved.
I just think it's great that we're sitting here not talking about alternative constituent weightings and that we're talking about all the greatness around active to passive, just that entire continuum.

Gillian Kemmerer:
Yeah, incredible, the diversity of offerings available.

Marc Zeitoun:
Yeah.

Gillian Kemmerer:
Tony, was there anything that you wanted to add there?

Anthony Rochte:
No, I just think going back to the comment around choice. I agree with your point. Whether it's smart beta, whether it's passive, whether it's active, I think it's a win for the different channels that use ETFs. I will say, going back to my opening comments around institutional demand, they're certainly gravitating towards passive and factor-based, but we continue to see growing usage of ETFs from institutions.

Gillian Kemmerer:
Passing the puck back to you, Marc, so to speak, as an industry, we often talk about ETFs in a way that makes them seem separate from other investment opportunities. So I think it begs the question, do we need to shift the focus of this conversation a bit?

Marc Zeitoun:
Well, just building on what Tony just mentioned around institutional appetites, a lot of the strategies that we would offer them, they would execute in a separate account. I think that in the same way that we don't talk about mutual funds only, we talk about the strategies that they encapsulate. I think that the ETF conversation has become to mean more and more beyond just a benchmark and that in order to get that message through, you have to spend more time talking about the investment strategy and then follow up with the chassis.
Now one of the things that we've focused on in our product development is we have tapped our active managers to help build our passive solutions. And so, we're going to market with the same portfolio team, and that gets a different kind of ... Actually, I think what it does is it focuses the conversations primarily on the things that matter first, which is how are you managing the asset, and then to the packaging and the pricing, which comes after. Then there's a choice when positioned as a competency.

Gillian Kemmerer:
I saw you nodding. Was there anything that you wanted to add, Tony?

Anthony Rochte:
No. I think to the point on the Intel Inside is the portfolio management. I agree, an ETF in its simplest form, is a wrapper. So it really has to do with the investment capability.

Gillian Kemmerer:
Now that we've discussed some of the trends that you're seeing, some of the diversity of offerings, I want to get a little bit more granular and talk about each of the strategies that you're presenting to us today, and we have such a nice variety here. So I think, Rob, I'm going to start with you.

Rob Bush:
Mm-hmm.

Gillian Kemmerer:
Let's talk about the role of thematics. Do you look at thematics as a diversification tool or do they comprise a return enhancement strategy?

Rob Bush:
Yes, a very important question for anybody to think about as they approach thematics. I think that we probably in the industry throw around the term diversification probably a bit too much in the sense that we tend to believe that anything that isn't currently in our portfolio is a diversifier. It probably, in many cases, has the potential to be, but you have to check it. It's not always going to be the case.
It's not obvious that it's going to diversify you, because, without getting overly technical, there's always a couple of different moving parts there. There's the standalone risks of what you're thinking about, and then there's the interaction of those risks, and they can be pulling in opposite directions sometimes.
So to put a bit more specific example on this, we've looked at standard portfolios of equities and fixed income and we've looked at the impact of adding different thematics to them either individually or as a package of thematics. I certainly wouldn't say it's true of all thematics, not at all, but it's true of the ones that we looked at that actually because they are a subset of the market, they tend to be, in some cases, a little bit higher risk because they're smaller baskets of securities.
Yes, it's true that they are not fully correlated with the stock market, although that correlation will often be quite high because they are, after all, in many cases equities. So you've got a relatively high correlation, you've got a relatively high risk.
So it turns out if you're going to make an allocation, it doesn't lower the portfolio of volatility. That's what I would define diversification as really doing, lowering risk. So I don't think that in many cases you can make that claim, though, again, it's not going to be true in every case. So I'm afraid the answer is you have to evaluate it on a case-by-case basis, and it's important that you do. You'll find that those two moving parts and the way they interact will give you a clean answer.
But if it's not a diversification story in a relatively simple way that is for other asset classes, where you really must own them because they spread risk, then I think it probably does have to become a little bit of a return story, Gillian.
That's why I mentioned that economic puck argument because what I'm saying is that probably the investor has to think about their conviction, their belief that the theme they're getting exposure to is going to outperform the stock market and the economy. They have to believe that it's not currently priced in and they have to believe that that is going to be sufficient to compensate for any additional risk or fee or complication that arises by adding that theme to the portfolio.
So I'm afraid it's a very long-winded answer. I'd love to give you a more simple one, but the answer is really case-by-case basis. It needs very careful analysis and you need to think carefully about your motivation and rationale for doing it.

Gillian Kemmerer:
Reframing the diversification conversation. Really important point there.

Rob Bush:
Mm-hmm.

Gillian Kemmerer:
Marc, Columbia Threadneedle has focused on strategic beta. To Tony's point, there is this trend and a lot of inflows toward active. So how do you think that's changing the way investors are interacting with your ETFs?

Marc Zeitoun:
I don't think it changes. I think it expands the audience that might be interested in what we have. We approach the market on a continuum basis where alpha and beta on one end, and pure benchmarks are pure beta and there's no alpha, and alpha-seeking strategies are on the other end. We also tend to accept in our industry that pricing follows suit. The more alpha, the greater the fee. What we've learned is not every client wishes to acquire alpha at any given price.
So what we're trying to do is dynamically meet the client where they want to be met. What are your parameters in terms of performance outcome, investment theme, but also fee and accessibility. Somewhere in that matrix is the right fit for the client.
It's not a surprise that we've gone from commingle to customized on our way to personalized. We're in that generation. We are dealing with people who want their solution for their investment portfolio, for their objectives. Whether you start with an ETF or you start with a strategy that is passive or active, you can get to that customization level along the continuum of the client interest. You just have to have a freer conversation that is not chassis limited.
And so, that long answer to the short question, we're focused on positioning the entire array and asking the clients where they feel more comfortable implementing.

Gillian Kemmerer:
So on this point about client demand coming to you, Tony, what channels are you seeing the strongest appetites for active ETFs coming from and how do you see that evolving long-term?

Anthony Rochte:
Yeah. So to build on Marc's point around wrapping these solutions across active and passive and smart beta, we own Parametric, right? Parametric is a customization engine, a self-index machine, and they run a large SMA business. We've got Calvert, which is an ESG pioneer. They've done it for over 40 years. Then Eaton Vance and certainly Morgan Stanley in the alpha category.
When we look at our client base, we serve financial advisors, we serve the self-directed, and we spend a lot of time with institutional clients. What we've seen over the last 10 years is the transition ... Well, even 20 years, the transition from a commission-based compensation model to a fee-based. In the case of an REA, mostly fee only.
And so, as much as all three of us have been talking about ETFs, we've seen it grow. I've seen it grow from an $80 billion category to $7.5 trillion. Behind that, though, is the client demand and the way in which they build clients for portfolios, and they charge a fee. That's what's really driving this.
So when we look at self-directed investors, that's a growing part of the market. But I think the sophistication that was just discussed really is led by the financial advisor. I think expanding choice with all of these, whether it's thematic, pure active, passive, I think that enables a richer client experience for the end user. But I do think the financial advisor is in the center of this, and ETFs make it easier to execute.
It's not to say that mutual funds aren't important. They're certainly critical in the 401K arena and they're certainly very important alongside ETF. So I don't want to make the claim that it's only about an ETF solution.

Gillian Kemmerer:
Sure. Rob, coming back to you, what's the timeframe for thematics?

Rob Bush:
Yeah, timeframe is also like diversification, so a word we throw around. But actually in the case of timeframe, we probably don't throw it around enough, because I actually think it's very important to think about that. In fact, if I was a bit more pompous, every time someone asks me a question, I'd say what timeframe are you talking about? Because they don't often ask the timeframe.
But it's critical, really, if you think about it. It is critical because everyone has a different timeframe. Everyone's operating on a different set of horizons that matter to them. It's very easy to fall into the fallacy of believing that your timeframe is the same one that's relevant to somebody else.
And so, I think that with a thematic, I think that you have to have some sort of taxonomy for thinking about that. What I would probably argue is that they are not, I don't think, tactical. By tactical, I mean we'll all have different ideas in mind what that means, but let's call it somewhere zero to two years. I mean we could debate that, but let's say relatively short term.
I don't think it's that. The reason I don't think it's that is because the economic park that I talked about earlier ... It's going to take some time to get to. It takes a little while to skate across the ice and reach it. A lot of the thematics that we and others have launched are not ones that are necessarily going to come to fruition today or within the next month or quarter, but they may, we hope, play out over the next, let's say, five to 10 years.
So on the short side, I don't think they ... Now that's not to say you can't use them tactically. You probably can. I'm just saying that I don't think that's where they naturally sit. That's really all I'm saying.
If you take that to the other side and you think about strategic, I mean I would argue, and we have argued, that strategic beta or factor investing is much longer term in nature. It's something that you can actually legitimately hold almost forever because as an expectation of alpha generation even over the very long run.
But I don't think that that can necessarily be true of thematics, and I'll explain why, because if your thesis is that a certain theme is going to outperform, I think it makes sense that you can't argue it'll outperform forever. The reason for that is that eventually it would grow bigger than the stock market or the economy.
Also, if it does outperform, it'll naturally attract attention and investment, which should lower the return on it. So I don't think it's reasonable to believe that an allocation to a thematic can necessarily be forever either.
So we're bounded on both ends. I'm hedging my bets here. But we're bounded on both ends. But that leaves you somewhere in the middle, I think, where you almost have to turn off your tactical and strategic thinking and say, "Well, I want to make an informed decision about this. I believe in this thematic as a thesis, but I also need to think carefully about over what time period I think this will work. What am I really talking about here?" That will vary by theme to theme and it'll vary by investor to investor, but I don't think it's going to be very short and I don't think it's going to be forever.

Gillian Kemmerer:
Now Rob teed us up nicely to talk a little bit more about strategic beta, Marc. We talked about the fact that you have the strategic beta approach to ETFs. But put a finer point on it. How does it work?

Marc Zeitoun:
We have two product development paths when it comes to our strategic beta ETFs. I should also mention that we have launched active, and we're also going to get more and more into that area. But we've been in the business for 10 years. And so, up until now we focused on strategic beta.
On the fixed income side, as I mentioned before, we go straight to our portfolio managers and we ask them to distill the basic concepts of their portfolio and put it in a strategic allocation that, to your point, could last for an entire market cycle.
On the equity side, we found a different use case, and that was the idea of enhanced benchmark investing. So we take benchmarks, traditional benchmarks, that drive the capital market assumptions, that drive the asset allocations, that drive the portfolio creation, and we simply remove names that our research doesn't like.
We find sometimes thematic is what people want to be in, but sometimes it's what people don't want to be in. We think that advisors ... Well, we think their clients would expect from their asset managers to not give them names that their research doesn't like, and that's our biggest problem with benchmark investing is that you're getting the good and the bad. So we take a shot at just removing the bad.
That has found a good following. People understand that. One of the things that we haven't talked about yet is the simplicity factor, whether it's thematic, whether it's factor-based, which I don't like as a word because it complicates things, but can the client and the advisor easily understand what you're doing on a repeatable process? I think that's the key to everything that we're talking about.
We as an industry try sometimes to get too clever and then we scratch our heads and try to figure out why it wasn't adopted. So we took a simple approach in equities of benchmark enhancing, and that's worked out.

Gillian Kemmerer:
If we zoom out to broader economic trends, we're coming off of the most aggressive Fed rate hike cycle in 40 years. We have everyone saying fixed income is back, the income's back in fixed income. So, Tony, I would imagine there's probably some interesting trends in fixed income ETFs today.

Anthony Rochte:
Yeah. We have fixed income capability across Morgan Stanley, certainly in Vance, Calvert, and Parametric. Again, going back to Marc's comments around providing choice for the client, I think this is critical.
Specific to fixed income, we've definitely seen demand for high-yield ETFs, definitely shorter duration. Obviously clients, advisors, institutions are staying short on the curve. Ultra-short has grown. In fact, almost half that ultra-short category is actively managed ETFs. I think that's very noteworthy because it's a fast-growing part of the market. We've also seen demand for municipal bond ETFs.
We filed at the end of July for a high yield and ultra-short and a municipal bond ETF. All three will be from Eaton Vance. We're in a quiet period, so I can't say a lot more. But what I can tell you is we go to our active teams and we'll differentiate the ETF from the mutual fund that they manage. But clearly fixed income is growing fast and approaching almost $2 trillion in assets just in the us. So we think it's a significant trend.
It's actually growing faster off of a smaller base than equity ETFs, and I think that's surprising. I was actually part of the ag iShare ETF launch. I looked, it was over 20 years ago. Time flies. But I remember going to an equity desk and explaining the underlying is powered by bonds, and that was unheard of 20 years ago.
Fast forward, and again, it was probably 10 or 15 years where fixed income ETFs, all passive, grew, but they didn't accelerate. We've seen an acceleration from world-class fixed income managers in the last 36 months, and we think that's an important secular trend. We anticipate we'll be a big part of it.

Rob Bush:
Gillian, may I just add on that?

Gillian Kemmerer:
Please.

Rob Bush:
I know I'm not here to speak about fixed income ETFs myself, but a question I'd like to ask of the panel, I guess, is that ... And it links to our earlier conversation about innovation. One thing I've heard, and I think it's true, is that the development of fixed income ETFs has actually been good for the whole fixed income market, slightly counterintuitively, because you would think it just simply represents almost a competitor of buying cash bonds.
But what I've heard, and I'm no expert on this, is that actually it's completed the ecosystem in a sense and it's created this circularity or triangularity of different ways of accessing the same asset class. So you've got the cash market, the ETF market, the futures. Is that something you agree with or thought about?

Anthony Rochte:
Yeah, because I've been a part of many of the fixed income launches, both passive and active. It comes back to price discovery. If you have another vehicle that drives additional price discovery alongside the cash market, no question about it. You see spreads continue to tighten. I think the ultra-short ETF category is noteworthy because it's grown just in the past five years and it's almost half active.

Rob Bush:
Right.

Anthony Rochte:
There's still a big passive market. But I do think it comes back to price discovery. Certainly there are categories where spreads are going to be wider, like emerging market debt. It stands to reason that's going to be wider. But, over time, you'll see the more market participants enter, the spreads get thinner and thinner.
That's why high-yield ETFs oftentimes trade at penny wide. I remember the Japan ETF 15 years ago traded at penny wide. It was more expensive to go buy the underlying than it was just buying the ETF exposure. So, again, I think the same is happening in fixed income. It's earlier than equity, no doubt about it, but I think price discovery is the answer that we see.

Rob Bush:
Yeah, interesting.

Marc Zeitoun:
And liquidity.

Anthony Rochte:
Yeah.

Marc Zeitoun:
I think it adds liquidity, it makes markets deeper. When you think about an active manager thinking about using a passive bond ETF to increase their capacity, it tells you the interplay between the two right there.

Rob Bush:
Even as a parking place, I mean, for-

Marc Zeitoun:
Absolutely.

Rob Bush:
Yeah.

Marc Zeitoun:
Absolutely. Active managers can focus more and more on new issues, whereas the ETF is picking up that bulk beta.

Rob Bush:
Right, right.

Gillian Kemmerer:
Well, Rob, you are making hockey puns and you're also posing questions, so we might have to switch seats at some point.

Rob Bush:
Sorry.

Gillian Kemmerer:
No, I appreciate it. Coming back to the equities conversation, what are your thoughts on thematics versus single-stock approaches?

Rob Bush:
I have very strong views on that, actually. I think that ... And this is well-known, of course, by all of us in finance, is that single stock is a touch problematic because you're taking on company-specific risk that you're not paid for as an investor and that you don't need to hold. This is 101. This is why we diversify, to get rid of that company-specific risk.
So I think that there's a place for that really good fundamental analysis, but I would almost say you leave it in the hands of the pros, because if you think about yourself as a retail investor particularly, are you as well-resourced? Do you have the time, energy, effort, access that it takes to really understand a company? That's what stock analysts are for. That's their full-time job, and it's tough to go up against that.
So I think that it's very credible to me that you may have a well-formulated opinion about a theme or about a sector of the market or an economy. I think that's less true of a single-stock position because, as I say, it demands so much work and attention and constant vigilance essentially to make sure that you know at all times what's going on in that company.
So I think that if you're probably more on the retail side and you're thinking about doing this, I think that what the thematic does, and this is true of any portfolio in a sense, is it gives you a safety net, and that safety net is diversifying your thesis across different companies.
So if I, for example, want exposure to the semiconductor industry, it makes a lot of sense to me to do that via a basket of semiconductor stocks as opposed to an individual security, because you could be right on the thesis and wrong on the company by sheer bad luck, and that's really going to be a painful experience. It was almost as if you got it right, but you were punished and you were punished because of the way you decided to implement as opposed to your insight, which was correct.
So I think that one thing thematics do, and I don't think we talk about this a huge amount, but one thing they do is give you that safety net. They give you the ability to approach a thesis while removing ... Not all of course, but a lot of that company's specific risk is going to be diversified away, and it leaves you a pure exposure to what it is you think you know about and takes away some of the things that you'll never really be able to control.

Anthony Rochte:
I was just going to add to Rob's comment. In my former life, I ran the sector business at a large global asset manager. We spent a lot of time on this industry sector thematic. What we heard loud and clear from advisors, exactly what you said, and they would use single-stock positions and dial back the risk using an ETF portion. So they would use both. That was very common. Then, over time, they would use more and more of the ETF. But that's really how sector ETFs, now thematic in industry, really grew. Initially they were just 10 GECs or nine GECs initially.

Marc Zeitoun:
Well, these have migrated from being tools to being portfolios.

Anthony Rochte:
Yeah.

Marc Zeitoun:
I think that, as you were saying, it is a full-time job to manage a portfolio of individual securities. Unless you're willing to do that, you shouldn't. It's as basic as that. I think that's meeting the client where they want to be met. I had never considered ETFs versus a single stock, but it makes all the sense in the world.

Gillian Kemmerer:
What I admire about this conversation is that we've kept the client and the advisor top of mind. So much of the choice that's being offered has been in response to the demand that you've referenced. So, Marc, I'd like to be a fly on the wall for some of those conversations. What's been working and what are advisors saying to you? What are they doing with smart beta strategies? What should they be doing?

Marc Zeitoun:
So we do a lot of surveys. We think it's important to understand what the market's thinking. We can define the market differently. Basically, it's whoever responds to our surveys is a good start, and then we'll slice and dice that into cohorts.
But even passive investors are frustrated by not being able to change names inside a portfolio, sort of this dichotomous I want bulk beta, but I don't want the bad names, because when I read their names in the press, I now have to explain to my client why we're still invested in them.
And so, this concept of how can I get broad exposure without some of the stuff that I want? So, for example, I talked about it before, research, but also in sectors. How do I earn regions? How do I get an exposure to emerging markets, but I'm not so sure I want China?
All of these preferences can be customized and offered in the many things that we do. How they're used is back to the advisor, and I would submit that these are allocations. You are allocating to a strategy. You are not trading. You're not trying to make a quick buck, so to speak. There's no such thing, at least for professionals, and you are hedging risk. No matter what your intent is, it's for a period of time.
Some people use our smart beta to express a preference. Some people use smart beta to differentiate their practice. You talked about FAs. If they all use the S&P and the ag, how are they going to differentiate themselves? So they need something. Then, finally, it's a great way to reduce that fee budget, and that is a reality.
And so, rather than completely leave your active allocation, some advisors are just shaving off a piece and putting it in a smart beta strategy that rhymes with what we're doing on the active side, which is why we sell the competency, but it could be somebody else's active. Then that fee budget is back into place. So these are core allocations that can be used to mitigate risk or mitigate increasing fees.

Gillian Kemmerer:
I think, Tony, you were the first person that brought mutual funds into the conversation. So I'd like to come back there for a moment. What are we seeing in mutual fund to ETF conversions now?

Anthony Rochte:
Yeah. A number of large organizations have filed for a proxy to actually convert the mutual fund to an ETF share class. We're certainly evaluating it. I think it's important. But by the same token, we think there's a space for mutual funds alongside ETFs, alongside SMAs. The advisor and the intermediaries, they're the pilot. They're controlling this.
But I do anticipate you'll see more mutual fund to ETF conversions. Why? ETFs tend to be lower cost, they tend to be much more tax-efficient, and they trade on exchange and they're transparent. So you can see on any given day.
The only trend that I would add, and it's just answering the question, but to Marc's point, is last year the advisor saw something they hadn't seen probably in their career. The 60/40 portfolio didn't work, right?

Marc Zeitoun:
Mm-hmm.

Anthony Rochte:
We're talking about equity and fixed. And so, you have these clients that want to de-risk their portfolio, and they always did it with fixed income. Then all of a sudden you know what '22 presented.

Marc Zeitoun:
That's right.

Anthony Rochte:
So I do think when we talk about innovation, there are ETFs being launched in the derivative income category, for example, that are helping advisors get their clients back into the market with a hedge that you mentioned and also in some ways re-risking the portfolio. But we all know what happened in '22. The 60/40 didn't work. And so, I think the industry's ripe for innovation.
In terms of ... Back to the initial question, though, I do anticipate you'll probably see more mutual fund ETF conversions, but again we don't have any current plans at this time.

Rob Bush:
[inaudible 00:39:54].

Marc Zeitoun:
I think it's important to add that we can launch all the products we want, they need to get onboarded. There's a very important need for a gatekeeping process that all of our clients have. Part of that gatekeeping process is have you been in business for a while? Do you have a track record? Is this repeatable?
Unfortunately, when you launch a new product, you haven't proven that. When you convert, you get the AUM, you get the track record. So there's a benefit to that. It goes both ways, and it's a very complicated issue that all of us are wrestling with. I would suspect that all of us will try one or two, and then decide if that's the way to continue or if we should just go de novo.

Anthony Rochte:
I do think it's a good point, though. You do pick up the assets and the track record, and that is from a distribution standpoint.

Marc Zeitoun:
Very important.

Anthony Rochte:
Really important. I would say this, though. If it's an underperforming mutual fund-

Marc Zeitoun:
Don't bother.

Anthony Rochte:
... it's not going to make a great ETF. If it's an outperforming mutual fund, it may or may not make a great ETF. But the reality is if it's performing really well, I'm sure clients are satisfied. So, again, back to that theme around choice.

Gillian Kemmerer:
Each of you have done a great job of this already, incorporating into the conversation, but I'd like to talk about your firm specifically and what you're seeing and what your value add is. Actually, Rob, if I start with you. We've talked about thematics in theory, but in practice, tell us about something that DWS has recently launched and why now is the time to go to market with it?

Rob Bush:
Yeah, sure, sure. So we recently launched a package of three, which is quite interesting to me. They sound relatively separate, but actually I'll make the case that there's actually a coherence that's quite interesting.
So we've done cybersecurity, semiconductors, and green infrastructure. I think that if you think about particularly a lot of the legislation that's come out of the US over the last few years, there's been a recognition that we are not where we need to be in terms of infrastructure. That's the first point. And so, we think that that's going to be a real priority and has been made a priority through spending commitments in those bills.
But we think that it's going to be done in a different way. We need to rethink the way we do infrastructure, and it doesn't just mean heavy industry and vast bridges and roads and airports, the traditional things we think of. We actually think that a lot of infrastructure has embedded technology, and it's going to be done in a much more environmentally friendly way. And so, that's the rationale on the green infrastructure side.
But that digitalization of infrastructure is going to rely on the semiconductor industry. And so, that's going to be important, too. And so, we think that there's a natural alignment there. It's incredible when you think about the pervasiveness of semiconductors in today's economy.
Then the third part of it is the cyber part, which is really fascinating. There was a paper came out from the White House this year, earlier this year, the White House Cybersecurity National Strategy paper, and it's fascinating reading. It's actually quite ... It makes me laugh because in the first section of it, they talk about how detrimental technology has really been to society. They come up with this litany of reasons why technology is awful, which I did read with a wry smile. But then they go on to say, but actually we recognize that this ship has sailed and we're never going to pull back from this.
So for all its negative effects, there's been some positive ones, too. And so, digitalization and the trend towards digitalization is just an irreversible trend according to this document as I read it.
And so, if you accept that thesis, since I've used the word so many times, if you accept that thesis, then I think you have to look at the data as we did and say there's also going to be an awful lot of illicit activity linked to that. The number of hacks and the way this is being done, and the economic cost of it, has gone up over the last decade or so, and is forecast to increase dramatically, not just by ourselves but by the World Economic Forum and others as well. When you look at their forecasts for that activity, its forecast to really increase.
The argument is that we're just not there yet as an industry, as a government in terms of our response to it. It's problematic not just because of the gulf between the number of attacks and their cost and the current lack in response, but it's also problematic because of its dynamic nature. So a lot of these reports talk about the fact that it's different people doing it all the time and they're doing it in different ways.
So there's this constant criminal innovation, which isn't a very nice thing, but we argue that cybersecurity, therefore, is an interesting response to that because it's going to need to be as innovative and it's going to need to be a partnership between public and private sector to fight that. It's a trend that of course we don't love, but we don't see it as going away. So it's a realistic approach to think about cybersecurity.
So I think it's a cohesive package in that sense. I think that, again, what it's trying to do is recognize the importance the government is putting on it and therefore the spending that may follow. Importantly, coming back to what I said right at the beginning of the conversation, that that is not currently priced in today. The way we think about those three things today is arguably ... The impact of it is underestimated.

Gillian Kemmerer:
Whoever was lamenting technology's rise at the White House was clearly not talking about innovations in ETFs, which generally have been wonderful and in response to clients.

Rob Bush:
Well, it's funny you say that, Gillian, if I may-

Gillian Kemmerer:
Sure.

Rob Bush:
... because there was a famous quote, wasn't there, by ... I think it was Paul Volcker who said there's been no good financial innovation other than the ATM in the last 50 years. Every time I read that quote, I think ETF.

Gillian Kemmerer:
Absolutely.

Rob Bush:
There's another one for you.

Gillian Kemmerer:
As this conversation would attest. Yes. You've been throwing out the great quotes today. Marc, obviously this discussion can get pretty technical. So how does Columbia Threadneedle target the right advisors?

Marc Zeitoun:
It's interesting because we're all about data-driven distribution and segmentation. I would suggest that factor conversations are different than thematic conversations, which are different than active conversations. But you don't want to lead with product.
And so, this goes back to the way that we go to market. We'll go to market with a competency, whether it's multi-sector fixed income, we'll go to market with emerging markets, or we'll talk about equity benchmarks, or large-cap value, or large-cap growth. Then from there, we will expand and offer the client choice depending on where the conversation is going.
That's the right way to approach it because they're trying to solve a problem. We're not trying to sell products. We have to offer these as solutions for them. We have to offer them choice as opposed to, "Here's what you need to do." They may want to hear that, but the broader the conversation, the more fuller the research and the greater the outcome for the client. So the segmentation is important in terms of people who might be looking for one type of strategy versus another, but not necessarily the chassis.

Gillian Kemmerer:
It's a really interesting reframing of how you're talking to clients. It's not about product.

Marc Zeitoun:
Well, that's not how the clients think, right?

Gillian Kemmerer:
Sure.

Marc Zeitoun:
So it's important for us to get on the same page.

Gillian Kemmerer:
Sure. Tony, how does Morgan Stanley stand out and offer value for investors in your new venture in ETFs?

Anthony Rochte:
Yes. As I mentioned, we've been at it about a year and a half. We've been in market just six months, and we're building a multi-brand global platform across equity and fixed, in brands, as I mentioned, Parametric, Eaton Vance, Morgan Stanley, and Eaton Vance.
I think what's critical is we take a client-centric approach, we work backwards. That's where we start. We're definitely looking to compliment, not clone our existing mutual fund lineup. And so, we'll differentiate in the ETFs that we're launching, and you'll see more from us.
Then the third thing, and it's foundational, is we want to launch ETFs where we have a core capability, and we've done it for decades. It so happens to be that at the core is active management. I do think advisors will use passive and active. So I think we'll be now in the mix. But active management is certainly central to what we're doing. We look forward to future launches from certainly Parametric and Eaton Vance.

Gillian Kemmerer:
Coming back to this Wayne Gretzky metaphor about skating to where the puck will be, via Rob, let's talk about where this puck is going and what innovations in the ETF space that you're expecting are going to dominate the conversation in, let's say, the short to medium term. So, Marc, starting with you, where are you looking ahead right now?

Marc Zeitoun:
Well, I think active is a very interesting place. There are other asset classes that haven't necessarily been served appropriately, and I think we can all see them whether we were focused on equity, but there's real estate and there's other varieties of non-US equities that we can talk about. There's the model portfolios, all of that.
But I think that for a shop that spent the last 10 years building strategic beta, we want to start expanding now, as Rob was saying, to that full portfolio of capabilities. I don't know that clients need active as much as they look for research and insight, and we can deliver that across that whole portfolio. But active, I think, especially transparent, is something that we're going to pay some attention to, whether it's through conversion, whether it's through de novo. That whole area, I think, is ripening now for acceptance.

Gillian Kemmerer:
Rob, where are we skating to?

Rob Bush:
Definitely active, definitely, I think ... Thematic is limited only by imagination and also by the way the economy develops, because things that we don't think about today will exist. I mean AI is a good example of something that didn't exist, or it existed but no one was talking about it five years ago. So there's always going to be something that's coming along, which is a natural place for product innovation. That's the dynamic nature of it and that's what makes it so interesting.
I think we're seeing a lot more optionality in portfolios. So a lot of ... I think, Tony, you alluded to this structured and income-enhanced ideas. So there's a lot that probably can still be done with the derivatives markets. That is a natural progression, and it took a bit of time probably to get there from a regulatory standpoint. Digital probably is the other thing that I think will obviously be important at some point. But, yeah, I think those would be the main ones.

Gillian Kemmerer:
Tony, where are we headed?

Anthony Rochte:
I think the irony is if ... You had that question 20 years ago, this idea that you could put a treasury bond in an ETF was like cutting edge. Then you could actually store physical metal in a vault. We all know about GLD and IAU, and that was cutting edge.
I do think derivative income is very interesting today. A number of different sponsors have brought this capability where you can actually deliver alternative income through covered call writing and dividend-paying equities. As I mentioned, we have filed for an exposure like that through Parametric.
But I do think these tools are sharper and sharper every day, and that's even more important that there's an advisor or an intermediary in the middle of the conversation. That's why I think while the self-directed market is growing, I do think as these instruments become sharper and more complicated, it's important that there's a professional helping guide, that portfolio construction.

Marc Zeitoun:
Absolutely.

Gillian Kemmerer:
I'm conscious that we're coming toward the end of our discussion. So, Marc, if there's one takeaway that you would suggest that our viewers of this masterclass should bring with them, what would you say?

Marc Zeitoun:
I would say don't generalize that ETFs are all benchmarks. Spend a little bit more time understanding the rule set and who created it and how it fits in a portfolio, and that the trend towards personalization is only going to continue. So from customization to personalization. Sometimes the strategy is best in an ETF and sometimes it's best in a separate account, and we rely on the advisor to figure that out.

Gillian Kemmerer:
Rob, final thoughts from you?

Rob Bush:
Yeah, I think I would say take a look at thematic, but take a very measured and careful look. Think carefully about the impact it'll have on the portfolio. Don't assume. Think carefully about your timeframe that you think that will come to fruition over and have clear idea of that before you go into it. Also make sure that you have strong conviction that the economic thesis is aligned with your worldview.

Gillian Kemmerer:
Mm-hmm. And, Tony, [inaudible 00:52:35]?

Anthony Rochte:
Yeah. I mean just keeping it short. When I think about ETFs, I always say it's not an either-or, it's an and. It's to the point made earlier, that there's great capabilities from a lot of organizations globally.
The ETF, in its simplest form, is a wrapper. I do think the ecosystem is different, though, because it trades on exchange. There's capital markets behind it. So it is more nuanced than just the vehicle. However, it will sit alongside SMA and mutual fund and self-indexing. So thank you for the opportunity.

Gillian Kemmerer:
Well, from active to thematic, to strategic beta, Volcker to Gretzky, we've covered a lot of ground today. So thank you for taking the time to give such a comprehensive overview and to educate our audience.

Marc Zeitoun:
Thank you.

Rob Bush:
Thank you.

Gillian Kemmerer:
And thank you for tuning in. From our studios in New York, I'm Gillian Kemmerer, and you just watched the ETF Masterclass.