ETF Prime: Lydon on Active Management and ETF Growth

Geraci and Lydon kicked off the episode by talking about Future Proof, a wealth festival produced by Ritholtz Wealth Management and Advisor’s Circle. Lydon said, “collectively they took a pretty big risk.” Lydon saw the risk as paying off, with a new, younger, diverse group of advisors getting to connect in the impressive, festival-like conference. Lydon highlighted some of the unusual and effective panels at the event, including Brian Portnoy’s Storytelling For Financial Advisors. “Today it is all about creativity and finding the right clients for your practice.”

Charles Schwab released an ETF study. The study started with Schwab surveying 1,000 investors who bought or sold ETFs over the past two years and a thousand investors who haven’t. One big result was that 93% of ETF investors expect to purchase ETFs within the next two years, and 41% of non-ETF investors expect to do the same. “It’s not a big surprise that ETFs are the investment vehicle of choice for today’s investors,” Lydon said, “money is coming out of mutual funds.” Lydon sees ETFs as inevitably surpassing mutual funds, as millennials and Generation X take the investment mantle from baby boomers, who grew up with mutual funds.

Geraci noted that “in 2008 we saw active mutual funds underperform.” Geraci sees this as a catalyst for the emergence of the ETF. “This type of market environment is really beneficial to ETFs.”

Another big data point from the survey was that 80% of ETF investors said that ETFs were their investment vehicle of choice. This is up from last year’s 71%. ETFs now make up 33% of ETF investor portfolios, up from 27% five years ago. Geraci notes that it is expected to hit 40% in the next five years.

“ETFs are the investment vehicle of choice for all the right reason, there’s more optionality than ever,” Lydon said.

The second story covered by Lydon and Geraci was the entrance of AllianceBernstein into the ETF world with the AB Ultra Short Income ETF (YEAR ) and AB Tax-Aware Short Duration Municipal ETF (TAFI ). These are supposed to be the first of many active ETFs for AllianceBernstein, according to their press materials. “Smart team, they grabbed a bunch of all-stars from the space,” Lydon noted. “This is just a start, they are going to be moving into the equity space. Why are they doing that? Because their clients are asking them to.”

Lydon thinks that this move makes sense for AllianceBernstein, especially with the bloom coming off the rise of passive management of late. “Watch them, they are going to be a big player and they are one-hundred and ten percent committed to the space.”

Continuing the big news for active management, Geraci and Lydon discussed the SPIVA scorecard, which measured how active managers did compared to their benchmarks. 45% of large-cap funds outperformed their benchmark over one year and 49% outperformed for the first six months this year. This could mark an “active comeback” as it is significantly better than what it has been.

Though those numbers could look modest, Lydon pointed out that, “for the last 10 or 20 years the number has been 7% that have outperformed. Passive has crushed active.” With challenging markets and interesting opportunities, Lydon sees active strategies might have avenues available to set themselves apart.

“We’ll see if they can continue to do that,” Lydon said. “My big concern is if we have a run of two or three years where active does beat passive, we’re going to see that pendulum shift, and people will start to be stock cowboys again, and that’s not a good thing.” Only 10% of large-cap managers have outperformed over the past ten years.

Geraci thinks that the unusual dispersion in today’s market is fueling the active comeback, noting that something similar happened in 2009.

Asked if the surge of flows to active funds might backfire on ETFs, Lydon was quick to point out that we’re on pace to have the second biggest year of ETF flows ever despite net redemptions in fixed income ETFs over the first four months of the year. “It is the best game in town,” Lydon said, pointing back to the Schwab survey.

To wrap things up, Geraci and Lydon pivoted to general market discussion. Top of mind was the coming rate hikes, which many experts see as likely another 75bps. VettaFi’s advisor surveys have indicated that 57% of investors expect rates to continue rising into 2023.

“When the Fed became more transparent about what they were doing,” Lydon noted, “all of a sudden the market stabilized.” Lydon thinks this transparency gave advisors more confidence. A 75bps hike is already baked in, so barring a surprise 100bps hike, Lydon thinks it could be good for the market. “As long as we stabilize above that June 16th low and get through the year, it’ll give the Fed some time to fight inflation.”

Subversive Capital’s Michael Auerbach has several interesting ETFs in the hopper. Geraci noted that two of them have caused quite a stir. The Unusual Whales Subversive Democratic Trading ETF (NANC) and the Unusual Whales Subversive Republican Trading ETF (KRUZ). There is also a cannabis ETF, a decarbonization ETF, a mental health ETF, and a food security ETF in the works.

A commercial diplomat by trade with a background working with Madeline Albright, Auerbach started Subversive capital to invest in companies that require government relationships or regulatory support. “We made our first big bet in the cannabis industry,” Auerbach said, “from there we diversified.” Subversive, though new to ETFs, has played in the thematic space quite a bit.

“We’re picking themes that are really important to a set of investors.” Auerbach sees these products as part of a larger conversation. Pointing to the upcoming NANC and KRUZ, Auerbach noted that, “we’re the only democracy in the world that lets our elected officials buy stocks.”

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