Bloomberg: Gold, BTC, NVIDIA — Why Everything Can Be an ETF

Author: Alexander Sugiura, Adriana Tapia Zafra, Bloomberg; Translator: Baishui, Golden Finance

Investment in exchange-traded funds (ETFs) is approaching $13 trillion. These ETFs mirror the S&P 500. There are gold ETFs, Bitcoin ETFs, and even vegetarian ETFs. How did this market become so large and diverse? And what does it contain?

BlackRock’s iShares Ethereum Trust ETF (ETHA) saw $248 million in trading volume, one of the highest first-day volumes ever, according to Bloomberg Industry Research. Photographer: Victor J. Blue/Bloomberg

In today’s podcast, we continue with Eric Balchunas, senior ETF analyst at Bloomberg Intelligence and co-host of the Trillions podcast. He tells host David Gura about the unlikely duo who created the first-ever ETF as a last-ditch effort to save the struggling exchange. And Katie Greifeld, co-host of Bloomberg ETF IQ and Money Stuff, breaks down the current booming market and outlines which ETFs are safe investments and which ones are best left out.

Here’s a transcript of the conversation:

David Gura:Sarah.

Sarah Holder:David.

Gura:I want you to come into the studio with me today because I have to ask you about ETFs and what you know about them.

Holder:Okay, ETFs…I feel like what I usually hear is don’t bother researching all these individual stocks.

Gura:Yeah.

Holder:Just find one ETF and put all your money in that ETF basket.

Dave Nadig：These things can really change the way we think about investing.

Zachary Mider：We have this big hole, let's use it in new and creative ways.

Emily Graffeo：So in the last six months, 94% of ETFs have had positive returns.

Mider：You know that's a big tax advantage for a lot of people.

Gura：But, Sarah, to be honest, I'm not entirely sure how they work and why they're so popular.

Holder：Yeah, I'm not sure either, why are they such a good investment, David? What's in them? How are they different from a mutual fund or an index fund?

Gura: These are great questions, Sarah, I have the same questions.

Holder: Thank God, I needed it.

Gura: This is our series where from time to time we analyze the biggest parts of the financial system. We'll look at how they came to be, and what they mean for all of us. Even if you're a financial expert.

Holder: Or if you just want to learn more about what exactly is in your portfolio.

Gura: I promise there's something for everyone!

Holder: I'm Sarah Holder.

Gura: I'm David Gura. Exchange-traded funds (ETFs) are one of the stars of today's investing world. They have Meryl Streep status: They're respected, loved, and...adored by professional and amateur investors alike.

Since their inception more than 30 years ago, ETFs have become one of the world’s most popular investments. But to understand how ETFs have grown and prospered, you first need to understand their origins.

At Bloomberg, we’re lucky to have an ETF expert who has been covering ETFs for decades: Eric Balchunas.

Eric Balchunas: I’m a Senior ETF Analyst, and I write about, analyze, and discuss ETFs, and lead a team of about 10 people around the world who do the same.

Gura: Do you have a favorite ETF?

Balchunas: It’s hard to pick a favorite. You know I love this stuff. I wouldn’t say it like my kids would, I wouldn’t go that far.

Gura: Eric says ETFs were born during… one of Wall Street’s darkest times.

James Limbach: It was the worst day in the history of the stock market by any measure.

Balchunas: On Black Monday in October of 1987, the stock market fell 24%. I mean, in percentage terms, that's a huge number. That's a quarter of the stock market wiped out.

Limbach: The Dow Jones Industrial Average fell almost three times as much as the previous single-day high.

Gura: After that crash, the Securities and Exchange Commission (SEC) wrote a report analyzing the causes of the crash and making some recommendations on how to avoid another crash.

Eric said there was a modest suggestion from the SEC lawyers buried in the middle of the report.

Balchunas:What if we came up with some kind of market basket instrument that traded on the NYSE under our supervision?

Gura:Two traders, Nate Most and Steve Bloom, didn't work for the NYSE, they worked for its competitor, the American Stock Exchange.

Most is in his 70s. He's a Canadian physicist who served in the military.

Balchunas:Steve Bloom's partner was like a Harvard wunderkind, a prodigy, a rocket scientist, good at math, and younger. So they were an interesting pairing. I think Nate was probably two or three times older than Steve, um, but they worked well together.

Gura: The problem was where they worked:

Balchunas: The American Stock Exchange was not doing well at the time. They were third in terms of listings and trading volume, behind the New York Stock Exchange and Nasdaq.

Gura: What the American Stock Exchange needed was an edge, and that’s when Most and Bloom got their hands on that SEC report. That 800-page post-mortem of Black Monday.

Balchunas: Well, Nate and Steve read the book, and they’re really nerdy, and they said, wait a minute. The market basket tool, the SEC is asking for it, and they’re probably going to approve it. So let’s do it. So no stocks are going to be listed on our exchange. So why don’t we invent something to create more trading on our exchange?

Gura: So, they started trying to design a market basket trading instrument: something that could be bought and sold on a stock exchange, that acted like a stock, but was actually a basket of stocks: a basket that reflected the market.

Balchunas: The idea actually came out of the head of some lawyer at the SEC, which is interesting. And that laid the foundation for them to find and invent ETFs, because they were really desperate.

Gura: But it wasn't easy to turn that idea into an actual product that could be bought and sold.

Balchunas: So what Nate Most did was a stroke of genius, and the real secret to the ETF was that he remembered his time at the Pacific Mercantile Exchange, where you had something called a commodity warehouse receipt. A commodity warehouse is where you store different commodities. For example, soybean oil. You go there and you put your soybean oil in a locker. You get a receipt for the exact amount of soybean oil. And then you trade the receipt so you don't have to move a lot of commodities.

And then if you have a bunch of receipts and you want soybean oil, you can take them to the locker and you get the oil back. So Nate Most was like, why don't we have receipts, but for S&P 500 stocks. They'll sit in this warehouse, but it's actually a custodian. And then you get enough receipts and then you get the stock back. That's called the create redemption process.

So, it was really genius because it kept the receipts available to trade all day without messing with the commodity. They were actually tied to the physical commodity in the proverbial warehouse.

Gura: The idea was to create a commodity warehouse that would hold stocks, bonds, or whatever you wanted to bundle together. And then, ETFs were born.

The first ETF was created by Nate Most and Steve Bloom and included all the stocks in the S&P 500, and they called it the Standard & Poor's Depositary Receipt ETF, or SPDR.

State Street launched it in 1993 and it got a lot of attention.

Balchunas: I remember they had spiders hanging from the ceiling and they were handing out hats. It was a fun day, well, they traded, and they traded a million shares on the first day.

Gura: A million shares on the first day. Eventually, Eric says, the amount of money invested in ETFs started doubling year over year. That's because people started realizing that ETFs had some real advantages over other bundled investments, like mutual funds or index funds.

Balchunas:Generally speaking, they're cheaper. Right. So that's important. The second thing is that they're transparent, you know, what's going on with them day to day, whereas with other mutual funds and hedge funds, you don't know quarterly or even at all. So the transparency is great.

Gura:What's the other big attraction of ETFs? Taxes. ETFs only have to pay taxes when they're sold. Mutual funds are taxed every year. But another big advantage of ETFs, Eric argues, is that, unlike a lot of investments on Wall Street, ETFs are very user-friendly.

Balchunas:It's like if you have a computer and you have a mouse, and you just click and buy whatever you want to invest in. You get it, you own it. That removes a lot of friction. It's almost like Amazon. You know, it's fast, it's good, and it's cheap. It's hard to have all three of those things at once.

Gura: Today, about thirty years after the SPDR launched, there are now thousands of ETFs with trillions of dollars invested.

Later, we'll have a guide for users on the best, the worst, and the weirdest ETFs.

Gura: Speaking of the state of ETFs, we found another person at Bloomberg who is obsessed with them. She's Katie Greifield:

Katie Greifeld: I'm the co-host of the Open Interest show on Bloomberg TV. I write the ETFIQ Brief for Bloomberg News. I also host the TV show Bloomberg ETFIQ and I co-host the Money Stuff podcast with Matt Levine.

Gura: Katie has a lot on her plate…

Greifeld: I’m so exhausted.

Gura: But she’s so passionate about ETFs that she dropped everything to come talk to us about them.

Katie, you told me that ETFs are your favorite thing. They are. Explain. Why is that?

Greifeld: I started covering ETFs in January 2020, and well, January 2020 was a weird time to be in a new space. But the most exciting thing and I think the reason I love ETFs is that during this time, I’ve seen the industry grow and evolve at such a rapid pace.

David Gura: Give me a sense of how big the ETF industry has become.

Greifeld: It’s massive, and it’s growing. So, the market cap of ETFs listed in the U.S. is about $9.5 trillion.

Gura: Trillion, with a T.

Greifeld: Oh, yeah. Uh, worldwide, it's about $12.8 trillion.

Gura: Now, that's less than half the size of the mutual fund market -- the traditional choice for more conservative investors. But ETFs are gaining ground.

A lot of the reason for all of this growth is that ETFs are seen as safe investments, just like mutual funds. That, coupled with the lower fees of ETFs, makes them very attractive to people who want a safe, low-cost place to save.

Greifeld:This is one of my favorite charts, and I know we’re on the podcast, but if you look at the money that flows into ETFs and out of mutual funds each year, you’ll see that some years, it’s basically a zero-sum game.

Gura:But not all ETFs are the same. There are gold ETFs, palladium ETFs, corn futures ETFs, and there’s an ETF that’s just Nvidia stock. Now, there are spot Bitcoin ETFs…and they’re some of the most popular ETFs.

Gura:How do they work? Is BlackRock buying a lot of Bitcoin and holding it?

Greifeld:That’s basically it. Well, I find it helpful to compare it to the spot gold ETF. Because a spot gold ETF does have to buy a lot of gold.

Gura: It has to be backed by something actual.

Greifeld: Yeah. There are a lot of conspiracy theorists who say State Street can't possibly own that much gold.

But they do. They store it in a vault in London, underneath the City of London. If you look at the spot Bitcoin ETF. You do have companies like Fidelity, BlackRock buying a lot of Bitcoin. Same thing with spot Ethereum.

Gura:It occurs to me thatwe're seeing this ETF-ification of all kinds of assets. Like, can you really get an ETF that tracks anything?

Greifeld:Yeah, almost.There's an ETF for almost everything under the sun.

Gura:There's an ETF that invests in every stock that Jim Cramer of C-N-B-C recommends. And then there's the Inverse Cramer Tracker, which is a bet on all the stocks that Jim Cramer picks.

Both of those closed last year, but others like them are launched every day.

A lot of these companies aren't designed for the average investor, they're more geared toward sports,

Gura:There's an ETF that invests in every stock that Jim Cramer of C-N-B-C recommends.

And then there's the Inverse Cramer Tracker, which is a bet on all the stocks that Jim Cramer picks.

Both of those companies closed last year, but others like them are launched every day.

A lot of these companies aren't designed for the average investor, they're more geared toward sports,

Gura:There's an ETF that invests in every stock that Jim Cramer of C-N-B-C recommends.

Greifeld:NVIDIA: Especially the single stock ETFs, Tesla, so it's definitely fun to watch those stocks every day as they go up tens of thousands of times and then down tens of thousands of times.

Gura:I asked Katie what's next for ETFs.

Greifeld:An interesting conversation happening in the industry right now is whether you can put private assets into ETFs. Private markets are hot right now, uh, especially for companies that are no longer public.

Gura:But even as the number of ETFs has exploded, the number of companies making money from them is still concentrated in a few well-known companies.

Greifeld:The economics of ETFs are terrible because they tend to be much cheaper than mutual funds. I think it's very interesting that Vanguard is the second largest ETF issuer, behind BlackRock. Bloomberg Intelligence found that their average fee is only 9 basis points. Even though they have close to $2.5 trillion in ETF assets, they're only making $1.3 billion a year on that, which is not chump change. I accept that. But you'd think if it was $2.5 trillion, that number would be higher. So, the real way to make money here is through scale. Gura: Now, there are some downsides to the proliferation of ETFs. Eric Baltchunas, ETF analyst at Bloomberg Intelligence, said that because they're so easy to use ... and easy to start, that can be a problem.

Balchunas: If you can't control yourself and you're like, you, you're like in a gambling mentality. Like, you know, you might want to buy a mutual fund, even one with an early withdrawal fee, if it helps you trade, but an ETF can be dangerous.

Gura: A lot of the safer, more obvious investments are already covered, Eric says. So a lot of the new ETFs can be a little off the mark.

Balchunas: It's kind of like the FrankenETF , it's like nobody's coming out with the normal stuff anymore. They're all trying to invent new things that will attract investors. That's where you get into the FrankenETF  situation.

Gura:In fact, the advent of FrankenETFs worried Vanguard legend Jack Bogle.

He was an early proponent of index funds and advised Nate Most and Steve Bloom as they were developing ETFs.

According to Eric, Bogle got worried when he saw everyone getting creative with ETFs.

Balchunas:Bogle said he sometimes wakes up feeling like Dr. Frankenstein, since he’s arguably the father of index funds. He’d think, What have they done to my son?

Gura:Beyond the FrankenETF, Eric and Katie both agreed that, generally speaking, the more basic ETFs are getting all the hype.

Gura:

They’re transparent, easy to use, and they cost less.

It all started with the market crash of 1987, an SEC lawyer and two entrepreneurial traders who saw an opportunity after the fact, and Sarah…it got me thinking.

Holder: Really?

Gura: Maybe we should launch our own ETF…

Holder: Really? Like the Big Take Away ETF?

Gura: Really.

Holder: Okay, you mean podcast-related stocks? I don’t know…

Gura: Yeah…it didn’t seem like a good idea, but I did pitch the idea to Eric Balchunus. He agreed to advise us on the launch.

Balchunas: Well, the ticker could be TAKE. Well, if you have a topic and a guest, you can basically invest in that sector.

Wait until the next show airs, then trade into different sectors and see what happens.

Gura: So Sarah, what do you think about the Take ETF? What kind of news investments should we be considering?

Holder: Simple – we’d be long the 2024 election, targeted investments in K-pop, must-go Olympics – but honestly – we’re just betting on Brat.