ETF Expert Corner

ETF Q&A with Toroso’s Mike Venuto

March 27th, 2018 by ETF Store Staff

A rapid fire Q&A with Mike Venuto, ETF industry veteran and CIO at Toroso Investments.  Mike also spotlights the index behind the ETF Industry Exposure & Financial Services ETF (TETF).



Transcript

You can listen to our interview with Mike Venuto by using the above media player or enjoy a full transcription of the interview below.

Nate Geraci: Our guest today is Mike Venuto, Chief Investment Officer at Toroso Investments. Mike is a highly respected ETF industry veteran. He previously headed investments at ETF provider Global X, he's worked at Horizon Kinetics, the New York Stock Exchange and he's also behind the index for the ETF Industry Exposure and Financial Services ETF, ticker symbol TETF. This attempts to capitalize on the growth of the ETF industry as a whole. Mike is joining us via phone from New York. Mike great to have you back on the program.

Mike Venuto: Nate, Jason, thank you very much. I'm excited to be here and I love being introduced with Jimi Hendrix.

Nate Geraci: Well, thank you Mike. Mike, you and I actually had an opportunity to visit in person back in February. You were kind enough to invite me to attend the bell ringing ceremony at the New York Stock Exchange to celebrate the ETF Industry Exposure and Financial Services ETF. I've got to tell you - it was an absolute blast. I'd never been part of a bell ringing before. But I wanted to ask you, what was that experience like for the Toroso team? Had you ever rung the bell before and what was it like taking part in a bell ringing for an ETF that was your brainchild?

Mike Venuto: So it was an amazing experience, and we really tried to incorporate the entire industry. We had over 80 people join us in the board room and my partner Guillermo and I really went through the list of ETF ecosystem players that were there. People like you who allocate capital using ETFs, but also the reporters that cover this. The news stories, the index providers, the other issuers. We had so many people come together to celebrate the growth of this industry. And it was the first time I rang the bell for myself, for a product that I was completely behind. But, ironically, the true first time I ever rang the bell was back in 2009 because the way I got involved with ETFs was as a private equity investor in an ETF startup at the time, which was called Emerging Global Advisors. They have that popular ETF ECON, "the emerging market consumer". They were acquired by Columbia Threadneedle a couple of years ago. It was how I got involved and it's also the nexus for TETF. I looked at the world and said "I was successful as an investor in ETF growth, how can I make this access democratized for others?"

Nate Geraci: Mike, tell our listeners more about the index behind TETF. You developed this index, it's called the Toroso ETF Industry Index. And look, the ETF itself has performed very well since its launch. Just at a high level, how is this index constructed? And tell us anything else noteworthy about it.

Mike Venuto: Sure. So the very simple idea was ETFs are growing in terms of assets at around 20% a year for over the last decade and we wanted to figure out a way to get that exposure democratized in an ETF structure for others to participate. The nexus of the idea was this isn't just about the sponsors. Yes, we have a very high exposure to companies like Blackrock, StateStreet, Invesco, WisdomTree, but we also wanted to incorporate the rest of the ecosystem. So the exchanges, the service providers, the index companies, the liquidity providers, all of those are inside the ETF and exposures that have helped us create, essentially, a global growth thematic ETF that captures the growth of the ETF industry.

Nate Geraci: Mike, when you talk about ETF growth, ETFs had a record breaking 2017, they also had the largest month of inflows ever in January of this year. This index and ETF obviously seek to capitalize on that growth. Paint the picture for us on the potential opportunity moving forward. Do you expect to see more of the same from ETFs? Do you expect growth to actually accelerate? What's the overall investment case for TETF?

Mike Venuto: Sure. So I can cite fifty different big consulting firms who've spent time on this and ways that they've come up with "seven-trillion in three years" or "ten-trillion in five years". I look at it and say "20% annualized growth is healthy". It's not extreme, we have an open to close ratio over the last twelve months of 2.2. That means for every 2.2 ETFs that have opened, one has closed. All of this growth seems very healthy to me and I expect it to continue at those rates at least until we reach parity with mutual funds. Right now, if we look at the mutual fund versus ETF over total assets, ETFs represent about 18%. I would anticipate that growth to continue at least until we are at a 50/50 and then potentially slow down a little bit. The only thing that I see getting in the way of that is a lack of innovation. If we just stick with what I like to call "client alignment factors" - the fact that ETFs are low cost, transparent, liquid, tax efficient - if that becomes their only value prop and we stop innovating where we find ways to access gold or volatility or bitcoins, that's the only thing I see potentially slowing the growth. But I don't see any indication that innovation is dead. I see all indication that it's moving forward rapidly.

Nate Geraci: Our guest today is Mike Venuto, ETF industry veteran and Chief Investment Officer at Toroso Investments. Alright Mike, we're going to try something a little bit different today, just given your breadth of knowledge in the ETF space. We're going to try sort of a rapid-fire Q&A. So you get to be our guinea pig, we've actually never done this on the program before. So I'm going to bring up an ETF topic, you just tell us the first thing that comes to mind. We'll try to hit on as many topics as possible, no rules here, just go off the cuff. So let me know if you're ready.

Mike Venuto: I'm ready but I don't know, don't we need to play more Jimi Hendrix? Fire away!

Nate Geraci: Alright so first, just because Jason and I talked about this in our first segment, should index fund providers be able to vote proxies and are they equipped to engage on corporate governance issues?

Mike Venuto: I absolutely think they should vote the proxies and some of them are ahead of others. Vanguard is catching up, but they were way behind. Blackrock was way ahead, but it's limited in its way of expressing values as they may be two specific individuals. The hardest thing with this proxy voting and these ESG kind of topics is the "S", and I think Jason was hitting on this in the earlier segment. We don't know exactly if the values of an ESG concept are consistent with the values of the individual investors. So sometimes you've got to get more specific, but this is where it gets complicated. Many companies, like a Vanguard, have a traditional proxy voting policy such as maximize returns. That's the simple version, but then they'll have a socially responsible fund that may represent less than 1% of their assets. But they vote with different proxies where they're really looking at the social causes. That said, all the other votes that they may make may contradict what they are voting on that, so it is an extremely complicated issue and I give you credit for bringing its attention to everyone because it really needs to be discussed. But the short answer, back to the beginning is “yes” they should vote it and they’ve got a lot of work to do.

Nate Geraci: Alright, on a bit of a lighter note, even though things have been rather quiet on this front, bitcoin ETFs. Will we ever see a bitcoin ETF and if so, when?

Mike Venuto: So, I do not think we will see one this year. I would give it a 50% next year and then the odds go up from there. And the reason is there are very big regulatory hurdles for the SEC to get their hands around, and they've outlined them for us and some of them in the current environment are simply insurmountable. Now all that said, I'm going to say something a little bit hypocritical. I would love there to be a bitcoin ETF, but at the same time I don't think it makes sense for bitcoin. The entire purpose of bitcoin was to get rid of the need for a trusted third party and it seems many investors want the ETF to step in as the trusted third party to give them exposure to bitcoin. So there is this philosophical contradiction that makes me uncomfortable with it. That said, I do wish it existed because I would like that access for the client that I allocate capital for.

Nate Geraci: What's your favorite under-the-radar ETF? And for our listeners, this isn't an investment recommendation. Mike, just give us an ETF that doesn't get nearly the attention you think it deserves, besides TETF of course.

Mike Venuto: Of course. So, my favorite hidden gem is the ticker BTAL. That's Boy-Thomas-Apple-Larry, and this one is especially interesting when we have the volatility that we've seen in the last few weeks. This is an ETF that's from AGF that's designed to be anti-beta. Meaning, like what we've heard from other products, it's designed to go up when the market goes down. Unlike other products, it doesn't use futures and it's not connected to VIX or leverage or any other thing like that. This simply shorts the high beta stocks in the S&P while being long the low beta stocks, and the net result is something that can protect on the downside. It's unique, it's different, and it's a tool I've never seen a copycat for.

Nate Geraci: What's the craziest ETF idea you've ever heard? Maybe an idea that's not actually in an ETF currently.

Mike Venuto: Usually I hear those from Meb Faber. Usually he starts with a ticker and works backwards. I love his idea of a free ETF. It's one of the things we talk about when we look at the ETF industry. It's not just their expense ratio, right? If you simply take the average weight of the expense ratios of all ETFs, which is about 22 basis points, and you multiply that times the assets, you can very quickly see that the US ETF industry is going to generate about seven and a half billion in revenue in the next 12 months. But if you start to think about all the other ways they make money, for example, securities lending - which is where they lend out securities in the portfolio and keep part of that profit - there's a whole other set of revenue. So, I love Meb's idea of an ETF that was completely free because it just used securities lending. Now there are other iterations of it that could come in the future, but I think that's a unique idea and a great idea of ETF innovation.

Nate Geraci: Mike, I've got to tell you, you are the perfect person to do this rapid-fire Q&A with. I'm glad that you're the guest that we debuted this with, this is fantastic.

Mike Venuto: I'm having fun!

Nate Geraci: So let me get continue down my list here, let me know if you become fatigued at all. Why haven't more actively managed mutual funds launched ETF versions of themselves? So for example, the Fidelity Contrafund. Why not launch in an ETF wrapper?

Mike Venuto: I'd like to say Fidelity has more lawyers than they have client service reps, and those lawyers are there to protect the 401K world for them. I think Fidelity will embrace it eventually, but cannibalization is a hard decision to make. That said, Vanguard again, a culprit in probably another socially irresponsible thing, is their patent has really slowed the ability for others to jump on that bandwagon. That will be resolved in the near future and I think we'll see more. But when it all comes down to it, I think the answer is “greed”. They're afraid to take the risk on revenue that they've already got, and that's a huge mistake. I think people like Schwab, who's come from nowhere in the ETF industry, to solidly the fifth largest issuer with two and a half percent market share with only 22 ETFs is unbelievable. And if others don't get on the bandwagon, they're going to be left in the dust.

Jason Lank: Mike, this is Jason Lank. Boy, you've hit on a point right where I want to go. One of the last strongholds of the mutual fund space is the 401k or the retirement system. Will we ever see large scale adoption or inclusion of ETFs in this space?

Mike Venuto: I don't know, and I'm not sure that it really matters. A index mutual fund at the same kind of cost that an ETF is at is a better vehicle for a 401k than an ETF is. So I don't know why this part of the discussion really matters that much. A mutual fund and an ETF are built under the same laws. An ETF is better for taxable investors, better for trading investors. A mutual fund, as long as it's low cost, is actually pretty good for 401k investors. The only place where it gets complicated is when we want to bring in more interesting or thematic things, which most of the time probably don't belong in a 401k. So I think mutual funds will survive because they do make sense in 401ks.

Nate Geraci: Mike, going back to actively managed mutual funds launching ETF versions of themselves - one of the reasons that's out there as to why that's not occurring is the daily transparency of ETFs. That active managers are afraid they're going to get front-run, their special sauce is going to be out there. Do you think that's a real concern or do you think that's overblown?

Mike Venuto: So, in full disclosure, I am the sub-advisor of an actively managed ETF. The blockchain one, BLOK, and I can tell you it doesn't scare me at all. Like, I love the idea that I can show everybody at the close what I did today and I can tell you from experience that people are looking because they ask. They call immediately, and obviously I can't answer too much. So don't call immediately on that. But I have met advisors, usually they are quant-based groups, that are afraid to have that transparency. I think it's a mistake. I do think there are ways to handle that. There are ways to have semi-transparency. If I was a manager who was active and shorting, I would be very concerned. And a manager that is active and long, I don't understand why they care so much. The extra five basis points of alpha they might generate, it's going to go away eventually anyway and they're going to have to develop something else to generate alpha. I think that it's just confusion, but there is a more quick issue there, which is: I think a lot of active managers don't want to see the market fluctuation. Right? They don't want to see investors come in and go out and force them to trade something, and that's a lot of why they don't want their active strategy in the wrapper that has intraday creation and redemption. I think that's actually a bigger issue that they don't state as much than the true transparency.

Nate Geraci: Our guest is Mike Venuto, Chief Investment Officer at Toroso Investments. Mike, a few more questions here and then we'll let you off the hook. Biggest misconception about ETFs?

Mike Venuto: "ETFs are a bubble". That one blows me away because ETFs are just a wrapper, so they can cause bubbles but they can't be a bubble, right? ETFs today, the exact number right this second, own exactly seven percent of the market cap on average of every U.S. stock. So everybody's got this headline: "This structure is a bubble". No, it's not possible for the structure to be a bubble. It is possible, however, for the structure to over-own certain areas where too many people decide "I want to own this asset class passively". The best example of that is REITs today. Real estate investment trusts on average are 15 to 20% owned by passive investors through ETFs and then if you include other passive funds, the number goes up astronomically. So this is a place where people are not thinking about the value of the underlying. They are simply wanting yield and a theoretical alternative exposure. So my biggest concern with this "ETFs are a bubble" is that it actually is a red herring. It obscures people's vision to the actual bubbles that could be caused in sub-sectors.

Nate Geraci: High yield bond ETFs, are you concerned with liquidity in the event of a major sell-off?

Mike Venuto: I don't think you can ignore it. I thought Eric from Bloomberg has covered this very well. It's something to be aware of, just like everything we saw with the VIX ETFs in the last two or three months. You've got to be aware of what's underneath, and we are all acutely aware that the liquidity of the underlying is not nearly as liquid as the liquidity of the actual fund. So, I understand why you should be aware of it and be careful with it. The broad-based indexes are not something that I use in that space, but I don't think it's something that you have to be totally fearful of because it should never be a large part of your portfolio. If you're happy with the risk-reward of that asset, understanding that there's this one in a million chance that it could blow up, well then be aware with it. It's just like the VIX stuff. Read the prospectus, know what you're up against.

Jason Lank: Mike, I want to go back to a comment you made. You mentioned that the open to close ratio was approximately 2.2 to one if I caught that correctly, and you said that was healthy. But I'll go out to the World Wide Web and there will be a Deathwatch where lightly traded funds are soon to close, that sort of thing. I would think from critics of the structure of the ETF. Who's right here?

Mike Venuto: I think that "the Deathwatch" is an awesome tagline, and they do a great job of telling a story. It's just another rating system for them though. Most ETFs don't get traction until they're three years old. I mean, we work with the folks at ROBO Global. Robotics ETFs took three years of stagnant assets and then has now well over two billion. Same with EMQQ. The same with so many of these out there. So the Deathwatch is just a rating to look at and some of the information in there is very helpful. The idea that an ETF closes is a problem makes no sense to me. I've owned three or four ETFs over my career in my client accounts that have closed, and almost every one of them worked out well because by waiting for the issuer to give me NAV, I usually got more of a return than selling it when they announced them being closed because they tend to trade at discounts when they announce the closure.

Nate Geraci: Alright, Mike, two more questions for you. Speaking of ETF rating systems, what's a better ETF rating system? And both of these were the creation of Bloomberg's Eric Balchunas. Do you like the movie rating system or the stoplight system better? And for our listeners who are unfamiliar with these, Eric has proposed that we assign a movie rating to each ETF. So for example, perhaps a basic S&P 500 ETF is rated "G", and a leveraged gold mining ETF is rated "R". Or with a stoplight system the S&P 500 ETF is green, and the gold mining ETF is red. Your preference, Mike?

Mike Venuto: I definitely like the stoplight better because I feel like it's extremely quantitative. The hardest part of rating ETFs, and so many companies have gone through this - ETF.com went through it, Morningstar's gone through it, Market Realist has gone through it - it's really hard to rate them because the nomenclature isn't out there, right? We don't collectively agree on what is a smart beta ETF. So it's very hard to rate them within each other, but with the stoplight system it's not about rating the investment or anything like that. It's just the structure. It's kind of like back to ESG - inclusionary metrics versus exclusionary. So excluding guns is like: "stoplight red", whereas other rating systems try and reward good behavior. That's a lot more complicated.

Nate Geraci: Alright, last question, and you began to touch on this a bit earlier, will ETF assets ever surpass mutual fund assets? And if so, give us your prediction on the year that occurs.

Mike Venuto: I would say, "Absolutely, yes." And probably within five years. The other part though is: Will they ever wipe out mutual fund assets? And I would say: "Absolutely not.". I mean mutual funds are a superior vehicle to annuities, and annuities still exist. Each one of these has its place. For taxable investors and traders, ETFs are a far superior vehicle. And I anticipate that growth to continue, and that cannibalization of those assets at at least 20% a year, and I hope to track it.

Nate Geraci: Mike, quickly here before we let you go, I know you've been developing something called "The ETF Think Tank". Can you just tell us a little bit about that and perhaps what the goal is here?

Mike Venuto: Sure. So, the ETF Think Tank is the culmination of the last six years of our research looking at ETFs and talking with advisors. So what we've created is a platform that includes a whole bunch of ETF tools or apps that are unique to a lot of the ideas and data points that we talked about today, as well as a research library, discussion forum and a way for advisors who use ETFs to connect with each other as well as innovative issues. And it's free to qualified advisors.

Nate Geraci: Well, Mike. excellent stuff today on a wide variety of ETF topics. That was a lot of fun, really enjoyed that and we certainly appreciate you joining us on the program today. Thank you very much.

Mike Venuto: Thank you Nate, thank you Jason. This has been a lot of fun.

Nate Geraci: That was Mike Venuto, Chief Investment Officer at Toroso Investments, and if you would like to learn more about the Toroso ETF industry Index, you can do so by visiting torosoam.com.