ETF Expert Corner

State Street’s Matt Bartolini on SPY Turning 25

January 23rd, 2018 by ETF Store Staff

The first U.S.-listed ETF, the SPDR S&P 500 ETF (SPY), recently turned 25 years old.  Matt Bartolini, Head of SPDR Americas Research at State Street Global Advisors, offers his unique perspective on ETF history.



Transcript

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

Nate Geraci: Our guest today is Matt Bartolini, Head of SPDR Americas Research at State Street Global Advisors. Of course, State Street is the third-largest ETF provider in the country. They offer over 130 ETFs with more than $630 billion invested in those ETFs, and as we were discussing before break, State Street was behind the first ever U.S.-listed ETF, the SPDR S&P 500 ETF, ticker symbol SPY. This is the largest ETF in the world. It's the most heavily traded security in the world. And SPY is celebrating its 25th anniversary this month. Matt is joining us via phone today from Boston. Matt, great to have you back on the program.

Matt Bartolini: Yeah, great to be here. Very excited about the opportunity we have with SPY, and just ETFs overall, and can't wait to dig into it.

Nate Geraci: First, with SPY celebrating its 25th anniversary, I'm curious, is State Street doing anything special to honor the occasion?

Matt Bartolini: Most definitely. SPY is just such an important product, not only to the ETF landscape, but to our firm as well. Actually, down at Inside ETFs, we're going to have a lot of advertising out there, branding a walkway as the “SPY Walk”, having multiple different panels and discussions, and then actually, on January 29th, we're going to be ringing the closing bell at the New York Stock Exchange. Essentially, 25 years after the ETF was launched, we'll be back at the site where it all started.

Nate Geraci: Matt, in our first segment, Conor and I walked through the backstory of SPY. I think it's a wonderful story, but it has been fairly well documented. Is there anything in the annals of State Street lore that maybe isn't as well known by the public as it relates to the creation of SPY? Maybe some challenges or some other interesting tidbits?

Matt Bartolini: Yeah, there's essentially three I would say to point to. I think some of them are whimsical and some of them are just interesting factoids. One of them being, we actually had an inflatable spider hanging from the New York Stock Exchange when the ETF first started trading. If we had that up there now, I think it would look more like a cartoon than some sort of financial revolution that sparked a $4 trillion industry. The second one is SPY, even though it has 270 billion in assets and it's the world's largest ETF, it actually had a rocky start. Assets actually dipped in the second year, so it wasn't a linear trend up and to the right that we’re seeing with ETFs over the last 10 years. I think the behind-the-scene one that gets people more interested is really, and this really underscores how new of an industry that was created, in the first basket file, it had to be put together by hand - basically physically printing out a physical list of tickers and cutting and pasting each onto a piece of paper with a glue stick, physically pasting them onto the final document. And as we're about ready to hit print, our auditors came back and said, "Hey, wait a minute, guys. You only have 499 tickers on here." We were missing one ticker. Jim Ross, actually on the original team, and our Global Chairman today, had to go back and do a cross-check versus all 500 tickers to make sure that they had everything for the initial launch of the fund. We had 499. We're supposed to have 500. Ended up having the 500, and $270 billion later, that gets lost in the annals of SPY's history.

Nate Geraci: Obviously technology has changed just a bit since that time. I'm not sure we'd run into that issue in today's world.

Matt Bartolini: No, God forbid. The way we do it now, it's all automated.

Nate Geraci: Matt, obviously, SPY did spark an entire industry. ETFs now have some $3.5 trillion invested in them. There have been all sorts of benefits that have accrued to investors. In your mind, what is the single biggest impact SPY has had on investing?

Matt Bartolini: For me, I think even for our entire firm, and really what we stand behind is saying, "SPY fundamentally changed the way investors and advisors view the market and invest." They shifted their focus from a single stock selection to building and managing portfolios to deliver a specific outcome. It essentially just improved the portfolio construction process, improving access to asset classes, strategies, and managers overall.

Nate Geraci: What do you think about the role of cost? When SPY first launched, I believe it had an expense ratio of 20 basis points, which outside of some Vanguard mutual funds, that was essentially unheard of back in the 1990s. Today, SPY has a cost of nine basis points. Obviously, there's now a much greater focus on cost overall. What role has cost played in the growth of ETFs?

Matt Bartolini: I think cost has been very important. So has performance. In this environment, every little basis point counts and having a lower hurdle rate in terms of your expense ratio can improve performance. Given where ETFs were grown up, it's on the index or passively managed side, where expenses are just naturally lower. And as manifested in itself, where SPY is actually a top quintile performer on a 3, 5, and 10-year basis, while sometimes having a low cost is the mover for an investor because they want to manage their fee budget, also having better performance than a large selection of active managers can actually drive assets as well. I think it's twofold. The cost gives you that lower hurdle rate in order to provide the performance, and then that performance will speak in volumes and actually lead towards investors using the products.

Nate Geraci: Along these lines, back in October, State Street announced the launch of a new suite of ETFs. They're called SPDR Portfolio ETFs. These are 15 ETFs, many of which are either tied with or are the lowest-cost ETFs in their respective categories. Can you tell us a little bit more about this lineup, I guess with a context of cost and performance?

Matt Bartolini: When we were looking at how investors were starting to allocate portfolios, we really had heard time and time again that cost was becoming a significant part of that portfolio construction process. Part of that was from a regulatory perspective. We had different fiduciary rules coming to fruition, but also, like I said earlier, we are in a low return environment. I know the S&P 500 is off to a banner year so far in 2018, but looking at valuations, return expectations should be lower because we have stretched valuations. On the fixed income side, we're generally around 250 basis points from a 10-year yield perspective. That's generally not a low return. In this type of environment, every little basis point counts, and having a lower cost exposure in the largest part of your portfolio is actually a sound positioning point from a portfolio construction process. We continually heard this, and we continually heard that advisors, investors wanted someone that wasn't really competing for their business. State Street has such a large heritage in fiduciary responsibility and investing assets, as well as providing that portfolio guidance so to speak from a construction process, that we looked at our suite, and we restructured 15 funds that had existing assets and that had existing liquidity, but lowered those costs to a level that was either, like you said, below the lowest cost as well as or at the lowest cost provider.

Nate Geraci: The whole idea with these ETFs is obviously to provide broad-based, global exposure to both stocks and bonds.

Matt Bartolini: That's right. We wanted to be able to provide building blocks for investors. That's one of the reasons why we actually named them Portfolio ETFs. These are for portfolio allocations. These are the portfolio building blocks to create diversified 60-40, 70-30 asset allocations that not only can meet your client's goals from a return perspective, but also manage risk diversification. Because when we look at it, there are four principles of portfolio construction, one being cost. Given that we're ultra-low cost, we hit upon that, but we also want to be able to diversify, customize, and then of course the last one, by providing these tools, you can actually rebalance effectively to maintain your goals.

Nate Geraci: Yeah, and we should mention that those SPDR Portfolio ETFs trade commission-free at TD Ameritrade. Our guest is Matt Bartolini, Head of SPDR Americas Research at State Street Global Advisors. Matt, something that's interesting to me is that ETFs have now been around for 25 years, but in many respects, they still feel so new to many investors. Why do you think that is?

Matt Bartolini: Part of it is the exponential growth we've had has actually just come within the last I would say 10 years, or really 5 years. The expansion of asset classes has been a slow build. SPY originated back 25 years ago, and we liken it to the iPhone. Without the iPhone, you probably wouldn't have all these different apps that allow you to hail a ride or pay a bill while sitting on your couch. These democratized areas. SPY was like that, because now it has spawned different asset classes, like emerging market fixed income as well as smart beta. I think what happens is investors need time to evaluate those strategies, and I think that time has essentially come where now we're seeing that exponential growth rate. You just look at fixed income ETFs. They are nearing $600 billion AUM even though they've been around since 2002. I think it's more about just understanding the use case but also getting over some of the myths that were propagated in the early days that ETF were not a sound investment vehicle. I think that can be thrown aside given how much or how many different periods these ETFs have stood the test of time.

Nate Geraci: I'm glad you mentioned myths around ETFs, because I still think there are some of those that exist today. Even though ETFs have been around for 25 years now, and they've gone through several bull and bear markets, there are still some questions regarding their overall impact on the financial markets. I think back to last year. There seemed to be a lot of talk about how ETFs could exacerbate some sort of a market selloff. I guess that goes back to the flash crash of August 2015. What's interesting is, SPY was originally created to help provide liquidity, right, to be a buffer during a market downturn? How do you think this narrative got flipped around and do you have any concerns regarding how ETFs might react to a significant market downturn?

Matt Bartolini: It's interesting you point out, yes, SPY was basically there to create a market tool for large-scale investors, institutional investors to use during market volatility. That obviously stands true today, just given the vast amount of volume and institutional usage of SPY, but also the second derivative of SPY was it spawned a more democratized society of more retail usage of ETFs. That's an interesting fact overall, of how unintended consequences of SPY created something else. As far as this idea that ETFs can exacerbate a market selloff, I think that's just really unfounded. It's probably created as a result of not fully knowing the structure. It's very new. The in-kind creation and redemption process, being able to trade something on the secondary market. And what happens when something's new and you don't fully understand it? You try to knock it down and discredit it, particularly if you have a difference of opinion and it's competing against your business. If you're an active manager, you're surely not going to all of a sudden love something that is trying to take your business. I think these narratives started to persist throughout the marketplace, and in my role and our company's role at SSGA, we've tried very much so to be an advocate, to say, "No, the ETF structure is actually quite sound." We point to different areas. For instance, you mentioned the August 24th selloff. People are like, "ETFs caused this. It's a problem." I always say, "No, it's not." If you look at actually the ETF structure that day, fixed income ETFs, they didn't have a problem. They still traded throughout the day as if everything was okay. It was equity ETFs, because of the underlying market structure. The exchanges were having a hard time opening the securities. If you can't open the securities, then any strategy tracking that is clearly going to have an issue. It wasn't an ETF issue. Fixed income ETFs, commodity ETFs, they were fine. I think that what we always point to is these realistic time frames. We have multiple of them.

Nate Geraci: What about just the growth of indexing overall? Obviously, most ETFs are index-based or passive investments. There's been some talk that as flows go into more passive investments, perhaps that can cause a market bubble, otherwise distort market prices. Any thoughts on those concerns?

Matt Bartolini: A lot is made of this 4.1 trillion, or over four trillion depending on the time that you're looking at it, of ETF assets globally. A lot of those are in indexed areas. However, let's really dig down into what means index or what means passive. Just because you're investing in a passive vehicle doesn't mean there wasn't an active decision backing it. This idea that all of a sudden four trillion is in an index and that everything's on autopilot is completely unfounded. The example I always give is XLF, financials, took in I think somewhere north of three billion to five billion after the election. A lot of investors rushed into financials because of the rates market and this reflationary idea from the U.S. In one day, $500 million came into XLF. If you're purely looking at fund flows, you'd say, "Wow, index passive, 500 million in one day. Everything's going on autopilot." If we actually dig down to how that ETF creation unit was created, it was because of an options trade. Someone put on an options trade worth $500 million, and the market maker needed to basically offset their book. What was actually a passive flow in terms of the underlying instrument was actually based on one of probably the most active decisions you could possibly make within an options trade. I think we really need to think about what means index, passive, pure autopilot. To me, it's the big, broad exposures like the Russell, S&P 500, EM, EAFE. If we just use those broad benchmarks that assets are tied to, you get to around one and a half trillion. I don't think one and a half trillion is going to push the market, given that the global market cap is north of 30 trillion, 40 trillion.

Nate Geraci: Our guest today is Matt Bartolini, Head of SPDR Americas Research at State Street Global Advisors. Matt, we have just a few minutes left here. I'm curious, looking forward, what's next for ETFs? There's obviously been a tremendous amount of innovation in the 25 years since SPY first launched. What are some areas of opportunity moving forward?

Matt Bartolini: I think it's probably from the most boring part of the portfolio, in bonds. That's just a trend that's been increasing. In 2015, they took in 96 billion of flows in U.S.-listed ETFs. Then last year, they took in 130 billion. That type of growth rate is something that you typically don't see from an industry that, fixed income speaking, is 16 years old, and ETFs 25 years old. Part of that has to do with just more adoption, or more adoption and demographics. We're getting older, and there's more demand for bonds. ETFs are a very efficient vehicle for that given their low expense ratio and just transparency, so asset allocators are using fixed income ETFs more and more to provide that ballast in portfolios for that stable income retiree. I think fixed income is going to be an area of growth. The other one is actively managed, and that does speak to fixed income as well. Actively managed ETFs are continuing to grow, and they're actually being fueled by fixed income. Active ETFs, 80% of the AUM is from fixed income. A lot of that has to do with some of those early skeptics, some advisors who don't like the ETF structure or are unfamiliar with it. They do use active management in bonds, so that's an early entry point, because they're still going to the active space. The active fixed income ETF actually looks very similar to the active mutual fund, with the biggest exception being the ability to trade on the secondary market, which can actually increase some of the tax efficiency.

Nate Geraci: Matt, as it relates to active ETFs, any thoughts or preference on transparent versus non-transparent structures?

Matt Bartolini: In our business, we only have transparent. I think that is really, from a due diligence perspective, probably going to be higher adopted than non-transparent. When you're looking at it from an investment perspective, you want to be able to know exactly what you're holding. I think if you're doing a non-transparent ETF, that's going to cloud a lot of the judgment.

Nate Geraci: Quickly here, two other areas that seem to get a lot of attention as potential growth areas for ETFs are obviously smart beta or strategic beta and then ESG or socially responsible investing. Any thoughts on either of those categories?

Matt Bartolini: Yes. I think smart beta is definitely an area of growth. One interesting thing is how it's going to manifest itself, though, because there is still a great deal of education that is needed, particularly even what constitutes smart beta. If you look at some of the biggest data providers, such as FactSet, or Bloomberg, or Morningstar, they actually all have different categorizations of what constitutes smart beta. All that's going to do is cloud the due diligence process. I think if we can, as an industry, coalesce around a standard classification, that'll help the growth rate. I think investors are going to gravitate toward smart beta to meet outcomes, and I think multifactor smart beta is going to be the one that actually drives growth. I think that's something definitely interesting to watch. The other one, ESG, is I think still very much in the early days. I think we're probably only in the second inning of this game. As I always like to say, ESG has taken in a lot of mind share. It hasn't had a lot of market share yet. I think there's still a lot of due diligence needed, and the biggest one is how does it fit into portfolios, because the last thing someone wants to do is sacrifice their financial goals for social goals. Being able to blend both of those I think is going to be the winner overall. If you can allocate capital aligned with your liabilities and return expectations, but still be able to invest environmentally or socially responsible, that's going to be the game-changer.

Nate Geraci: It's truly remarkable how far ETFs have come in the 25 years since SPY launched, and I know we're very excited here to watch how the industry evolves over the next 25 years. We'll have to leave it there. Really enjoyed the conversation today. Thank you for taking the time to join us.

Matt Bartolini: My pleasure.

Nate Geraci: That was Matt Bartolini, Head of SPDR Americas Research at State Street Global Advisors. If you would like to learn more about the SPDR ETFs, you can do so by visiting spdrs.com.