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

Authors: Alexander Sugiura, Adriana Tapia Zafra, Bloomberg; Compiled by: Bai Shui, Golden Finance

The investment amount in exchange-traded funds (ETFs) is nearing $13 trillion. These ETFs reflect the S&P 500 index. There are gold ETFs, bitcoin ETFs, and even vegan ETFs. How did this market become so large and diverse? What does it encompass?

According to Bloomberg Industry Research, BlackRock's iShares Ethereum Trust ETF (ETHA) had a trading volume of $248 million, setting one of the highest first-day trading volume records in history. Photographer: Victor J. Blue/Bloomberg

In today's podcast, we continue to invite Eric Balchunas, Senior ETF Analyst at Bloomberg Intelligence and co-host of the Trillions podcast. He talks to host David Gura about this unexpected duo who created the first-ever ETF as a last-ditch effort to save a struggling exchange. Meanwhile, Katie Greifeld, co-host of Bloomberg ETF IQ and Money Stuff, analyzes the current booming market and outlines which ETFs are safe investments and which ETFs are best to avoid.

The following is the conversation record:

David Gura: Sarah.

Sarah Holder: David.

Gura: Today I want you to join me in the studio because I have to ask you about ETFs and what you know about them.

Holder: Alright, ETF... I feel like what I usually hear is not to bother putting too much effort into researching all these individual stocks.

Gura: Hmm.

Holder: Just find an ETF and put all your money into the ETF basket.

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

Zachary Mider: We have such a big loophole, let's exploit it in new and creative ways.

Emily Graffeo:** So in the past six months, 94% of ETFs have achieved positive returns.**

Mider: You know this is a significant tax advantage for many people.

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

Holder: Yes, I'm not sure either, why they are such a good investment, David? What exactly is inside them? How are they different from mutual funds or index funds?

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

Holder: Thank God, I need it.

Gura: This is our series where we will periodically analyze the largest parts of the financial system. We will look at how they are formed and what they mean for all of us, even if you are a financial expert.

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

Gura: I guarantee that everyone will gain something!

Holder: I am Sarah Holder.

Gura: I am David Gura. The exchange-traded fund (ETF) is one of the stars in today's investment world. They hold the status of Meryl Streep: they are respected, loved, and... adored by professional and amateur investors.

Since their inception over 30 years ago, ETFs have become one of the most popular investments globally. However, to understand how ETFs have grown, it's essential to first understand their origins.

At Bloomberg, we are fortunate to have an ETF expert who has been reporting on ETFs for decades: Eric Balchunas.

Eric Balchunas: I am a senior ETF analyst, I write, analyze, and discuss ETFs, and I lead a team of about 10 people globally who do the same work.

Gura: Do you have a favorite ETF?

Balchunas: It's hard to pick a favorite. You know I really like this thing. I won't go so far as to say it's like my children.

Gura: Eric said the ETF was born during... one of the darkest times on Wall Street.

James Limbach: Regardless, this is the worst day in stock market history.

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

Limbach: The decline of the Dow Jones Industrial Average is nearly three times the previous single-day record.

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

Eric said that the middle part of this report conceals a mild suggestion from a lawyer at the U.S. Securities and Exchange Commission.

Balchunas: What would it be like if we came up with some kind of market basket tool traded on the New York Stock Exchange under our supervision?

Gura: Traders Nate Most and Steve Bloom do not work at the New York Stock Exchange, but at its competitor, the American Stock Exchange.

Most is already over 70 years old. He is a Canadian physicist who served in the military.

Balchunas: Steve Bloom's partner is like a Harvard prodigy, a genius, a rocket scientist, very good at math, and also younger. So they make an interesting pair. I think Nate is probably two to three times older than Steve, hmm, but they work together very well.

Gura: The problem lies in the place where they work:

Balchunas: At that time, the American stock exchanges were performing poorly. They ranked third in terms of the number of listings and trading volume, behind the New York Stock Exchange and NASDAQ.

Gura: What the American Stock Exchange needs is an advantage, and at that time Most and Bloom got the report from the U.S. Securities and Exchange Commission. That 800-page post-analysis report on "Black Monday."

Balchunas: Well, Nate and Steve have read the book, and they are such nerds, they said, hold on. The market basket tool, the SEC is asking for it, and they might approve it. So let's do it. So no stocks will be listed here. So why don't we invent something to create more trading on our exchange?

Gura: So, they started to design a market basket trading tool: something that can be traded on the stock exchange, its function is similar to stocks, but it is actually a basket of stocks: a basket that reflects the market.

Balchunas: This idea actually originated from the mind of a lawyer at the U.S. Securities and Exchange Commission, which is quite interesting. It laid the groundwork for them to find and invent ETFs because they were really desperate.

Gura: But turning this idea into a tangible product that can be bought and sold is not easy.

Balchunas: So Nate Most's approach is a stroke of genius, the real secret of the ETF is that he recalled his time at the Pacific Commodity Exchange, where there is something called a commodity warehouse receipt. A commodity warehouse is where you store different commodities. For example, soybean oil. You go there, put soybean oil in a locker. You will receive a receipt for the exact amount of soybean oil. Then you trade the receipt, so you don't have to move large quantities of commodities.

Then if you have a bunch of receipts and want soybean oil, you can take them to the storage locker, and then you can get the oil back. So Nate Most is like, why don't we have receipts for S&P 500 stocks? They would sit in this warehouse, but it's actually a custodian. Then, you get enough receipts, and then you can get the stocks back. This is what's called creating a redemption process.

So, this is really a genius because it can keep receipts that can trade all day without messing up the goods. They are actually associated with physical goods in well-known warehouses.

Gura: Our idea is to create a commodity warehouse for storing stocks, bonds, or anything else you want to bundle together. Then, exchange-traded funds were born.

The first ETF was created by Nate Most and Steve Bloom, containing all the stocks in the S&P 500 index, which they called the "Standard & Poor's Depositary Receipts ETF," abbreviated as SPDR.

State Street Bank launched this ETF in 1993, attracting widespread attention.

Balchunas: I remember they had spiders hanging from the ceiling and were handing out hats. That day was fun, yeah, they traded, they traded 1 million shares on the first day.

Gura: On the first day, 1 million shares were traded. Eric said that eventually, the funds invested in ETFs began to double year after year. This is because people started to realize that ETFs have some real advantages over other bundled investments like mutual funds or index funds.**

Balchunas: In general, they are cheaper. Right. So it's important. The second thing is that they're transparent, you know, you know, how they go on a day-to-day basis, whereas other mutual funds and hedge funds, you don't know on a quarterly basis or even at all. So the transparency is good.

Gura: What is another major attraction of ETFs? Taxes. ETFs only tax upon sale. In contrast, mutual funds are taxed annually. However, Eric believes that another significant advantage of ETFs is that, unlike many investments on Wall Street, ETFs are very user-friendly.**

Balchunas: It's like you have a computer, a mouse, and no matter what you want to invest in, you just click to buy. You get it, you own it. This eliminates 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 at the same time.

Gura: Today, SPDR launched about thirty years later, there are now thousands of ETFs with an investment amount reaching trillions of dollars.

Later, we will provide users with a guide to the best, worst, and strangest ETFs.

Gura: Speaking of the current state of ETFs, we found that there is another person at Bloomberg who is very obsessed with them. She is Katie Greifield:

Katie Greifeld: I am the co-host of the Open Interest program on Bloomberg Television. I write the ETFIQ briefing for Bloomberg News. I also host the Bloomberg ETFIQ television program and co-host the Money Stuff podcast with Matt Levine.

Gura: Katie has a lot of work...

Greifeld: I'm so tired.

Gura: But she is very interested in ETFs, so she put everything down to talk to us about them. Katie, you told me ETFs are your favorite thing. They really are. Explain. Why is that?

Greifeld: I started reporting on ETFs in January 2020, and January 2020 was a strange time to enter a new field. But the most exciting thing, and the reason I think I like ETFs, is that during this time, I witnessed the industry grow and develop at such a rapid pace.

David Gura: Let me understand how much the ETF industry has developed.

Greifeld: This industry is huge and is still growing. Therefore, the market value of ETFs listed in the United States is approximately $9.5 trillion.

Gura: Trillions, starting with T.

Greifeld: Oh, yes. Uh, there is about 12.8 trillion dollars worldwide.

Gura: Currently, this is less than half the size of the mutual fund market - mutual funds are the traditional choice for more conservative investors. But ETFs are making progress.

A large part of all this growth is due to ETFs being viewed as safe investments, similar to mutual funds. Coupled with the lower fees of ETFs, they are very attractive to those looking for a safe, low-cost savings vehicle.

Greifeld: This is one of my favorite charts. I know we are on a podcast, but if you look at the money flowing into ETFs and out of mutual funds each year, you'll find that in 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 an ETF that only contains Nvidia stocks. Now, there is also a spot Bitcoin ETF... they are one of the most popular ETFs.

Gura: How do they work? Did BlackRock buy a large amount of Bitcoin and hold it?

Greifeld: Basically, that's it. Uh, I find it helpful to compare it with spot gold ETFs, because spot gold ETFs do have to purchase a large amount of gold.

Gura: It must have something real to back it up.

Greifeld: Yes. There are many conspiracy theorists who say that State Street cannot possibly own that much gold.

But they do have it. They store gold in a vault in London, right under the city of London. If you look at the spot Bitcoin ETF, you do have companies like Fidelity and BlackRock buying large amounts of Bitcoin. The same goes for spot Ethereum.

Gura: I suddenly thought, we have seen this kind of ETFification across various assets. For example, can you really get an ETF that tracks anything?

Greifeld: Yes, almost. Almost everything in the world has an ETF.

Gura: Each stock recommended by Jim Cramer of C-N-B-C has an ETF for investment. Additionally, there is a reverse Cramer tracker that bets on all the stocks picked by Jim Cramer.

Both companies closed last year, but other similar companies launch every day. Katie said that many of these companies are not designed for ordinary investors; they are more suitable for sports.

Greifeld: NVIDIA: Especially the single stock ETFs, like Tesla, so watching these stocks every day is definitely interesting as they have gone up thousands of times and then fallen thousands of times.

Gura: I asked Katie what the next step for the ETF is.

Greifeld: An interesting conversation happening in the industry right now is whether you can put private assets into ETFs. The private market is currently booming, especially for companies that are no longer publicly traded.

Gura: However, even with the surge in the number of ETFs, the number of companies making profits from them remains concentrated among a few well-known companies.

Greifeld: The economic benefits of ETFs are very poor, as their prices are often much cheaper than mutual funds. I find it very interesting that Vanguard is the second largest ETF issuer, second only to BlackRock. Bloomberg Intelligence found that their average fee is only 9 basis points. Despite their ETF assets being close to $2.5 trillion, they only earn $1.3 billion from it each year, which is not a small amount. I accept that. But you might think that if the asset size reaches $2.5 trillion, then that number would be higher. So, the real way to make money here is through scale.

Gura: Now, the surge of ETFs also has some downsides. Bloomberg Intelligence ETF analyst Eric Baltchunas stated that due to their ease of use... and ease of launch, problems may arise.

Balchunas: If you can't control yourself, and you're like, you know, you have a gambling mentality. For example, you know, you might want to buy mutual funds, even if they have early withdrawal fees, if it can help you trade, then ETFs can be quite risky.

Gura: Many safer and more obvious investments have already been covered, Eric said. Therefore, many new ETFs may be a bit out of place.

Balchunas: This is a bit like FrankenETF, as if no one is launching ordinary things anymore. They are all trying to invent new things to attract investors. This is where you get caught up in the situation of FrankenETF.

Gura: In fact, the emergence of FrankenETF has caused concern for Jack Bogle, the legendary figure of Vanguard.

He was an early supporter of index funds and provided advice to Nate Most and Steve Bloom when they developed ETFs.

According to Eric, Bog felt concerned when he saw everyone being creative with ETFs.

Balchunas: Bogle said that sometimes when he wakes up, he feels like Dr. Frankenstein, because he can be considered the father of index funds. He would think, what have they done to my son?

Gura: Aside from FrankenETF, both Eric and Katie agreed that, in general, more basic ETFs have received all the hype.

They are transparent, easy to use, and more cost-effective.

All of this can be attributed to the market crash of 1987, an SEC lawyer, and two entrepreneurial traders who saw an opportunity in hindsight, and Sarah... this got me thinking.

Holder: Is it?

Gura: Maybe we should launch our own ETF...

Holder: Really? Just like the Big Take Away ETF?

Gura: Really.

Holder: Okay, are you referring to podcast-related stocks? I'm not sure...

Gura: Yes... this doesn't seem like a good idea, but I did bring this idea up to Eric Balchunus. He agreed to provide advice for our launch.

Balchunas: Well, the stock code could be TAKE. Um, if you have topics and guests, you can basically invest in that area.

Until the next program is broadcast, then trade to different fields and see what happens.

Gura: So Sarah, Take ETF, what do you think? What kind of news investments should we consider?

Holder: Simple - we will go long on the 2024 election, strategically investing in K-pop, must participate in the Olympics - but to be honest - we only bet on Brat.