Digging Deep into ETFs with Davie Nadig of ETF Trends

How is the ETF sausage made? Who creates the filling? The casing? Who buys it at the store? What other meat is it replacing?  We dig into all these tasty morsels and more with this episode’s guest – the ETF expert Dave Nadig, who has spent his career analyzing ETFs, their asset managers, and how investors fit them into portfolios. We’re talking with Dave about why nobody in Springfield, MA likes Tom Brady, how ETFs went from nothing to a Trillion to $7 Trillion (with a ‘T’), and why exactly they get that super beneficial tax treatment.
He covers whether they spell the end for mutual funds, whether they brought on the boom in RIAs, if they’re actually tied to indices anymore?, and how to square passive investment with active allocations to ETFs. Then onto how the SEC punted to Gensler at the CFTC re: Crytpo ETFs (and now he’s at the SEC…wtf), why the future could be ETFs by voting style, and the obligatory Cathie Wood/ARK questions on a pod talking ETFs. Finally, we’re talking what it takes to launch an ETF, who you need on your side in terms of market makers and distributors, and how the ticker has become all important. Don’t miss this informative chat with an insider in the huge world of ETFs. Enjoy.

Find the full episode links for The Derivative below:



Check out the complete Transcript from this weeks podcast below:


Digging Deep into ETFs with Dave Nadig of ETF Trends:

Jeff Malec  02:15

Okay, we’re here with Dave Nadig, Chief Investment Officer and Director of Research at ETF trends. And guess what we’re going to talk about ETFs you know, those little things that bring in trillions of dollars in flows every month, seemingly those nifty little securities that let you be long, the NASDAQ, short oil drillers, and seemingly everything in between. So welcome, Dave. Well, thanks for having me. I’m a fan of the show. Awesome. Thanks for listening. And where are you in the world these days?


Dave Nadig  02:40

So I live in western Massachusetts, which for some reason, I was able to move. This is where I grew up. And despite having career and you know, Boston and Chicago, you know, Chicago and San Francisco over the years, managed to move back here after 911 and managed to not leave very much sense. So working in a home office I’ve been in for the last 20 years.


Jeff Malec  02:59

Nice what a what city Exactly. I went to school across the border and Union College in Schenectady. So now Yeah, no, I’m so great. Over the board right over the border. Yeah, cool. My favorite Western master is Tom Brady broke up with that. Uh, what’s your name? Bridget Moynahan. Who’s from Springfield, I think. Yeah. And so they show those like Patriots fan charts and there’s that little circle, right? They all hater they all hate him in Springfield. Yes, there’s like high Valley hatred for the Jets at this point. And I got to ask you about the guitar over your right shoulder.


Dave Nadig  03:35

Yeah, that’s a humbucker single American Standard Fender Strat and the default guitar bad rhythm guitarists, which is what I am nice.


Jeff Malec  03:48

But you enjoy it helps you relax. I do. I do. I enjoy it. My brother’s in a band out in Seattle. He does punk surf rock, which isn’t quite my thing. But it takes a lot of practice. We do mostly terrible grunge covers from the 90s because we’re all a bunch of 55 year old white guys, right? I was depressed the other day. It was like Pearl Jam was on like, oldies or a soft rock station. Like what what’s happening?


Dave Nadig  04:17

Yeah, yeah, you know, the aging thing. At this point, I get called a boomer, which that really bothers me because I’m not quite a boomer. I’m firmly Generation X in your face. Yes to my face, but I know


Jeff Malec  04:31

What was the meme A while ago? Yeah. Whatever, whatever. Boomer. Whatever, Boomer. So give us a little personal background. What how you got to where you’re at ETF pro and, and what you’re doing at ETF trends. Sure.


Dave Nadig  04:48

So my ETF career really starts when I joined what was then Wells Fargo Nikko investment advisors in 92. And they hired me out of really associates which was a consulting practice critical And I built in Boston, sort of right in 19 9091. And what I was doing then was really work on the financial advisor market, which at that point was kind of a booming growth market. The whole idea of fee only advice was a radical new departure from the commission base days of the 80s. So I did a lot of work there and then went to Wells Fargo, Nikko to build out what they called retail, which included mutual funds, and then ETF says ETFs became a thing in the mid 90s. And worked on the launch of those first, what became the iShares country funds at the time, which you know, some of them are still in existence trading, you know, international markets all over the world that you couldn’t trade any other way with any ease. And so worked on those products for a couple years was pretty skeptical of them. Honestly, I wasn’t like a big booster of ETS at the time, I couldn’t figure out how they’d ever work. Obviously, they ended up working. Took a took a brief detour to be an actively managed fund manager in the late 90s. As a in the tech boom running an internet fund. In 99 2000 2001. We were


Jeff Malec  06:02

Matched by that ended the Janas. net fund, what was the big net fund?


Dave Nadig  06:08

Yeah, they were our biggest competitor we were called Open fund was the name of our fund. We were fully transparent, active managers, which now seems like a whole new thing, but back then it was unheard of and wasn’t as well received as we’d hoped. So I took a couple years off after 2001 and then came back into the industry. A few years later, as the director of research for what was then index universe, which became etf.com built a little data analytics business there, which we sold the FactSet went over with that business to fax out for a year and a day ish to bed that down and then came back to etf.com as CEO for a couple years through them being purchased by CBOE global markets. And then after the CBOE Mark markets purchase for a few years came over to ETF trends to join Tom Leyden and Tom Hendrickson, who had merged ETF trends in ETF database sort of you can think of that as content and data on the ETF business they had merged those together is kind of a you know, Voltron, you know, behemoth to take on the industry, and join the director of research about two years ago.


Jeff Malec  07:15

And what all those sites like I use them all the time, right? You’re like, how do I be I use short oil drillers before, like, what’s the short oil ETF and you Google it and those, and you get the list? Like? What’s the economics behind that? Then you’re running the ads of the ETF companies? Or what yeah,


Dave Nadig  07:32

I mean, there, we are pretty straightforward. Advertising supported media, which, you know, in the age of, you know, trenched crypto contracts seems decidedly old school. But fundamentally, we’re in the business of helping financial advisors make good choices for their clients by getting exposure. And that’s honestly what I’ve been doing for about the last 20 years is working with financial advisors, helping them understand the ETF market, the FA market has really been the growth engine for the ETF industry, honestly, since the very end of the 90s. And as the financial advice market starts adopting product and demanding product that actually trickles down into the retail market, so I spend a decent amount of time there as well. And then, of course, there’s always this push from the institutional market to get more sophisticated product to get better access to liquidity, to be able to manage risk better. And so it’s fun, because you get to play in all three of those markets pretty much every day.


Jeff Malec  08:29

Awesome. And I’m going to push you on the FAA definition, because I refer to them as ra is usually, but yeah, so same thing. Yeah, I


Dave Nadig  08:38

mean, pretty much we’re talking about the same thing. So we tend to think of Ra is independence, both, I guess, sort of hang up their own shingle, they may be platformed, at some place, like TD or Schwab or something like that. That’s sort of the traditional independent market. But at the same time, there’s still a huge wirehouse market, there’s still a lot of, you know, Wells Fargo advisors out there, a lot of Merrill Lynch advisors out there. And some of those folks are still collecting commissions, most of them have honestly moved towards some form of fee for service model, usually on a basis point level. Many of them use model portfolios now that have ETFs bolted into them, even though 10 years ago, they might have still been selling a share front loaded, mutual funds and collecting commission. So that market continues to evolve to something that I think is honestly just a whole lot more stable, a whole lot better for investors where you just sort of pay for the services you get. And then there’s a whole third section of that, which is the sort of the regionals right, the Lynn’s go private Ledger’s and the rage A’s and the Jones and those kinds of folks.


Jeff Malec  09:36

And so maybe you could debunk this right in my brain, it’s all the rage are flooding out of wirehouses and becoming because of ETFs. Right, and they can set up and they can give their clients cheap access. They don’t have to sell the wirehouse internal product. But it sounds like you’re saying well hold on. There’s a whole ream of Fs inside of the wirehouses that are doing basically the same thing.


Dave Nadig  10:00

Ya know, and you’re right that if you if you read, you know, all the industry rags, you’ll see this daily cavalcade of, you know, six advisors leave XYZ wire house to form their own shop with $2 billion. I mean that like, you can just print that headline every single day, and you haven’t been able to for about 10 years. But despite that, there’s still like 100,000 wirehouse, captive folks out there helping manage people’s money. And they are heavy users of ETFs,


Jeff Malec  10:26

200,000 advisors not Yeah,


Dave Nadig  10:30

I mean, there’s lots of planning on how you count roughly 300,000 folks in the US are in the advice giving business around finance, with some level of certification, you know, some of those bolts may be primarily insurance oriented, some of them may be still, you know, boiler rooming stocks out, I’m sure some of those guys still exist somewhere. But in general of that 300,000, it’s, it’s roughly a third, a third, a third between the wire house market, the sort of what we would call a regional market, and then true independents that are absolutely captains of their own chips. And that market continues to evolve. But the pressure is towards independence. No question.


Jeff Malec  11:06

Yeah, for sure. And does that even exist anymore? I don’t know, the laws of 10 the wire, I’ll say you have to sell our internal funds. No, there’s


Dave Nadig  11:14

there’s a lot of rules and regulation. Now, you know, reg bi, you know, definitely puts a lot of the older issues to bed in terms of, you know, yeah, to go sell more Apple, because we’re getting subscription revenue off. But you know, that that doesn’t really happen very much anymore. I think there’s still some shady corners of the insurance market. And there’s still some folks out there, you know, probably pushing, you know, UI tees and structured products that people probably shouldn’t be buying. But for the most part, I feel like we’re in a bit of a golden age for advice, right? There’s so many ways to get good advice, almost regardless of whether you’re a $10,000 investor or a $10 million investor.


Jeff Malec  11:53

Yeah. And how do you view it’s a little contrary to the whole concept of ETFs. So that you need the advice, right, like kind of the in my brain, like, Hey, here’s this product, you can just get access to all 500. S&p stocks, you don’t need the advisor to help you, you just grab it. But the advisors love it. So how do you square them?


Dave Nadig  12:14

Yeah, well, I push back on that a little bit. I think what the ETFs have done, it’s useful to go back to the beginning of ETFs. Right, the read the originally ETFs were not designed as things that an average investor advisor were going to use as their way of getting beta like and getting exposure for their, you know, growing wealth over decades. That was not the plan. The plan was the Harvard endowment is sitting on a million dollars in cash every day because they get dividend payments in or, you know, coupons get clipped off the bonds, they old or rents get paid on property. So there’s just constant influx of cash and most big institutional portfolios. And prior to the invention of ETFs, almost the only thing you could do with that was go into the futures market, there was no way to equities that cash on a daily basis without taking on some level of derivatives risk you may or may not want it to take on. So the ETF just instantly solve that problem, right. And instead of paying, you know, some sort of implied futures, contango, instead of paying the you know, wide spreads in what were pretty illiquid derivatives markets back then you could just get them for a 30 basis point spread, which seemed like nothing at the time, you could get in and out of the s&p 20 times a day. And that was a real revolution for institutional investors, institutional cash management. So from that what we built was just this giant toolbox full of tools. But honestly, very, very few of those ETFs were ever launched with the idea that they were solving the advice problem. I mean, a handful there were there used to be some target date funds, I share still has a few managed sort of risk managed funds that are balanced the where you can sort of get a conservative allocation that’s got some bonds and got some equities and a little bit of that, but we’re talking about less than 10 basis points, the whole industry is in those kinds of funds. So everything else is just beta exposure, or some kind of tool to make some sort of position in your portfolio, you still need to know what to do.


Jeff Malec  14:16

Yeah. Which I talked about on this pod a lot with hedge fund managers, right? They have this other side of the coin of change your stripes or go out of business sometimes right and investor would love for them to just Hey, do this one thing day in day out, I want to rely on that beta. You know, even if it’s some weird, it’s not tied to the stock market, but we’ll call it a beta here. But they have a business run ETFs kind of let you I remember talking with a provider once he’s like, Oh, we’ve had the short Japanese yen ETF for 10 years, it had 3 million in assets. All of a sudden there’s a move there it goes up to 300 billion or 300 million, but it’s just sitting on the shelf waiting for that to come in. A hedge fund manager can’t do that though. To go out of business, right,


Dave Nadig  15:01

right, exactly. You can’t warehouse, you can’t warehouse tools as a hedge fund manager. But that, you know, this is the flip side of the fact that the ETF industry has become so concentrated, you know, the top, top three top five providers have the vast majority of the assets. But you look inside their product line, and what you’ll find is those really cool tools, right? Yeah, we can sit here and go Gosh, does BlackRock need to have 400 and something ETFs. But then you look and you say, okay, but if you want Brazil exposure, the fact that they have one that’s incredibly liquid, and very cheap, and it’s been trading for a decade is kind of helpful, like as an institution or an individual.


Jeff Malec  15:45

You jumped into the history a little bit, let’s go back even further, and just give us the super brief history of the ETF you mentioned PIMCO before. And basically how big of a space is today, we mentioned BlackRock, so give us the


Dave Nadig  15:59

Yes. So, you know, it started in 93, with the launch of spy actually started a couple years earlier in Canada with the Toronto version of spy which were called tips. But spy was sort of the first one that really caught anybody’s attention globally, followed by the web’s products, world equity benchmark shares, which are the ones that I worked on in the early 90s. And then that was sort of it for a little while. And then later in the 90s, we got the queues. And I think that was a big wide open idea for a lot of people. But at that time, I was trading them. So I was trading queues as a way to get you know, intraday tech exposure when I didn’t have any better ideas, which was most of the time. And then, you know, it sort of languished for a little bit. And then coming out of 2000 2001, we really saw an explosion in new product ideas and new ways of working with the structure, we got the first fixed income ETFs, that was a big opening early 2000s got us GLD, to get gold exposure got us the first commodities funds that were trading futures, which are a whole nother different kettle of fish that got us our first active products. So that sort of that decade of sort of 2003 to 2010, I sort of called a golden age in ETF innovation, because all sorts of crazy ideas came out now some of them didn’t work, right. Some of those things went into the dustbin macro shares, right, which, where you’d be trading off exposure from one half of an ETF to another half of an ETF all sorts of stuff went by the wayside. But what it meant was we kind of went through this period, this trial by fire survived the global financial crisis quite well, that was a huge hockey stick moment for growth in the ETF industry, because so many active managers did so badly, particularly in the credit space, in 2008 2009. And then from there, we’ve had a pretty steady growth in what I would call a more measured type of innovation since then, largely, because there’s been a lot more regulatory scrutiny. You know, ETFs lived predominantly through loopholes. Since 93. Everything was an exception. You know, you had to fight. I mean, the whole fundamental filing process used to be called exemptive. relief. It’s not exactly a doesn’t roll off the tongue. So you know, none of this was happening by right, it was all happening by, you know, by sec, FIA, if you will, they would allow this thing to happen. That was the ETF until we passed an actual ETF rule year and a half ago, or two years ago, I guess, at this point. And that sort of codifies what an ETF is today. So now we live in a very tightly regulated and structured environment. But what that’s led us do is really go deep on what we can do. And that’s why we’re sitting at $7 trillion, roughly today.


Jeff Malec  18:41

Seven t with a with a T the trillion dollar. Yeah, we’re 6.9 as of this morning, I think. Yeah. And break that down. What percent of that is BlackRock and Barclays? And I should,


Dave Nadig  18:52

yeah, so you know, if you go through BlackRock, State Street saga, that’s the spider products. And Vanguard, you’re roughly 80% of the industry, right. So the top three players really do own it. And if you break it down even more on, like, if we don’t look at it by company, but like sort of by kind of Fund, the vast majority is what I would call cheap data, you know, funds that are under 25 basis points and expense ratio, indexed and providing Tricor asset class exposure, right. The bars are the Bloomberg aggregate, the GSCI commodities index, the s&p 500, the Russell 1000, those mean, those kinds of products, vast majority of the assets,


Jeff Malec  19:36

and what was that? You mentioned, kind of that hockey stick meme or let’s say, what was that in 2000, and then 2007, just the total assets


Dave Nadig  19:44

up top, Oh, God, at the top of my mind, I could pull it up off the top of my head. You know, we were we were knocking on 5,000,000,000,003 years ago, we were knocking on the first trillion 2004 2005, early 2000. So it’s just It’s gone. Just ballistic. And the catalyst is always the same. Anytime there’s a giant market crisis, the exact same thing happens. And this has happened, honestly, since 1986, even before we had ETFs. But every time we have a giant market crisis, a huge chunk of the active management community gets flushed. They just absolutely get flushed, they may still survive, but the assets leave. And where did those assets go? Well, initially, they usually go to cash. And you can track that. And we always look at the you know, balloon and money supply and margin rates and all that stuff. But then eventually, that money needs to find a home again, and every single time it shows up in whatever the cheapest most liquid passive vehicle is. And that has just been an inexorable trend since the 80s. So you know, global financial crisis, boom, another trillion dollars shows up in ETFs. You know, what we saw in March 20. Last year, boom, another trillion dollars shows up in ETS, because they are the natural place to go if you get if you managed to get out of your underperforming mutual fund without taking an enormous tax hit because you’ve been sitting on it for 10 years or something like that. Boy, why would you go back in in March, you know, in April of 2020, why would you be taking that as your moment to make a giant bet on a new active manager?


Jeff Malec  21:17

It’s kind of perverse incentives, right? Like the whole index ETF space like, hey, if we could lose 40% of our assets, in the short term, we’ll will triple them in the in the long term with the new flows. Yeah.


Dave Nadig  21:29

Well, I think the funny thing is like, I mean, I’ve been kicking around this industry long enough. The joke we make is there only 400 people in the ETF industry. And it’s not true, but it’s pretty close, right? I mean, it’s a very small world, we all end up working for each other one day or another. There’s a bit of a revolving door around the industry where talent sort of moves where it’s most valued, as you would expect. But you know, in that group of folks who have seen some things over the last 25 years, every time the market pulls back five or 10%, you don’t see anybody crying, everybody’s mobilizing the forces, they’re just like, Alright, let’s go, we got to get the marketing spend up, we got to figure out how to, you know, how are we going to get retail this time, etc, etc, people chasing 13 f filings to look who is in terrible underperforming hedge funds, the whole nine yards.


Jeff Malec  22:14

All this growth is at the expense of actively traded mutual funds, mainly for


Dave Nadig  22:18

the most part, right? I mean, the, you know, I have some slides in a few decks where I sort of point out that since the global financial crisis, it’s been about, you know, however many trillion dollars have showed up in flows into the ETF industry at this point, it’s probably four. And it’s been about 2 trillion out on actively managed mutual funds, right. So that’s, that’s if there is a balance, that’s where you’d pick it from. Now, obviously, you can’t tie dollar for dollar something moving out of something and into something else. But yeah, it’s mostly come at the expense of expensive underperforming benchmark hugging active managers, because those are the active managers to get flushed every time we have a crisis.


Jeff Malec  22:55

What and I think you had a little nugget in there of benchmark hugging and underperforming. So are you in the camp of like, all active mutual funds will disappear eventually?


Dave Nadig  23:05

No, not at all. I’m neither will active disappear, nor will mutual funds disappear, they both have very important roles to play in the markets. They just they needed to be they needed to be shaken up. active management, we’re actually in the middle of a huge active management resurgence, largely on the back of Cathy wood and the folks at Ark that really sort of put old school stock picking active management back on the map, which if nothing else, has been enormously entertaining. But I think it’s also really pointing out what active management should be, which is having a very strong investment thesis and then sticking to that, regardless of what the headlines look like, right? That’s what you want that of an active manager you want them to take the hard bets and I think we’re seeing a lot of that in the ETF industry. And certainly anything interesting in the active management space is either in a hedge fund or an ETF right now, I don’t think anybody’s super excited about any recent mutual fund launches.


Jeff Malec  24:04

Yeah, or torpedoes be damned is what you want out of your active management. Yeah, yeah, exactly. And but what and I’ll, we work with a few mutual funds, who are pairing the beta with active kind of long ball positive strategies that can be balanced daily, and that’s kind of a more exciting piece of the active space environment.


Dave Nadig  24:23

And ETFs have become largely vehicles for active managers, right. And that’s a huge component of this. I you know, anybody who’s running of all strategy, probably using some ETF beta under the hood, even if it’s just through the options market.


Jeff Malec  24:44

So you mentioned Kathy worked hard to talk about ETFs these days without that. You gave your quick thoughts just how fast is her Ascension been of ARKS ascension, and there’s lots been written about all the problems with it too concentrated into illiquid of stocks. Give us your overall view on Ark. And yeah,


Dave Nadig  25:04

so, you know, I should caveat this by saying, you know, I’ve known Kathy for a decently long time. And, and obviously, I think I should probably carry this reading. But essentially every ETF issuer does business with her firm. So like, there is some financial involvement, but nobody’s paying me to talk about it now. So look, Kathy has been sticking to her knitting on innovation for about 20 years. And some years, that’s been great. And some years, it hasn’t been great, both in terms of performance and in terms of how it’s received by the market and everything else. You know, what she’s doing now, what her team and I should point out, like, she is not a stock picker, she is a team manager and her team is fantastic. Just like as individuals, they’re some of the smartest people I’ve ever talked to, we can see totally rational have disagreements about what they do as an investment thesis, but the people no question incredibly sharp, and their core thesis of really focusing on transformative technologies with five year time horizons, and doing your own bottom up research where Wall Street isn’t, that’s legit, they’re doing that work. Now, whether that should be in an actively managed mutual fund, or an actively managed ETF tracking X number of stocks would do a split on genomic or split on space, or, you know, putting it all in one bucket. You know, those are largely, you know, marketing, access liquidity type discussions. And I think those, you know, those are reasonable. I think some people think that, you know, things like what they do in rkK should be only in a hedge fund environment, because then they can take private equity placement, and then they can really load up on the illiquid stuff. And yeah, there’s a version of that kind of strategy. And there are a lot of folks who do that kind of investing out there. Her whole thing was to bring this to the average investor, right? Because historically, these kinds of really forward thinking long term plays were only the province of institutions, they were the only people that actually invested that way. All right now, because they had a performance here, that was gangbusters last year, it obviously rose to the top of everybody’s screens, and all these retail investors with new money in their accounts founded at the top of their screens, and they’re really good at telling their story, right? They show all of their work with in a way that no issue where I’ve ever seen does down to, you know, you can, you know, attend a webinar with one of their PMS, and they’ll go through their analyst sheets and talk about why they’re saying this is the growth rate for this individual company. No manager does that, like openly,


Jeff Malec  27:33

almost borders on non compliant in my view, like when they show their test love growth outlook, I’m like, Whoa, that it’s completely hypothetical. Right? But so bad if that’s your numbers, that’s your number.


Dave Nadig  27:45

Yeah. And, and I you know, this this issue about whether or not talking your book is nefarious or noble, or like anything in between? To be blunt, I have a lot of sympathy with it. Because like I said, in 1999, I ran a mutual fund where we published our trade blotter in real time, right. So we were doing that, and we were talking your book every day on CNN, CNBC, and we got a lot of crap for it. I mean, Jim Cramer called me a criminal on air because he thought I was trying to run my own stocks. So Sure. Okay, that’s a reasonable question.


Jeff Malec  28:18

It’s a nice feather in your cap.


Dave Nadig  28:21

Yeah, well, I’d rather not have it but the flip side of that is, okay, well, then should they not tell investors why they’re invested in Tesla? Should they not put out what their targets are? The I don’t think you get to have your cake and eat it too on that, right. Either transparency is good, or transparency is not good. And I give them credit for being fully transparent about it, you can’t argue that you invest in one of their funds and don’t know what you’re getting. Right? You just can’t make that argument.


Jeff Malec  28:50

And so let’s talk a little on the two big concept, right, our arc individually or each, you know, I don’t even know the symbols of some of those sub ones that you just said, But um, are they getting too big? Right? If it’s a, everything you just said can be perfectly true. And they’re doing a good job needs the smartest people in the world, and they’re picking the right stocks. But if it’s too many assets chasing those stocks, does that eventually become a problem?


Dave Nadig  29:14

Yeah, I mean, this is sort of the tail wagging the dog problem. Yeah. And yeah, if you reduce the argument to its natural conclusion, you have, you know, $100 billion fund that’s trying to take a 10% 10% position and $100 million company. Yeah, okay. You can’t do it. Right. So yeah, there are natural limits on the concentration any fund can have based on its size and liquidity constraints. 100% true, and that is one of the issues with the ETF structure back to the point about, you know, mutual funds aren’t going to go away and either closed in funds or hedge funds, because there are some things you shouldn’t put in an ETF right? If you want to run a special situations micro cap fund, you cannot do it in an ETF because you can’t close it. You can never say hey, I’ve got my $5 million in closing the new business. You just Can’t do it in an ETF because you create massive dislocations and how the thing will trade? I mean, you technically can and it has happened. But it’s, it’s, you’d get a lot of scrutiny and not the good kind. So yeah, that is an issue. And to some extent that limits what something like a rkK could put in the fund, because they can’t just load it up with micro caps. Now, you have to ask yourself, do you think that they’re smart enough to understand that and manage that liquidity tightly and have relationships with the street that are good enough that should they want to liquidate something, they can do it without creating giant, you know, multi day market moving events? And the short answer is, yeah, they kind of have shown they can like they dumped wire card in a trade, the whole position out of the fun, one of the largest holders of that when wire called card turned out to be a fraud. And they’re one of the only institutional holders that was able to extract value out of wire cards crash to nothing, because they were able to work with the street and sell it very early. Right. And they, by the way, advertise that trade, because that’s what they do. So the one case we’ve had where they wanted to effectively panic exit a security, they did it better than anybody else on the street, I’ve been able to find,


Jeff Malec  31:13

yeah, I would argue they probably caused the crash down by them getting out, right. So if


Dave Nadig  31:18

I mean, it might belong to zero. So it’s not like they made it happen. It didn’t happen on purpose, you know.


Jeff Malec  31:26

But I guess my issue is, right, if they can’t set up a toll booth, they can’t say, Hey, no more money coming in, because we have these constraints. So what do they do with that money? does it become less innovative? does it become more of a s&p beta? Right, though, if they have to put that money to work and they can’t put it in these companies? Where does it go?


Dave Nadig  31:44

Well, you know, yes, if they became a $50 billion, Magellan like behemoths, the ability to make meaningful allocations to smallest securities goes away. There’s just no question about that. I don’t think that they’re near that problem yet. And I suspect that if they genuinely believed that they were getting there, you would see them talk about changing the fund strategy, or splitting the portfolio into sub tranches, which they’ve done with some of the other segments that they look at. So that people who are really only interested in say, the electric car industry can just get that exposure as well. So I think it’s a manageable problem. You know, ironically, there, there are some other much larger passive funds out there that go through rebalances, which are much more predictable, and thus much more exploitable. And we don’t talk about them all that often. Right. And those are, those are just genuinely broken market issues, right in the Russell rebill for a decade was something that people just could deliberately trade against the VIX, futures. etps. Right. 100% tradable everybody knows exactly what they’re going to do at the end of every single day.


Jeff Malec  32:49

Yeah, let’s dig into those. Because that comes back to I’m sure. I don’t know, if you’ve been on air debating with Mike green on


Dave Nadig  32:56

active versus passive. We’ve certainly had the discussions, I think, only once, maybe once on air, but we’ve had the discussion privately for sure.


Jeff Malec  33:03

Yeah. Right. His theory of try and boil it down to is you just have this one hose, right? And the more and more pressure that’s coming into that hose, eventually, it’s going to break or there’s going to be downstream problems, that you can’t fit everything through that one pipe, which is neither the bid ask spread or the assets they can invest in. Right. So I’ll take it from our all the way to the whole industry, like when can it get too big? Is there a point where passive you know, gets too big for its own good? And what would those problems look like?


Dave Nadig  33:36

Yeah, so I mean, there are a couple different angles to that. So the cleanest one is the price discovery question. Right? Which is that if yes, again, you reduce the argument to its absurd extreme where every single dollar in the world is passively invested. And then there is no price discovery? Sure. You’re imagining a world where the market disappears, and nobody takes risk. Okay? Yes, there is a problem that 99.9999% passive investing. The smartest piece I’ve seen on this with Andy Lowe at MIT, who his basic run through the math was, you need to get up to about 90% freeriders, before price discovery breaks down, and we’re all we’re maybe 25%. Like, that’s probably the best gross estimate you can make. Now, it’s not a trackable number. It’s not a measurable thing, and therefore, it’s not a regulatable thing. So it’s a bit of a, you know, it’s a bit of a specious argument, like, you know, what happens if it, you know, never rains for 18 years? I mean, okay, that would suck, we’d have no food, but like, that’s not the real world we live in. So I get a little frustrated with these discussions. Because, you know, if you, I mean, imagine the case, imagine you banned passive investing. How in the world could you possibly enforce that if I choose in my portfolio, using my swab account, to hit a button and buy all 500 stocks in the s&p and cap weights and then just rebalance that every month? How do you know that I’m doing that and how you banned me from doing it.


Jeff Malec  35:00

If I just buy an s&p future?


Dave Nadig  35:02

Well, exactly, well, I’m just saying you’d have to ban all of those instruments too. So if you banned passive investing, all you would do is make it only the province of institutions who could just do it on their own. And there’s no way you can ban somebody from that you can’t ban somebody from owning a collection of a certain set of publicly traded securities in a certain waiting. It’s crazy. So, you know, you could you could poke at the structures, you could poke at the infrastructure, and that’s probably where we will see some action. I think the more relevant question is about common ownership. And I think that is a legitimate discussion and doesn’t have as much to do with passive as it does with just common ownership, right giant institutions, owning either on their own or on behalf of other investors, enormous blocks of individual companies, and therefore having outsized impact on those companies activities. That is a legitimate area of discussion,


Jeff Malec  35:57

in terms of voting rights, or in terms of if they get out it causes price action.


Dave Nadig  36:03

Just in terms of voting rights, right. I think that’s, that’s a whole separate thing, corporate governance in the United States is kind of messed up. It’s not great anywhere, but it’s not particularly great in the United States. The way we you know, this sort of complete abdication we’ve given as individuals our votes to our asset managers, you know, I understand how we got here, like, I don’t want to see proxy statements for 3000 securities, because I own the Russell three, that’s terrible, right. So you’ve got, there’s got to be some level of abstraction on that, where I think we’re headed and we’re starting to see the crack in that is that people will start choosing their passive manager based on how they say they’re going to vote. Now, that’s really only hitting at the sort of fringe edge of ESG, we had a great launch a couple weeks ago fund called vote Bo t, which is basically just an s&p 500 fund with an attitude, right, it’s gonna get in there, and it’s going to pick its things it wants to get done in corporate America, and it’s going to go make a lot of noise and rally shareholders around predominantly ESG centric themes. But again, it’s just an it’s just an s&p 500 fund. And why they’re a little bit different is because not only are they worrying about voting, their shares, they’re lobbying everybody else. So they’re working with BlackRock to say, Hey, you know what, on this Exxon vote, we’ve done surveys, and this is what people really want. And then they’re convincing them. So that’s pretty cool.


Jeff Malec  37:27

Yeah. And what could the future that could look like hey, here’s the s&p maximize profits, but the SMP maximize social good vote, the s&p maximize environmental good. Yeah, exactly. Right. And you could have many trenches. Yeah,


Dave Nadig  37:42

yeah. And, and I think, you know, we’re headed, we’re in such an exciting period in time, because there’s so many incredible financial innovations, which are like one regulatory hitch away from being real. It’s like, technologically, it would be trivial for Schwab to send me a survey once a month, just asked me 10 questions about what I care about, that I don’t didn’t have to say this Exxon vote, they can just say, given a choice between these three things, hypothetically, and you pick things that are on the freakin every proxy solicitation, employee compensation, executive compensation, you know, carbon output, like all the stuff that’s hitting everybody, Schwab could just pull me they can hand that back to the asset managers and say, Hey, this is how our audience would like you to vote. That would be cool. And, and technologically, you can do it in you know, 24 hours with one good developer, but there’s no regulatory path for my opinion to end up in my fund. They there’s just spaces in between and everything in crypto is the same way really cool things we could do in a heartbeat that we have no regulatory path forward. Yeah. And I think most of these interesting issues and passive management fall into that bucket.


Jeff Malec  38:52

I think the s&p 500 CEOs would hate that idea. Right. Because I feel like the general public would say that compensation is way too high.


Dave Nadig  39:02

Yeah, exactly. Yeah. But you know, what? Isn’t that isn’t that Stark, right? Like, if all if all of the shareholders of IBM don’t like the CFO, they should be able to refer to the CFO? Right? Like, that’s just how that’s supposed to work.


Jeff Malec  39:15

Right? You’re a shareholder? Yeah, but how many people that actually own the Russell 2000 ETF think that they’re a shareholder of those 2000 companies?


Dave Nadig  39:26

Very few. You’re just buying, you know, magic internet coins, like effectively there’s no difference between the Russell 3000 and Bitcoin in most people’s mind. It’s just a number that goes up or down. Right. And I think honestly, anything we can do to make people realize that they’re actually participating in the economy, I think is good, right? I mean, I think it was, I think it was Meb Faber, Cambria who rent a bunch of ETFs and those is a financial adviser in his own right with somebody was asking him something on CNBC about like, you know, how can you not be invested in whatever Was it theory or something? It’s like It’s like, because I’m invested in the global production of the entire planet. And that seems like a pretty good place to start. Right? global equity portfolio. That’s what you’re doing. Yeah. You know, abs great. Yeah.


Jeff Malec  40:12

I think he’s over a billion now too. So yeah, he’s kudos to him. He’s been working on and as we become more of a corporate driven society, it’s almost like that needs to get you know that that needs to happen more and more in this society that we’re in. Well, we


Dave Nadig  40:26

can go down a big long rabbit hole of corporate statehood, but yeah, I mean, I don’t think that’s why you brought me on but I got to know we’ll leave


Jeff Malec  40:33

that there’s a good post reformed broker Josh Brown has on the new American Gods I think he called it you know, yeah, I mean, that that idea from religion to Apple and Netflix and these things and


Dave Nadig  40:47

yeah, there’s the whole issue of regulatory capture and oh my god, I could go on forever.


Jeff Malec  40:51

Yeah. Elon musk just tweeting out whatever he wants. You mentioned crypto in there. Let’s talk about how many Bitcoin ETFs are out there crypto ETFs waiting to be approved.


Dave Nadig  41:09

56 teens? I mean, it’s you know what, what day is it because yeah, change by tomorrow.




Jeff Malec  41:15

Alright, so waco viruses were there for 10 years just waiting, waiting. And now there’s so what what’s happening there? Is that good? Yeah.


Dave Nadig  41:20

So we’ve been back and forth. So originally, the Wink like to go back to the beginning. And I don’t think most people quite get this. And this is not from the Winklevoss brothers mouths. But this is just my summation. They came to the street with an idea to put Bitcoin in an ETF in a very GLD like structure, like just take the take the Bitcoin, put it in a box fractionalize it traded on an exchange, very straightforward. The reason that they did that as early as they did, which is, what, seven years six years ago, now is quite a while ago, was not so much because they were like, this is what makes us a bunch of money. It was because they wanted to force the hand of regulators to tell them what the heck Bitcoin was. Right. Okay. And that was, I think, a critical thing, right? And what they actually got out of that were a couple of really pretty key declarations about Bitcoin being property, like how it gets taxed. A lot of what we understand about where Bitcoin and crypto in general, sort of lives in the regulatory environment comes from that initial fairly aggressive push to get the SEC and the CFTC to tell them what the heck Bitcoin was from a sec, sort of punted, right and said, it’s a CFTC issue. Exactly. And that was the punt, right? They, at the time, kicked it over to Gary Gensler. Now the chairman of the SEC, then the chairman of the CFTC, right, who basically said, Yeah, we’re going to treat this as effectively a commodity asset that you can put futures on. And that’s as far as we’re gonna go. And so once they did that, they were able to say, Okay, now you have to go through this sort of futures not hold, and we’re just gonna leave you there for a while. Because once it’s in the futures not holding the 33 Act gives a lot of the CFTC has a lot of hand and what they say isn’t Okay, that the SEC has to play a little bit tighter to the rules about because the CFTC is managing very different and much smaller market in terms of number of participants. So that was the first push, then we had a whole bunch of people pile on with different approaches to it, how you store it, how you measure it, what you index it to how you handle creation, redemption, all very under the hood, not that interesting differentiation. All of them got rejected sec, hold them all the way back to the drawing board. Until very recently, when Gensler basically said, Hey, you know what, if you did something in the 40 Act that just use futures, we’d probably say yes, and then pro shares, like a ninja dropped the filing the next day effectively, and then got that fund approved. So there’s now a 40 $50 million US listed mutual fund that owns Bitcoin futures. Now, it seems like it should be a fairly trivial bridge from there to an ETF so much, though, that I can’t quite figure out why proshares couldn’t just convert the mutual fund in to an ETF now that it’s live. Yeah, so I think we’ll get a set of approvals here sometime before the end of the year. And then we’ll have a raft of these Bitcoin futures ETFs, which, frankly, not that many people are gonna want. Because it’s not particularly great way to get exposure to those assets. it’ll, it’ll fill the bucket for some folks, right? It’s probably a little better than GBTC, which is no TC list of trust, trades, a big premiums and discounts. So probably a little tighter tracking than GBTC has on average, but not really the tool anybody wants.


Jeff Malec  44:38

Well, I think the argument from the crypto community was this will let institutions who can invest in it investment because it’s a security, you know, it says yeah, and there’s


Dave Nadig  44:45

there’s, there’s truth to that, right? I think that look, are we going to get a billion dollars into bitcoin futures? ETFs Absolutely. Right. So it will be successful. I don’t know who’s going to be at the front of the list. If I had to pick one today. It’s going to be Valkyrie because their filings the cleanest but more likely the SEC comes back tells everybody this is what you need to look like everybody scrambles and pays their lawyers a lot of money, they refile in a way that the SEC has told them to and then they do a day one approval for everybody and then whoever has the biggest marketing budget wins.


Jeff Malec  45:17

Yeah. And but and so none of all those filings now we’re going to use the futures.


Dave Nadig  45:23

Yeah, currently, all of the extant filings use futures in the US because the SEC has told everybody else to pull their physical, physical, their, their, their, you know, and what is the physical? Physical? Yeah, um, you know, they’re speaking specie, you know, version of the Bitcoin filings. But that’s the only one that anybody wants. Really, all anybody wants is just a straight up creation redemption. GLD like Bitcoin fund.


Jeff Malec  45:48

Yeah. And our sponsor, CME Group. Thank you. Right, they can’t get hacked, right. It’s on an index of prices. So you’re not going to lose your exposure.


Dave Nadig  45:59

Yeah. On the future side. Yeah. But so like I said, Will a billion dollars show up in these funds? Of course, it will, because there’s enough use cases for it just as a tool, much less as anybody saying this is how I’m getting my Bitcoin exposure, just as a Delta one tool, just being able to manage that exposure, versus the futures versus the underlying creates an arbitrage circle that the market will jump into. And there’ll be a billion dollars in it just for people managing that arbitrage circle.


Jeff Malec  46:28

Yeah, just Chicago prop firms, right?


Dave Nadig  46:30

Yeah. So there will be plenty of money in those funds, people will short them. That’s another thing that’s useful here on it all makes me a little sad, to be honest, because the really interesting stuff is all being done in the crypto side of the balance sheet. Right. The stuff that’s happening outside of us jurisdiction is so much more interesting than the idea of baking CME futures into a fund.


Jeff Malec  46:54

Yeah, it’s been onsite, Bitcoin jazz hands, right. Like Wall Street’s just co opted it and trademarked it basically and said, hey,



Dave Nadig  47:03

yeah, exactly. But meanwhile, you’ve got, you know, gosh, you’ve got guys like, like barn bridge building, effectively trashed crypto securities that are like CEOs that are run through automated securities contracts that just completely disintermediate the entire financial services industry in one contract. And that stuff’s going to take over the world. But the problem is, it has no regulatory homes.


Jeff Malec  47:31

Does that kill ETFs? Eventually, right? If you can just yeah,


Dave Nadig  47:34

I wrote a piece I wrote a piece this this spring, effectively saying the only reason the ETF should exist at this point is because of the regulatory framework. If you look at what like the index Co Op is doing on the crypto side where they’re basically creating smart contracts that spit out a portfolio token when you present a portfolio of coins, in a certain that is that is the ETF creation redemption mechanism. That is exactly what it is the way it works, how it uses portfolio composition files, how it handles everything. It is automated ETF top the bottom, the only thing that we don’t have is a token you can submit to that that says Tesla or s&p or IBM. And once you do, which those tokens exists, they trade on ft. x but if you could trade them more broadly, then you could have anybody in the world could stand up an ETF with air quotes around it in 20 minutes by just modifying and you know an ERC 20 contract. It’s, it’s child’s play in terms of how obvious it seems. Yeah, the two big issues, I was just planning, I was just having this conversation with Adam Butler from resolve Asset Management last night about this. The two big issues are one, there’s no legal way to do any of this, right there is no regulatory framework that allows any of this to happen. The second one is there’s a huge timing mismatch, right? Because everything in crypto is instantaneously settled. Nothing in securities is instantaneously settled. So if you created an ETF, using all of these, like Tesla tokens and IBM tokens, and ran it through one of these sort of index, co op type smart contracts, who’s warehousing the settlement risk, because when you buy more of the one thing that Tesla, you don’t actually own it for a number of days. Whereas in crypto, that thing hits your wallet and it’s yours, for better for worse and that that timing gap and settlement is the hugest problem.


Jeff Malec  49:28

I’ll add a third problem. There’s $7 trillion worth of people disinterested in seeing this happen.


Dave Nadig  49:35

Yeah, I disagree with that, too. Like the most interesting stuff going on in the asset management industry is happening in these little crypto Tiger teams. I mean, wisdomtree filed for a Solano listed 40x register mutual fund. Like that’s bananas. The only way you’ll be able to buy it is through blockchain. Now, I don’t know whether that’s going to make anybody any money, but it’s not like, it was As a top 10 issuer, they should be interested in protecting their business. They’re not they’re building a whole new digital assets business and trying to wedge the 40 Act into it to create mutual funds. So I think there’s the ETF industry is I think a little bit further ahead than people think in terms of how they’re trying to get through this stuff. The huge problem is like warehousing the settlement risk and regulation. You need a group like


Jeff Malec  50:23

apple or Tesla who says we’re gonna direct list via some blockchain right? And then it would instantly settle via the blockchain and cut out but then you have NYU


Dave Nadig  50:34

break 50 securities laws at the moment. I mean, look, look at look at Uber, who is it that just got a you know, $2 billion sec investigation yesterday? Not in an ex, one of the one of the early guys who put it on an Ico on their exchange, I should know this, it was yesterday’s news. But my point is, like people have tried this was what Icos were supposed to do? And the SEC basically said, Oh, look, unregistered securities, congratulations, you’re going to jail, like the Danbury minimum.


Jeff Malec  51:13

So we’ve mentioned futures a few times, let’s talk we can come back. The creation redemption, the structure of ETFs, how much? How is future how our futures used inside of ETFs? That seems to be only growing, we seem to be getting more and more complex in the ETF world. So speak in the game for a minute know just how you’ve seen futures used and now they continue to be used.


Dave Nadig  51:38

Yeah, so um, so for a long time, futures were not used. And this this is the PIMCO story with such as there is so when PIMCO launched blnd, which was their clone of the PIMCO total return Mutual Fund, which at the time was the biggest mutual fund in the world this 15, year, 10 years ago, something like that 10 years ago, they, when they tried to launch it as a pure clone, and they couldn’t. And the reason they couldn’t was because they couldn’t get the SEC to approve allowing them to use things like interest rate futures, right, just simple stuff that they used in their bond portfolio to just manage risk around the edges get a little exposure here, a little convexity, they’re just like, really pretty straightforward stuff. From a futures trading position, and, and de minimis amounts of the fund. It’s not like this was 25% of the fund. It was, you know, a percent or two, right equities and cash, things like that. And when they watched as a fully active, fully transparent, ETF, the SEC said, No derivatives, period, top to bottom. And this was part of a set, I mean, and the dates don’t matter, but from about 2000. Through that 2015, the SEC has gone back and forth on how ETFs can or can’t use derivatives multiple times. And this is back to your they were just exceptions. There wasn’t one rule, it was just yeah, exactly


Jeff Malec  52:58

this issue at a better lawyer and got it through this one didn’t.


Dave Nadig  53:01

Yeah, and there was there and there still exists a huge mismatch in what individual firms are allowed to do based on when and how they got approval. So if you launch a fund now, thankfully, you’ve got a new set of laws, the 6011 rules for ETFs. But they’re still people have grandfathered stuff for another seven months or something like that, where they get to do stuff nobody else gets to do. And derivatives were one of these things where there was a real haves and have nots. In particular, you ended up with situations where like the leveraged and inverse guys direction and pro shares, could do a bunch of stuff wants a bunch of product, most of those are just regular old 40 Act funds that just sit on a whole bunch of cash and swap positions. And they were totally allowed to do that nobody else was nobody else could get permission. So they went back to the well, and they sort of rewrote those rules. And and now it’s relatively straightforward to use futures in one of two ways in ETF The most common way now and the way all of these Bitcoin products are being filed is through what’s called the Cayman Islands hack. And what that means is bloggers Yeah, so you just end up sticking, you know, you have a million dollars from your investors, you take most of that and you just leave it sitting in cash on your balance sheet, you buy some repo, you know, minimum risk collateral, you take 25% of it, you send it down to a subsidiary in the Caymans, which then leverage that up usually just using the inherent leverage in the futures contracts. To get you notionally 100% of the exposure, you wanted it in the first place. And what that lets you do is run a very concentrated portfolio in the Cayman Islands, because what you’re showing on your books is a whole pile of cash. And from an IRS perspective, that gives you It gets you out of jail on the tax front very easily. So you end up with notionally 100% of the futures exposure you wanted a little bit of cash which isn’t actually generating any revenue at this point. But you know, in the old days that used to be yield two and so you get effectively your notional Delta one exposure To the futures contracts you were looking at, and you don’t get a K one partnership tax form at the end of the year, which you would if you did it the other way, which is you just list a commodities pool to trade. That’s what something like uso which people used to trade front month oil futures. That’s just a listed commodity pool. And so that’s regulated by the CFTC. It’s not a 40 act fund, you get taxed on a 6040. longshore basis, you get mark to market every year, and you get a K one form. So it’s a huge pain in the ass from a tax perspective. That’s


Jeff Malec  55:29

because they’re holding the futures directly. Yeah,


Dave Nadig  55:32

that’s just, they’re just holding futures, right? They are a commodities pool. Okay. And those funds work great. It’s just they give you this weird tax treatment, which you know, for some industries is beneficial. If you’re a short term holder, you get some long term treatment, that’s a good thing.


Jeff Malec  55:48

And all of our listeners basically have that tax treatment. So go easy on them.


Dave Nadig  55:53

Yeah, so I mean, that’s, that’s the problem for most people trying to play in the commodities or futures space with ETFs is some of those the funds through these k one forms, and that’s a pain in the ass. Some of them don’t, the so called k no k one funds all use this Cayman Islands hack


Jeff Malec  56:12

to get around. If I’m an ATF, normal retail guy, I have no idea probably even when it came on is right. I’m just want to click it and get my 1099 D from Yeah. And


Dave Nadig  56:23

about six, seven years ago, I used to get the regular email from financial advisors who were saying, so I bought all this commodities exposure because you know, just 2010 2011 we’re in the middle of that commodities run, people are like, go go go. And then they’re sitting there in, you know, April of the next year, and they still haven’t gotten their k one forms from their clients, and they have 100 clients that can’t file their taxes, and they’re all grumpy about it. Because they didn’t realize that’s what k ones are, right? Everybody files an extension. If you’re waiting for K one, that’s just how that game is played.


Jeff Malec  56:53

And what are your thoughts? We did a post got must be like 10 years ago now. But it was the UMG I think was the natural gas. And I can’t remember there was the inverse and the positive. Yeah. And they were both down 95% life today. Right. So people are like, what, what is happening here? Shouldn’t one go up and that’s just as a result of as you said contango and backwardation and the role and daily rebalancing, they the inverse leveraged stuff. I think we talked about that. And how that works in the VIX and all that of why these aren’t. Investors shouldn’t think of them as buying Oh, right. Yeah,


Dave Nadig  57:28

yeah. I mean, the good news is, for the most part, I think the retail phase of heavy use of leverage and inverse funds seems to be over. They were never designed for retail investors leveraged and inverse products were always designed just trading vehicles, predominantly for hedge funds, or institutions to trade a lot. But the problem is, if you if you look at any things like nugget, which is the, you know, the double 2x gold miners ETF or something like that, the way they get that to x exposure is by resetting it every single day. So every morning at 930, when the market opens, you’re going to get to x the return when four o’clock rolls around. So if it’s up 1%, you’re going to be up 2%. But the problem is that means every single night, you have to rebalance that portfolio, it also means that you’re procyclical, whether you’re long or short, what I mean by that is like, if you’re in nugget and gold miners go up, you have to buy more, you have to notionally get more exposure tomorrow to keep your 2x leverage. So you got to go negotiate a swap contract to get more levered. If you were in the inverse of that, which I think is dust. Yeah, the exact same thing happens, right, your position just got shrunk, which means you now need to unload, which means that you were unloading your short means you’re a natural buyer. So everybody has to go in and buy at the close. If they’re rebalancing these leverage and inverse products, so in markets where the leverage and inverse products become a big part of the market, that’s a huge issue. And then where that’s shown up is index. There, there are windows of time, in which the daily rebalance of what are now a fairly small number of those volatility etps they basically absorb all of the available Vega you can buy in the market. Now, it hasn’t happened in a while. And it’s certainly not every day, but there are these windows of time and I have a spreadsheet I occasionally post on Twitter. That’s where shows when it’s a big deal, where you can look and say, Okay, what see the VIX futures complex is traded. I’m making up numbers here, a billion dollars notional through 330. And then all of a sudden, it’s got 10 billion notional to put on because that’s the rebalance from the complex. And it’s usually not that scaled. But a lot of these weird end of day things we see during times of significant crisis can actually be explained by the rebalance of the leverage and inverse etps.


Jeff Malec  59:45

But I think what we call vol mageddon right of the febby for sure is that effect going on into the close. Yep. And then actual options, traders were seeing their spreads blow out and it just


Dave Nadig  59:57

started to cascade well in these and this is sort of gets into The long ball stuff and the crystals and Jim Parsons and Mike Greene’s of the world knows folks that you’ve had on. This is just one more thing that is adding this weird procyclicality to all of our markets, right, which is part of the long ball thesis is we are Miss measuring the real tail risk here. because everything’s feels really nice and happy in central tendency and VIX is printing 15 as I’m writing this, except boy, does it go from 15 to 25 in a heartbeat, right? So we can’t count on those measurements at all. And that’s really what we’re talking about is just another procyclical factor that as prices move prices move.


Jeff Malec  1:00:38

I love and I’m going to come back because you had a nice piece on that about the GameStop, which sort of ties in there, but we mentioned that tax. So just quickly talk about the tax loophole. Is it a loophole or or you know, the benefit of ETFs? Oh,


Dave Nadig  1:00:52

so back to the beginning on ETFs? Yeah. So yeah, one of the one of the reasons ETFs caught advisors attention in the 2000s. And why they became the growth engine was because the vast majority of ETFs have never made a capital gains distribution. Yeah. And the reason that they do that is they rely on, I mean, I won’t get too deep in the weeds, but there’s a there’s a principle called general utilities, which comes back from the 20s, and was sort of codify by the Supreme Court in the 70s, or late 60s, which basically says, if a company hands out an asset to its shareholders, it is not a taxable event for the company. It is a taxable event for the shareholder. So that’s on that, like, whether they’re taxable or not, or how they do it, that principle was put in place to I mean, originally, because company happened to be sitting on an enormous amount of stock, and somebody wanted to buy it from them and in to avoid getting double taxed on both the corporation’s position and then the dividend that they would have had to pay out to their shareholders. They basically gave all their shareholders the stock and let them sell it to the buyer. That was generally utilities. That’s exactly what happens in an ETF every day, when the ETF needs to unload stock, they hand the stock out to an authorized participant, it’s not a taxable event for the fund, because since 1920s, it hasn’t been and then those individual shareholders have to deal with it. In this case, those individual shareholders with air quotes are authorized participants. So it’s Goldman Sachs and B and y, and, you know, GTS, and all those guys, Jane Street, all of whom get taxed as dealers. So it doesn’t matter to them what their basis is, they’re getting taxed on that stuff as inventory not as actual buying and selling for capital gains. So what that lesson at,


Jeff Malec  1:02:33

sorry, whatever, they’re flipping it, you know, 1000 times a day, anyway.


Dave Nadig  1:02:36

Yeah, exactly. Right. So it would be a nightmare if they actually had to track you know, basis, lots, they don’t, that’s not how to be a market maker works. So what that means for an average investor is when you go ahead and buy and sell an ETF, your tax experience is uniquely your own. You, you know what your cost basis is, when you bought it, you’ll get some dividends over time, maybe you’ll know what your tax basis is, when you sell it, you pay your taxes, then, as opposed to a mutual fund. We’re in a mutual fund because of the buying and selling and rebalancing inside the mutual fund. And even more importantly, because of selling to meet big redemptions, the fund actually has to end up booking that because they sell the securities to generate cash. And at that point, there’s no dodge available to them anymore, that the if a fun sell something they’re gonna own tax on it. So that’s why mutual fund investors get this tax distribution every year whether they did a thing or not, they get a capital gains distribution from most mutual funds that they have to pay taxes on in current years. So ETF sort of act as this accidental tax deferral, which is enormously valuable for anybody investing taxable money.


Jeff Malec  1:03:43

And do you see that ever either changing or the law of changing for the mutual funds, right, it seems like an uneven playing field that they should make even somewhat


Dave Nadig  1:03:54

mutual funds could do this. There’s no like, technically now in the regulations that we’re working under, there really isn’t a difference between an ETF and a mutual fund in any meaningful way except for how it’s distributed, like the actual endpoint of how it gets to an investor. Otherwise, they’re just mutual funds. So mutual funds could do this. And in fact, they are allowed to do this and do occasionally do it. Vanguards done this a few times, large investors can cash out of a mutual fund and get, you know, the in kind securities happens and bond funds, sometimes you’ll get a big institutional, go into a big, you know, less liquid mutual fund and then use that to get a bunch of securities out of that fund through a redemption. So it can happen, but it can’t happen on the individual in and out basis. Because the way an individual MC gets new shares of fidelity Magellan, the mutual fund, is they give them cash, and then they have to go buy securities, and when they get out, they get cash back.


Jeff Malec  1:04:50

But it seems like they said there should be some innovation. They’re like, okay, we’re not going to give you cash, we’re going to treat it the same as the ETF. Well, yeah,


Dave Nadig  1:04:57

ultimately, I think it’s just all gonna end up on the Yep, side of the balance sheet, right? With the exception of 401 K’s because you need fractional shares to do 401 K’s and that turns out to be pretty hard.


Jeff Malec  1:05:14

Let’s talk real quick about that. Are we becoming too complex? Is there any limit to like what we could do with these ETFs? Right? Like the you mentioned the inverse, the triple inverse, it seems like the LPL and those kind of groups like put limits on that basically right of like, Hey, you gotta sign these extra disclosures. So is that throttle down that innovation or you think that innovations alive and well?


Dave Nadig  1:05:38

Well, what’s happened is the those types of folks have to now be gatekeepers, right? And so if you’re if you’re a you know, an advisor who uses LPL, chances are you can’t trade triple leveraged anything, you may not even be able to trade commodities. ETFs, right, you’re gonna have to work underneath a list that they’re going to tell you is approved. That’s not a bad system, right? The whole mutual fund industry has worked that way for decades, and it’s worked pretty okay now puts a lot of pressure and a lot of responsibility on the hands of those gatekeepers, which the industry hates. Because they don’t want all these gatekeepers telling advisors, they can’t buy their products. But that’s sort of the world that we’ve come to now the bad part of that is, there’s a lot of pay to play that goes on was just


Jeff Malec  1:06:21

about to say that. Yeah, yeah. So much on the platform Once you’re at 100 million, and we make x off.


Dave Nadig  1:06:27

Yeah, exactly. So like, there’s a difference between saying, We want to see this much liquidity and your product, or we don’t think this is exposure we want our advisors getting, those are pretty reasonable things the we need to have you pay $100,000 to sponsor a conference every year, and then we’ll put your funds on our platform. Obviously, that is very different and a little bit less aboveboard. There is a decent amount of that that happens. And that is an issue. And I’d love to see that get reined in a little bit. Right?


Jeff Malec  1:06:54

I think the best products should be what when, and we you mentioned dig and dust like, to me the best innovation is in the naming conventions, which, like the ticker battles, they never pick your battles is awesome. Like, just quickly, how does that work? How do you apply for one are there is it like domains, like every four letter word I’m sure it’s probably already taken or closed


Dave Nadig  1:07:15

doesn’t quite work like that you have to. So if you’re an issue where you have to go to the person that the exchange that you’re working with your listing agent, and you ask them to reserve a ticker for you. And there’s a system that the exchanges all work into, I think technically it’s run through NASDAQ like the tape is, but it doesn’t really matter. There’s a system, all the exchanges use to reserve tickers, and you have a certain amount of time to use it. It might be six months, it might be a little longer now. But they roll off, right? You can’t You can’t squat on it forever. It’s not like a domain where you can just feed it 10 bucks a year and you get to own it forever. You have a bit of a user to lose it quality to it. And they should just


Jeff Malec  1:07:57

make that a crypto market where they trade.


Dave Nadig  1:07:59

Yeah. Because there’s no question like, if you can get weed as the ticker for your pot fund, you’re in better shape than if it’s you know, PT x or something like that. Yeah, we


Jeff Malec  1:08:09

a guy I know, had bought Bloomberg 2020 comm in like 2017 or something. And they the campaign came to him and was like, Hey, we need this. So I think he sold it for 75 grand or something nice. Yeah. Yeah, I don’t think you can do that. With tickers. I would have, like millions, if not billions of dollars would Yeah.



Dave Nadig  1:08:29

Well, yeah. Given what URL sell for that have anything ETF in the title right now. Good luck trying to get one of them. But yeah, the ticker system is definitely real. And a lot of that is the rise of retail. Right? We have a lot a lot more retail traders in the ETF market than we ever have before. And so having, particularly if you’re gonna do something dramatic, you know, having buzz as your ticker for your social media ETF is a whole lot better than you know. FCL.


Jeff Malec  1:08:56

Yeah. And then speaking of starting an ETF, so you get the name. You talk to us a little bit of like, I’ve gone down this path a little bit. We were trying to do a managed futures one in the past. The market maker is sort of heavily involved here, right? or correct me if I’m wrong,


Dave Nadig  1:09:12

but it depends on the depends on the kind of ETF you’re trying to launch. But you know, the critical component, there’s a lot of plumbing, the plumbing is relatively straightforward. Depending on how you do it. It’s somewhere between 150 and infinite amount of money to sort of just get a custodian and all that stuff and get a trust set up and get that board set up and get stuff filed with FINRA and all that jazz. It’s a pretty boilerplate process at this point, since we changed the rules a couple years ago, where it gets much trickier is trying to actually be successful. And that’s where things like seed money and who your market makers are and who your authorized participants are, who your who’s distributing for you how you’re going to market. That’s actually what determines almost all of your success. There are a lot of great products out there that have opened languished and closed Because nobody could figure out how to sell them or who to sell them to, or they had plumbing problems, right? They didn’t work with a market maker. They couldn’t keep their spreads tight. They couldn’t get creasing redemption done well. So those are really critical issues. But I would honestly say distributions, the biggest one, if you don’t know who’s going to buy the product, you shouldn’t watch it.


Jeff Malec  1:10:17

Yeah. And then the old days didn’t have to be tied to an index.


Dave Nadig  1:10:25

Yeah, pre 2000. challenging me on dates pre, early 2000s, when we had the first blnd filing, there were only passive ETFs. That’s all that existed.


Jeff Malec  1:10:36

And then, and then people started, like their trading strategy became an index, even though it wasn’t like it. Yeah. And you saw a lot


Dave Nadig  1:10:43

of firms. Like I think alpha architect West Gray’s group, like I think they went back and forth. I think Matt did it to a Cambria where they like, had stuff filed as an index, and then they came back to active, but then they went back to index because they wanted to be able to do custom baskets, which allows, you know, authorized participants to not be perfect in their creation redemption, which you couldn’t do in the active funds for a while. Now, it’s sort of come back because the ETF rule makes everything easier. So there’s been a lot of flip flopping on whether you take your intellectual property and roll it into an index or just launched a fund pros and cons to both sides. I think most managers believe it’s a lot easier to run those things active no matter how quantitative they are, because it’s just less paperwork.


Jeff Malec  1:11:24

Yeah, yeah. And then talk a little bit about that bid ask spread. And the that’s now a required listing on the website, like the average spread, I believe.


Dave Nadig  1:11:33

Yeah. So one of the things that came out of the 6011, the ETF rule was a bunch of standardized disclosures, which is all great around trading premiums and discounts, average spreads, portfolio holdings over time, like there’s a bunch of new material that really has to be on any traditional 40 act registered ETF. I make that distinction, because for instance, if you launch a futures fund, it’s not gonna have anything to do with that, if it’s if it’s a commodities pool, right. So this is only the stuff that’s going down the middle of the 40 Act. And yeah, and that stuff’s pretty straightforward. But the honest truth is ETFs are trading so well. Now I haven’t had to write like an ETF trading story in two years. And I used to write them all the time. Like it was such an easy throw away story, you find some ETF that printed badly, you go tease it out of the Bloomberg, run the tape show what happened, like, ah, here’s a guy who put in a giant fat finger limit order in the middle of a ramp, he got hosed. You don’t see that very much anymore. You don’t see big eggs, you know, erroneous trades, you know, with the big X on them on the tape. It just really hasn’t happened. It didn’t happen really at all in March 2020, which was shocking.


Jeff Malec  1:12:39

And what did happen in March 2020. Right, there was some, the bond ETFs especially are the high yield, dislocated from the index. Yeah, but that’s


Dave Nadig  1:12:48

what’s supposed to happen. Like that was cool, because the whole point of the ETF is it’s supposed to be the liquidity relief fell for the underlying, right you trade the ETF before you trade the underlying, that’s the whole point. I want exposure to Germany, but I don’t want to open an account over there. I buy the ETF, it buys Germany for me. So you’re buying on purpose for that dislocation to the underlying market, where people sometimes get hung up is on highly liquid markets that can go very illiquid, like bonds, you particularly high yield immune ease. When you get that switch and liquidity, you get a natural disconnect between what you think the underlying market should be doing and what the ETF is doing. And that’s a big distinction. Because when we had those, quote, unquote, dislocations and march 23, I think it was of 2020. The dislocation wasn’t that the ETF did something weird, it’s that the underlying market stopped trading entirely. So you went from trace eligible high yield bonds, that I would watch on my screen trading 50 times a day to trading three times a week. Right? And so at that point, how do you say what that thing is worth? Right? If it traded it, you know, par yesterday, and 10 down today? And then doesn’t trade for eight days? Do you assume that it’s still sitting 10? down? Yeah, back up, because something like, how do you so that’s the problem is you end up with net asset values that are completely bogus, because the underlying hasn’t traded, but the ETF trades, you know, every second. So that’s where you see the disconnect, because the ETF becomes the warehouse for all price discovery when liquidity hits,


Jeff Malec  1:14:27

and some people are putting that up there as like this proves the tips are going to ruin the whole market. Right? And in any Korean side, or no, it’s,


Dave Nadig  1:14:36

it’s 100%. The opposite Imagine a world where March 23, whatever day it was in 2020. The world’s melting the Fed hasn’t made any backstop announcement, everybody’s unloading corporate credit. So all the triple C’s go first they any bid gets hit. And now everybody’s sitting on the junkie as part of their portfolio knowing it’s at risk, assuming they’re not going to get backstop and there’s no ETFs in existence. Why What happens those things trade to zero? Yeah, literally, they start trading at pennies on the dollar, there’s no, because there’s managers out there that need to get these things off their books before the risk manager walks in the door, right? Like just real talk the human beings here. So we’ve seen that happen, right? This is what happened to some extent in 2008. In the worst trading days, right, people were just unloading anything they could. And that’s what drives things to crazy dumb discounts. Within ETF, you have a relief valve, you have a highly liquid single security as opposed to all those individual bonds that can absorb all of that panic, right. And so people who want to take risk by buying at the bottom, have one trade that they know they can get executed to take that risk people who want to unload that risk at any price, they can unload that risk at any price, but you don’t break the whole market. You allow those who are seeking and providing liquidity to reset the price. And that’s how markets are supposed to work.


Jeff Malec  1:15:58

Yeah. Well, same as a futures market. And that way, I guess. So want to finish up with talk a little bit about your post when that GameStop thing was happening. And I thought you had a really good post on how it was, you know, it’s not the same as in the past when there were either boiler rooms or chat rooms, or, you know, just enthusiasm. This is algorithmic driven enthusiasm. So just summarize, if you could that post and we’ll dig into it a little bit.


Dave Nadig  1:16:30

Yeah. So you know, I think the challenge of the game stop moment. And I think that’s really what it was because it hasn’t really ended. But it sort of kicked something off was that it pulled together multiple forces into a single event, the one that almost everybody got focused on was gamma, and totally legitimately a part of it right that the options dealers were trying to figure out how to hedge their gamma, and a bunch of guys in the internet had figured out how to put them in a tight spot and that move the price. So that is 100%, a thing that happened, I actually think it’s only about 20% of what happened. Because at the same time, what you ended up with was a whole lot of individual investors who now had access that they had not previously had, whether it was through Robin Hood or whatever, sitting at home, some of them with extra money that they hadn’t had before, but mostly just board on. And you know, I think there’s a cultural component to that, too. I’m Scott Galloway did a lot of great work talking about the challenge of specifically young men. I know gender is a tough thing to get into here. But you know, I think there was some truth to that, that you took a whole lot of young men and you locked them in a room and told them they got need to figure out something to do and a lot of them ended up on Reddit. Yeah, so that that was a piece of it as well. But I think the other piece people misses a whole lot of people had just made an awful lot of money in crypto in 2019, going into 2020. And that money did not sit on the crypto side of the balance sheet. And that’s part of why crypto goes up and down so much, right? Because people take their winnings and they move it to the other parts of the world. And the other parts of the world include things like GameStop stock. So I still believe that a lot of the activity we saw in GameStop, and continue to see in meme stocks today is driven by people who are fundamentally crypto traders. That’s where they started. That’s where they made their money. Right? And so when people look at even things like what’s going on in the NFT market right now, and they’re like, all in the world, Can people spend $2 million on a pixel and then shocked that it goes down to a million dollars the next day? And isn’t somebody know, people are crying in their soup? Because that money all started in crypto, people assume that things are going to be insane, and volatile, and driven by meme driven by intent, rather than by fundamentals. And that’s what we’ve seen, right? That trading by intent, and valuation by intent is everything that’s driving the stocks, right. That’s why I mean, I keep them up on my screen, just because it’s boring not to like, that’s why let who’s on top today. Jimmy is down, you know, 3% today, like tomorrow, it’ll be up 10%. This is not anybody trading these stocks on fundamentals.


Jeff Malec  1:19:03

Lilly Frank is on Twitter had a good quote of the regret per dollar is very low. Right? They have no regrets because it’s, it’s free money base, right? It’s house money. And


Dave Nadig  1:19:14

we can like we can, I mean, I got a rack of behavioral economist books on the back of my wall here that would tell me that was irrational, blah, blah, blah. It’s not house money is a fallacy. No, it’s not. This is how people are actually reacting to the world that’s been handed to them. And in a lot of cases, I know a bunch of folks that are heavily in this space trading, crypto, trading, defy trading mean stocks. It’s not that they don’t understand that a million dollars has a million dollars worth of economic value. It’s that they made enough money over the last three years that they feel like they’ve got their basics covered. And they’re willing to take enormous exogenous risk with the part that’s not that’s the old


Jeff Malec  1:19:56

trader Joe, what’s the best way to make a million dollars start with 10 Yeah, exactly. The but in tying it back your post a little bit was that this is algorithmically driven right up, the more people look at GameStop, the more the app is going to serve up stuff about GameStop.


Dave Nadig  1:20:12

That’s the other part. And this is something that I honestly, if people want to get up to speed on this, what they really should do is to spend way too much time on Tick Tock for a day, like just one day, just and for you know, particularly, you know, guys in my generation, you know, my socio economic bracket, bracket, we’re not sitting around on Tick Tock all day. Yet, if you go look at what’s happening, not just there, but on Instagram, and on Twitter, to some extent, and on Reddit, and even on Google News search, right? What you see is a result of what everybody else is talking about, and the result of an algorithm that’s trying to decide what you’ve been interested in before. So if you’re a crypto trader, and you’ve been trading a lot of wacky stuff on the side, and you’ve been liking a lot of posts about this guy’s defy project, and then all those people who are doing that migrate to talk me about GameStop, because there’s a technical hack, right? The game, the gamma piece, then all of a sudden, all you’re going to see is that, right? Even though it may be a terrible investment, even though something much more interesting, and much more valuable is happening somewhere else. Because you’re already part of an ecosystem of self reinforcement. You’ve limited your funnel, right? You’ve limited the access to information you’re going to get. So it creates this environment where herding isn’t just a thing that happens once in a while. It’s actually the driving force for a lot of this stuff. I keep a little chart on my Bloomberg, where I try to keep track of the amount of market cap moving between mean stocks and crypto. And it’s never perfect, but boy, there are definitely days when you can say Huh, 50 billion came out of Aetherium 50 billion showed up in AMC. I wonder what happened like and you can track it within minutes. Like it definitely happens.


Jeff Malec  1:21:53

Yeah, I love it. So, we do some quickfire favorites here. Favorite guitar player. Oh, boy.


Dave Nadig  1:22:09

That’s really incredibly difficult. I’m gonna this is boring. But I’m gonna say Jimi Hendrix. I’m not a huge I don’t like pop it on the listen. But


Jeff Malec  1:22:18

I love to break things from his. From his skill set. Yeah, just he reinvented? How Yeah, guitar. I was expecting that or prints but that’s good. Yeah. Favorite. You mentioned your books behind you their favorite investment book. And then we’ll do favorite non investment but, you know, include behavioral economics and investment category. Yeah. Oh, boy favorite.


Dave Nadig  1:22:43

I mean, I’m going to be boring here again. I’m going to start with Ben Graham, because that’s probably what kicked me off. Right? That’s probably the easiest one. But I probably then back up to this behavior of markets. Mandelbrot, yeah, probably be it. Love it. I’m just again, because he’s taking status quo and figuring out all the ways it’s broken. And that’s kind of been my whole career.


Jeff Malec  1:23:10

I was getting into the NFT a little bit looking at those and there was a couple of Mandelbrot images that were catching my eye. Yeah, I actually tried to buy one in my wallet. It was got complex for the time at night. And I’m like, I’ll do this Come on. So whatever


Dave Nadig  1:23:27

I was looking at, it’s probably a it’s probably 1,000% exact now It costs as much as a car. Yeah,


Jeff Malec  1:23:33

I missed it a favorite non investment boat, huh?



Dave Nadig  1:23:40

House of leaves by Daniel loose ski. All right, don’t know, which again, it’s a it’s a multi threaded narrative. You have to buy it in print because it’s color coded. So you can’t really read it on a Kindle. And it’s four or five stories told together through an interweaving narrative. It’s bonkers baby related.


Jeff Malec  1:24:03

Love it. Favorite ETF ticker tickers. Oh boy. It’s so hard to pick a favorite. I


Dave Nadig  1:24:17

guess we could say funny as PBJ I’ve always thought pvta was a great one because it’s food and beverage and that was one of the first tickers I remember seeing somebody trying to be clever with right and i right now. Now you have to be right or it’s right now leaving buzz and dust and nugget and you know, all that kind of stuff. So there are good ones out there. You know, and a lot of them are thematic, right so a lot of the thematic funds that have launched have fun ticker jets, you know jets is a great ticker. How can you not like jets, but I always have a soft spot for PBJ


Jeff Malec  1:24:50

my buddy’s a doctor and he was getting caught up in all the stock trading like we were just saying in March 2008. He just kept texting to everybody. Jet jets jet lag. During the rally with just text jet, GTS jet jet, and lastly, all our guests get the favorite Star Wars character. Okay, I’m gonna have to go with Luke. I mean, Lucas, I was,


Dave Nadig  1:25:14

you know I I’m old I was born in the mid 60s. So you know, Luke was Luke was teenage hero worship for me. I mean, I think I was 14 when I saw Star Wars then like,


Jeff Malec  1:25:26

were you a Mandalorian? watcher? Oh God, huge, huge. So that last episode where he caught the CGI version of Luke,


Dave Nadig  1:25:34

it was pretty cool. Wasn’t CGI, I think he’d think they wrote a script for it. I think he actually did the acting for it.


Jeff Malec  1:25:40

Really? Yeah. And there’s a I’ll send it to maybe we’ll put it in the show notes there. Someone put different music to that the I can’t remember the one of the themes from the earlier movies to him coming through there and knocking down all those guys. It’s awesome. Oh, my God. So great. I will send that to you just oil the end of the Mandalorian prayer. I know. Sorry. Spoiler alert. I mean, come on.


Dave Nadig  1:26:04

If you haven’t watched it by now, at this point, I think the statute of limitations is over on the Mandalorian.


Jeff Malec  1:26:06

Exactly. Awesome. Well, thanks so much. It’s been fun. It’s been great. I really appreciate the opportunity to be here. Yeah, look you up next time. We’re in upstate New York and shoot over the border and take grab a coffee for sure. Definitely. All right. Thanks so much. All right. Cheers.


From the episode:

Luke’s Entrance but with the Force Theme

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