Talk Your Book: The Biggest Active ETF

0:00Ben Carlson:Today's Animal Spirits Talk, your book, is brought to you by J.P. Morgan. Go to jpmorganassetmanagement.com to learn more about their whole suite of covered call option ETFs, option income ETFs. It's jpmorganassetmanagement.com to learn more. Welcome to Animal Spirits, a show about markets, life, and investing. Join Michael Batnick and Ben Carlson as they talk about what they're reading, writing, and watching. All opinions expressed by Michael and Ben are solely their own opinion and do not reflect the opinion of Ritholtz Wealth Management. This podcast is for informational purposes only and should not be relied upon for any investment decisions.

0:36Ben Carlson:Clients of Ritholtz Wealth Management may maintain positions in the securities discussed in this podcast.

0:45Ben Carlson:Welcome to Animal Spirits with Michael and Ben. On today's show, a returning champion guest. This is probably his third time, fourth time coming on the show?

0:52Michael Batnick:Yes, something like that.

0:53Ben Carlson:Hamilton Rainer from JP Morgan still holds the crown for the largest active ETF in the game, Jepi. It's pretty impressive because it's been the largest active ETF for a few years now. It hasn't been dethroned.

1:08Michael Batnick:I wonder what number two is. Probably Jep Q. But outside of, I wonder what number three is.

1:14Ben Carlson:It's just, it's interesting. We've talked about these covered call options strategies in the past. It's just interesting. In a decade that has been fueled by speculation, right? Everything is speculation these days. Prediction markets and gambling on sports and trading on your phone and zero-day options, that these are more conservative type of investments that have obviously taken mindshare. It's just an interesting dichotomy to me, that these aren't like the speculative fever, right? These are more, for lack of a better word, boring.

1:46Michael Batnick:I believe we spoke about this probably with Hamilton, but years and years ago, So Josh and I were in a meeting with a wholesaler, probably 2013. And at that time, people were still very scared of stocks. Very much in the aftermath of the GFC, still the cloud was still hanging over us. And this guy was pitching high yield bonds as a way to dip your toe in the water. a little bit more beta, not quite stocks, but closer to stocks and bonds, certainly. And needless to say, this is an obviously better solution for people that want equity exposure, but don't necessarily want all the smoke of the downside.

2:35Michael Batnick:Perfectly fine, not capturing all of the upside. If the S &P is up 30 % in a year, I'm sure people would be just fine being up 26 % or whatever it is. Right.

2:45Ben Carlson:People understand this. There's a trade-off for the income. Yeah, it's trade-offs.

2:49Michael Batnick:That's right, Ben.

2:50Ben Carlson:I do think it's interesting that we've seen the popularity of these strategies, that there's now offshoots. All right, if you like this but you want something different, here's another option. Here it is on the NASDAQ. Here it is where the income will be automatically reinvested for the option income if you're not going to spend it. Here are some different ways to do this with different holdings. And so Hamilton gets into that with us today with some of their new funds that they're using on the S &P and more NASDAQ-like on options. And I think these things are going to continue to just evolve.

3:17Ben Carlson:and have more options uh pun intended i guess there there you go okay so we always love talking to hamilton and the last time we saw him we mentioned um every time we go to future proof i see him at the at the concert that's the only place i see him is is he's rocking out to the concert right next to us anyway great guy always love catching up with him here's our talk with hamilton rainer from gipy morgan hamilton welcome back to the show glad to be back good to see you

3:44Michael Batnick:guys in Miami.

3:45Ben Carlson:Thanks for having me.

3:47Michael Batnick:Great to see you too. I'm sorry we didn't get to spend more time together, but it was great seeing your face.

3:50Ben Carlson:We always see Hamilton at the music show. That's where I always run into it, in the crowd watching the music.

3:56Michael Batnick:Absolutely. One of the highlights. All right. So Jeppy is still the largest actively traded ETF. Got to be, right? It's the largest active ETF in the world by AUM. And holy cow, coming up the rear, JEPQ is a monster too. JEPQ has$33 billion in assets under management. We're recording Monday, March 30th. It has. And it makes sense though, Michael, because if you think about it, when else can you hear growth in tech, income, and having expected less risk and volatility? Those three things are evergreen when thinking about clients' portfolios. Usually an income-oriented investor is missing out on growth in tech.

4:37That is true.

4:38Michael Batnick:That is true. So we've covered this the previous times that we've had you on. There is no free launch silver bullet. These things have trade-offs. You are going to be probably, not probably, definitionally leaving some on the table in a rip-waring bull market. But the idea is that when you're in a drawdown, you're going to suffer less of the drawdown. And it's early in the year, but not that early. We're through the first quarter. There's a couple of components to that. Obviously, the options premium helps buffer that a little bit. And Ben may not want to hear it, but I'll go there anyways. The active management of our stock selection has actually helped.

5:19So Ben, I'm sorry, but active management can help in both up and down markets. What are you coming at me for? I heard that you were a, I heard you were a bogle head.

5:30Ben Carlson:Oh, he sure is. Died in the wall. 80%. What are the stocks working this year? So you're like a high quality, low vol. If you had to put it down to a factor, what is helping this year? Yeah, so I wouldn't call it a factor. I'd say it's a little fastened stock selection. But what's helping is Jepi, by design, was designed to be one of the more conservative ways of getting income as well as a conservative equity. So how to think about that loan portfolio. Number one, it's very well diversified. We cap every name at about 2%. So we're going to be underweight the mega span. The second thing is that we want to be well diversified across sectors.

6:08And we know that whether it be communications or tech have actually become a huge part of the S &P, we cap every sector at about 17.5%. So the diversification across sectors and across names has actually been a nice tailwind.

6:22Michael Batnick:So 2022 was, correct me if I'm wrong, I feel like 2022 was the year of JEPI because it launched a Cambrian explosion of these derivative-based products inside of ETF. So the option overlays, all sorts of different strategies. But in 2022, not only did you protect the downside via the options in a down market, but it was the stock selection in 2022. It sounds like the stock selection is similarly adding alpha in 2026. What is the methodology behind this good old-fashioned stock picking. You're right. I mean, 2022, the stock selection and the sector allocations and being a more balanced allocation, not being as much in the megas, was absolutely a tailwind.

7:11When I think about what we do, we actually are lucky enough, Michael, to have boots on the ground across the world. We have 80 analysts. They all speak the same language when it comes to stock selection, a$200 million research budget. And when you have that opportunity to have access to management and to do the actual analysis, picking stocks that will give you a little bit more of the upside, maybe less of the downside. Now, when I think about stock selection, one of the things that's important to me is it's not just how much you buy, excuse me, it's not what you buy, but it's how much. Actually, stock selection is only 50 % of the alpha.

7:48It's how much of it you buy. The weighting of it is also incredibly important. And so strategies like Jeff B and Jeff Q actually balanced not to stock selection, but portfolio construction.

7:58Ben Carlson:I have a question for you about your process, because I don't know what the right answer is. Are you a guy that says, listen, the process is the process. This is what we do. All discipline. Or do you say, no, the process can evolve over time. Our stock selection can evolve, types of stocks we own. How are you? Are you like, no, it's set in stone? Or do you say, no, no, we're pretty flexible here? A couple of things I would say, Ben, I would say that there is a process, but the process is not that it's this way or the highway. It learns, it grows, it develops. As you get new information, I forget who we can attribute the quote to.

8:31I know you guys always know who said the quote, but when the information changes, I reserve the right to change my opinion. Was that Keynes? Yes, allegedly. I think it was allegedly Keynes. But the fact is, is we have a process where we look at cash flows, you know, in a normalized world out three years, then forecast out 30 years of cash flows. And then we're trying to say, what is this company worth today? So is that a process? Yes. Are we going to change it based upon information or new sources or other things that we can glean? Absolutely. But you need to, you need to root yourself in something to create perspective.

9:06You just can't come in every day and say, what did I read on Reddit or Speaking Alpha? And they say, That's going to be my favorite name of the day. That's where actually people chop themselves up and I think get destroyed.

9:16Michael Batnick:There is no shortage of different option-oriented strategies. In fact, there's a glut. It's overwhelming. How should investors who are listening to this think about observing or diligencing you versus a competitor? What questions should they be asking? There's a couple of things to that, Michael. The first thing I would say is we philosophically believe it's not just about income. It's about total return where income is a portion of it. You see these gaudy numbers in which there's huge, enormous distributions monthly or annually. And what you end up seeing is people have massive NAV erosion. And clients, even if they got the income, oftentimes forget.

9:59And they see their NAVs go from 100 to 80 to 60. and that's not actually a good thing from an overall portfolio perspective. So you don't like NAV erosion. The second thing is, I'll come back to something that Ben alluded to, and that is, you should almost ignore the income. Why? All of these strategies are going to give you income. You first need to start with what kind of stocks you want to own. With a strategy like Jeffy, you're looking for higher quality names with predictable earnings. With a strategy like Jeff Q, you're looking for more of a growth in tech footprint. But when you think about some of these other strategies, if you just look at the income, you may buy a stock you don't like, but because of the income you buy it.

10:41If you look at some of these other strategies that I would say, some folks say you need a PhD to understand what they do, a lot of financial engineering, you don't need to be complex to make money. You don't need to be complex to invest. I mean, It kind of goes back to what is one of the age-old philosophies that I have. If I can't explain it to somebody, I probably shouldn't be investing in it. So with our strategies, you understand what you're buying, the type of stocks. You're understanding how the income is generated. You're understanding that at a place like JP Morgan, we have not just portfolio managers and analysts.

11:23It takes a village to manage strategies like this. middle office, back office, clearance, custody, cloud management, cash management, corporate actions, trading, pricing, cap markets. I mean, you need that village. As you guys know, stocks don't die. Stocks either get taken over, they go bankrupt or they live forever. Options die. You need that team of people in order to do these things well. And so I would say it's not about that big gaudy income number. It's about really creating that balance of total return and income, Michael. Those are some of the things I would say. I'm curious.

11:55Ben Carlson:So you have the biggest active ETF. I don't know if they give you like a belt to wear around the office for that. But there's all these other, Michael mentioned, there's been an explosion in these products. Do all these other option income seeking funds, do they, is it a drop in the bucket in the options market? Or could these funds actually change the market in some ways? Is there any difference because all these funds are seeking this income? Or is it just like, no, no, no, you don't even realize how big the options market is. This is nothing. It's a good point, Ben. And the first thing I would say is that the S &P 500, the granddaddy of all options, actually trades over$3.5 trillion per day.

12:32What? And one of the pushbacks I'll get, and Michael's going to push back, is like, how about those zero dates? Well, let's just say that's half. It's still$1.75 trillion per day. These are some of the most liquid, if not the most liquid equities in the world. So I would say if you're using S &P 500 index options as the options, they truly are a small fraction of the overall market. The NASDAQ also trades an enormous amount, not nearly as much as the S &P, but a significant number, at least 600, 650 billion a day. And once again, those options are, and that's notional for both SAP and ASIC, those options and those strategies are still a tiny fraction.

13:19Where it could come into play is in some of the single names, because the fact is there's only so big you could be, whether it be position limits or the actual number of options that trade on individual names. I would say the big guys, the MAG7 plus three or whatever you want to call them, the fabulous 10 probably can withstand the amount of options that are trading. But as you go farther and farther down, it probably becomes a little bit more challenging at some point then. So I was going to ask about the retail crowd getting into the option game in a big, big,

13:54Michael Batnick:big way. And I don't know if they're primarily using individual stocks or if they're using the indexes or both or whatever. But one of the things about Jeppe, correct me if I'm wrong, that makes you different from a lot of the competitors is that you are not writing option overlays at the index level. You're actually doing it at the stock level. So talk about that dynamic. So actually in Jeppy, we are doing options at the index level, not on individual names. Just kidding. Okay. But the reason we do that is something that's important. And that is you don't want to be having your winners taken away and left with your losers.

14:28Let's go back to November. What happened? I think Google is up about 15 % and NVIDIA was down 15%. If you sold options on both of them, you would have been capped out in your Google and eaten all the downside in NVIDIA. But if you do options at the index level, you get all the alpha of Google as well as all the alpha with NVIDIA, but you don't get capped out on your winners and left with your losers. It's just not a good investment process. So what's next?

14:54Ben Carlson:So you have JEPI, which is high quality, S &P 500-ish, JEPQ.

14:59Michael Batnick:I believe tried and true is what you say on a podcast, Ben.