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Welcome to ETF Central, recorded here at the New York Stock Exchange, the home of ETFs. We're diving deep with the people shaping the space, the technologies driving innovation, and the stories behind the tickers. Whether you're an investor, issuer, or industry insider, welcome home.
Bilal Little:
Welcome to another edition of ETF Central, the podcast. I'm your host, Bilal Little, really excited about today's guest. We have Morgan Stanley Investment Management. They manage over $1.7 trillion in assets, and they're quickly growing in the ETF space. Today, I have Alex Zweber. He is a portfolio manager and strategist on some of their most exciting investment products. We will be talking about innovation, futures, options, and really unique risk-based investment solutions.
I appreciate you coming down. How's your trip been?
Alex Zweber:
Smooth. Can't complain.
Bilal Little:
Smooth. Nice and easy. All right, good. Look, I want to make sure that we understand who you are as a person. I think this is important when we sort of unpack who our investors are and who are the people behind the scenes leading a lot of the investment charges and themes for a lot of investors today. So, just provide a little backdrop as far as who is Alex and then who is Morgan Stanley Investment Management.
Alex Zweber:
Sure. Sure. I think I like to think of myself as a long-term investor. So I think it's fitting that in many ways, I'm still in my first role out of college. So, started 2006 with a small shop in Minneapolis called the Clifton Group, later became part of Parametric around 2012. And my initial role started out as working on a derivatives desk, managing exposures for large institutions, things like cash securitization, futures-based rebalancing, big macro ideas, currency hedging, equity hedging. And a lot of those same ideas have made their ways into strategies we manage today. We saw really strong growth, 2006, I started, into 2008. Obviously, some hiccups along the way. Maybe one example, my first son was born on September 29th, 2008. And if you look at the tables, it's still one of the biggest one-day drops, about a 9% drop, as I was a young, new dad, navigating all that.
Bilal Little:
That's your value trade.
Alex Zweber:
Yeah, there we go. So, been through a bit, still kind of middle stages of my career now. But became part of Parametric 2012, strategies and different things have evolved, but been through a lot of growth. It's been largely a linear career path, but I did take a two-year stint in London, where I stepped away from the day-to-day management of our strategies and sort of was an investment specialist for all things Parametric for clients and prospects across Europe. That was 2018 to 2020. Came back, stepped into my role.
I now sit and lead our liquid alternatives team from the investment strategy side. So, the way to think about that is... Liquid alternatives, what does that mean? It's sort of the assets that sit outside of traditional equity and fixed income. For us, it's primarily our options-based strategies. I lead that team. And oftentimes, it's strategies that may be combine more than one capability at Parametric into a single portfolio, ETFs being the most recent iteration of that. Strategies, we manage our systematic rules-based. So investment strategy is effectively tasked with building out that rule book, designing the strategy, the ongoing evolution. And it sort of takes us to today. And environments evolve. We've seen a lot over the last almost 20 years. But really what we're trying to do is build strategies that are robust across environments and cycles and different risk factors.
Bilal Little:
Okay. So, just so I make sure I'm clear, Parametric sits underneath the Morgan Stanley Investment Management umbrella?
Alex Zweber:
Exactly.
Bilal Little:
Okay.
Alex Zweber:
So, Parametric is, for those that don't know, it's gone through some pretty significant growth. Today, we manage about 600 billion under the Parametric name. About half of that is in custom equity portfolios. So about 300 billion is in our direct indexing platform. About 150 billion is in various derivatives exposures, primarily for large institutions. About 20 billion is managed in options-based strategies. So, a range of equity, fixed income, derivatives-based exposures kind of under that overall AUM level.
Bilal Little:
Beautiful. So, you're basically servicing ultra-high-net-worth clients and institutions. So you got a good pulse on what that group and audience is looking for.
Alex Zweber:
Yeah. It really does span, runs the gamut of investor types from largest institutions, large, high net worth, but even down to the smaller retail investors. And as we evolve today's conversation into the ETF, it's really just opened up a whole nother access to these sorts of strategies for even the smallest investors.
Bilal Little:
I couldn't agree more. So, Alex, I think this is a great opportunity to switch and just get your sense. You talked about being in the market since 2006. The landscape has completely changed. One would say that this is a bit of a unique market in the sense that we have high rates, we have a lot of global tension. Just from your perspective at the macro level, how do you rationalize or make sense of where we are today?
Alex Zweber:
Yeah. I'd say every market's unique, and there's certainly different concerns that come up depending on specific market environment. That said, I think there's a lot of concerns that are sort of evergreen. People are always concerned about risk, and that can take various forms. For a while, tail risk was the hottest topic. A lot of those tail risk strategies maybe didn't deliver in 2022, kind of our last decent-sized drawdown. Markets recover quickly. We're back at all-time highs. People are looking at different things, portable alpha, other type strategies. Things were rather smooth sailing overall. And then we hit a few snags in March and April. We had a pretty good drawdown reversal on the other side.
So, I would say the conversations are always evolving. There's always concern about downside protection. There's concern about adequate income. Varies by investor type. You might have a different conversation with a pension fund or an endowment or a hospital plan versus an individual investor. So, really, it's about, I think from our perspective, it's not trying to build a single strategy that's very narrow in scope, that's looking at a specific type of outcome and managing around that, but rather kind of long-term risk premiums, long-term objectives, things like downside protection, income, growth-type strategies.
Bilal Little:
Yeah. So, then let's kind of lean in there, because I think this is important within the ETF wrapper. We've seen a massive amount of adoption and innovation in the ETF wrapper when it comes to income and risk management. Could you talk a little bit about what you're doing differently in that space or how have you brought that institutional prowess into the ETF wrapper?
Alex Zweber:
Yeah. There's definitely been a lot of growth. I was looking and reviewing some of the stats. Right now, I think on the downside protection, hedged equity, defined outcome-type ETFs, that totals about 75 billion in aggregate. If you take a couple large mutual funds, really large ones in that same space, another 30 billion or so. So over 100 billion in downside protection listed US funds.
On the income side, that's another 100 billion-plus in aggregate. And so, 200 billion-plus. That's not even considering non-US-listed product, which is another sizable chunk. Some stats I saw from, I believe, Morningstar, that total, which is now over 200 billion, was less than 10 billion in 2019.
Bilal Little:
Oh, wow.
Alex Zweber:
So, 10 billion to more than 200 billion. And there's a recent piece by BlackRock, which was projecting, I believe, by 2030, 650 billion in that space. So, it's been growth. It's not been steady or linear. It's been very much exponential growth. So, huge, huge growth in this space.
For us, the ETF wrapper's relatively new. We launched our first Parametric-branded ETFs in 2023. It's really just the wrapper that's new. The capabilities within that has been things we've been refining over the better part of four decades, custom equity exposure, option overlays as a source of value-add, risk management, diversification. And so, for us, it was really a means of... We wanted to be very intentional about the types of ETFs and the areas that we would launch, again, back in 2023. And specifically, we want to be at the intersection of investor demand on the one side and what are our capabilities on the other and sort of meet at that intersection.
So, two very big areas that we just mentioned, across all these options-related ETFs, there's protection, and there's income, and there's growth. And we really wanted to be intentional about having a product in each of those. And I've sometimes described it as we looked at the landscape of what's out there. You could see some flaws and drawbacks, either from a institutional perspective or sitting in the seat of a high-net-worth investor or even just sitting in my personal seat. There's a lot of stuff out there that I would never buy. What are the flaws? What are the trade-offs they're making? And how can we improve on what's already out there? And that's really what we did.
I read this characterization of Steve Jobs where he wasn't necessarily the great inventor, which he's sometimes characterized as, but it was more about innovator, tinkerer, improving. And so, we wanted to kind of take that approach. The iPod wasn't the first music device, the iPhone, the AirPods, but they all improved on what was already there. So, we didn't invent any of these categories, but we looked at what was out there and tried to make tangible improvements that would lead to better outcomes for the investors in each category.
Bilal Little:
That's really good. So, let's maybe work through each of those categories, if you don't mind. So, let's just talk about growth for a moment, right? Equity markets in the US seem to be somewhat overvalued, one would argue, in certain pockets, various sectors. International seems to be somewhat undervalued in certain areas, although, obviously, it's had a nice run. If an investor was to come with you with capital allocation and said, "Hey, I need a core anchor strategy. Let's just look at your growth strategy for a moment," where does that fit? Is it large-cap growth? Is it conservative equity growth? Where does it fit in the growth bucket for investors?
Alex Zweber:
Yeah. So, there's different parts of the Parametric business where we can tackle that from different ways. If we limit it to ETFs, right now, we have three ETFs, and it's a US kind of large cap, an income and a protection strategy. On sort of our implementation custom equity, we can sort of implement any sort of exposure that the client wants. They're overweight this, underweight that, close that imbalance. We can rebalance via derivatives. We can run completion portfolios in the equity side to offset some of that maybe concentration risk. When it comes to our growth strategy, and this is maybe one that's... It's newer, it's smaller, but it's maybe the ETF strategy I'm most excited about, is one that fits squarely in the large-cap bucket. So, benchmark to the S&P. And one of the themes I've heard over the years from largely institutional clients is this quest for reliable alpha, right? It's tough to find-
Bilal Little:
Absolutely.
Alex Zweber:
... it's elusive. And frankly, many just don't believe in the ability to add value through stock picking in large-cap growth space. So, this one takes a different approach in that instead of relying on stock picking for alpha, it aims to isolate this options-based, little lingo to introduce, the volatility risk premium. And so, it starts with $100 in equity exposure. We sell call options against that, which introduces this options exposure but also lowers the beta, truncates that upside. And so, it uses derivatives to add back, kind of fill that beta glass back up to 1.0. And so, it's basically long equity plus a relative value trade. Sell what we deem to be expensive, which are short-dated call options, buy what's cheap, which is incremental beta, and that's really the source of value-add there, for kind of a one example of an implementation.
Bilal Little:
No, that's perfect. I'm glad you said it that way because that last button, I think, puts a bow on it for a retail investor to be able to understand. And at the same time, even some advisors may not fully understand how some of these strategies work. So, that was fantastic.
Let's switch now and look at income. Because we have the silver wave of retirees coming in, and everyone's looking for income. And I saw an interesting article on credit and high yield, not too long ago, about the massive amount of flow that's still going there, obviously, investors seeking income. How are you guys applying the income strategy in your ETF, given the fact of what you already manage today?
Alex Zweber:
Yeah. So, if we take a step back, what was the appeal of these income funds, it sort of started five or seven years ago, kind of on a decade in of near-zero rates and fixed income and people were starved for yield and looking for better ways to improve that. So, that was kind of the impetus to get some of these funds launched.
And things have shifted now. We got traditional fixed-income yields that are much higher, 4 or 5 or even higher on a percentage basis. But there still is some appeal for these in that, one, these kind of options-based derivative income, alternative income-type strategies can have higher absolute yield. So it might be 7 or 8 or 10% instead of that 4 or 5 or 6%. It can typically be more consistent, and consistent in that it's also not tied to the level or direction of interest rates.
And thirdly, I think there's an appeal where it's because it's coupled with an equity investment, it can have more upside than a traditional fixed income. So you combine the two. When we looked at this space... And I would say this might be the most interesting thing we're doing in the ETF space, is our income-focused strategy. It's a Parametric Equity Premium Income. The ticker is PAPI, P-A-P-I. But really, as we looked at the landscape of income-focused ETFs, it was really clear that there was kind of three goals that were in place simultaneously. And that was to deliver income that is high, that is stable, and thirdly, that is tax-efficient. And we sort of, again, looked at the landscape, see what trade-offs, because you can't optimize all three at the same time. You got to balance it.
You can have a really, really high distribution rate, but 12 or 15 or 18%, it's not a level that's sustainable. The NAV is declining. Returns of the underlying investments aren't supporting that level of distribution. Others might be very unstable, high some months or quarters and then dips, and investors would prefer stability. But it's really that third stool, that tax efficiency, that I think took a backseat for many, many competing funds. And one of the biggest things Parametric is known for is managing tax-efficient portfolios. So that was right in our swing plane, something we wanted to do. And that's where we have the biggest advantage. We think PAPI represents the best balance of those goals around high, stable, and, most importantly, the tax-efficient income.
Bilal Little:
Okay. So, I want to stay with this for a second.
Alex Zweber:
Yeah.
Bilal Little:
Let's talk risk, the other side of this. Most investors, they're still learning what derivatives are. Could you unpack that a little bit for them, for the audience, just how they should think about how money managers would leverage and build an income in a conservative risk-managed way?
Alex Zweber:
Yeah. I mean, anytime you're talking about derivatives, if you're new to the game or you're looking at these the first time, you get the old quotes of the weapons of mass destruction. Typically, that's done or that's the result when it's used incorrectly and it's high degrees of leverage. You have $100 in capital and you sell $1,000 worth of put options, 10x leverage. It's a recipe for disaster. And you've seen examples of that over the years.
Risk management is a huge focus of how we're implementing these strategies, and it starts with the design phase. So, it's not just risk management in that, "Oh, we got systems monitoring and we're going to adjust in real time," but really about, number one, designing the strategies in a way that doesn't employ leverage. So, sort of a constraint right off the bat. The income focus, we're holding equity exposure and then we're selling call options against that equity exposure. If we have $100 worth of equity exposure, we sell $100 or less worth of call options. So, you're sort of a covered call-type profile. You can have losses on any trade, but they're not the catastrophic forced unwind margin calls sort of thing. Losses are controlled. They're managed in a way and the pieces fit together. So, right at the construction level, avoiding leverage is a big piece.
The other big piece that I'll say, and this is an advantage that we see in our strategies compared to others, too, is weaving in risk management and diversification within the options portfolio. So, obviously, you want to build out equity portfolios that have balance of risks and it's diversified, and the free lunch in investing is diversification. But also, within our options portfolio, we want to do things like laddering of positions. So, that example, $100 in equity, $100 notional worth of call options, we don't want to hold a single call option. We want to ladder that and hold multiple observations that expire over the course of the month and the quarter and avoids things like when you go through a whipsaw, like we saw in April, market drops close to 20%, recovers back, now we're at all-time highs. You avoid some of that pin risk associated with options when you're more diversified.
Bilal Little:
It seems like you've kind of figured out how to spend time hedging out some of the time component of the risk, right?
Alex Zweber:
Exactly.
Bilal Little:
So, now let's go to hedged equity. Because I think that's the other part of the conversation.
Alex Zweber:
Yeah.
Bilal Little:
Okay. Let me say it this way. Given growth, given income, where does hedged equity fit for a client if they said, "Look, I need a suite of products"?
Alex Zweber:
So, there's a few different ways to think about or how we see these being used-
Bilal Little:
Yeah. And I know it's always risk management or demand or needs. With context.
Alex Zweber:
Yeah. So, on the institutional side, our hedged equity solution is the same sort of structure that we would use for a large, say, a pension fund that was concerned about risk. We would see these episodically where a large pension fund wants to protect its funded status. If markets drop significantly, leads to bad outcomes, they want to have some protection. Maybe they've had a really strong equity year. And we're halfway through the year, markets are up 20%. They want to protect some of that because it's an above-average result. So they can layer in a hedge to protect some of that if things don't go as well in the second half of the year. There could be a large hospital that has debt covenants and they need to have a certain floor on the portfolio. You can structure a hedge to manage that accordingly.
Bilal Little:
Great point.
Alex Zweber:
When it comes to individuals, retail investor, end users, I think it's just a constant concern about downside risk and what's a smarter way to maybe structure that. So, just like income, I think concerns about risk are evergreen in nature. We see it right after a crash, markets are at their lows and people are concerned and want to put on a hedge. We also see it on the other end when markets are back at all-time highs. Maybe it's time to take some chips off the table.
So, I would say the two main use cases for this hedged equity ETF are, number one, we're about where we are today, equities have had an amazing run, we're back at an all-time high. And maybe it's a way to take some chips off the table. I still want to stay invested in equities, but now I want to reduce that volatility, reduce that potential drawdown compared to just holding long equities. The other case is maybe an investor that's maybe made a behavioral decision and de-risked at the wrong time and got out of equities on April 7th or April 8th and sitting on a chunk of cash and maybe they want to get back into the equity market. So, it's maybe a de-risked way to dip your toes back into the equity markets if you've been sitting in cash on the sideline.
Bilal Little:
Fantastic point. With that being said, given the market, the backdrop today, where would you start, if I looked at that suite of products of I'm an investor?
Alex Zweber:
Yeah. It's a little bit different for each investor, but I think a balanced approach. Like we wanted to hit some of the main buckets that investors are after. So I think that enhanced equity, the relative value trade, sell calls, buy incremental long equity. I think that's a great core holding in sorting your equity bucket. But it's also good to have a risk offset and then different objective. But income, particularly tax-efficient income. I didn't walk through all the numbers and how we get there. On our PAPI, our Equity Premium Income-
Bilal Little:
Such a good name.
Alex Zweber:
Yeah. We get a lot of smiles from Boston Red Sox fans, Big Papi, David Ortiz.
Bilal Little:
Yeah. Yeah, of course, of course.
Alex Zweber:
Really, what we're trying to do there, again, we saw competitors that were de-emphasizing the tax piece. And in our view, was sort of the easiest layup you can take. It's the form of alpha that's not reliant on stock picking or market timing. It's consistent. It's reliable. It's measurable. And if you structure your portfolio thoughtfully, you can capture that pretty consistently.
And there's really three components to our tax-management technique within PAPI. Number one is to defer taxes. If you have the choice of paying a tax now or paying it sometime in the future, push it in the future.
Bilal Little:
Absolutely.
Alex Zweber:
Number two, when you are forced to pay the tax, you want to pay it at a preferred rate. So, ideally, long-term capital gains instead of short-term. You want to have qualified dividends. You want to get the preferred treatment.
And thirdly, and this is the other piece that Parametric brings to the table within the ETF wrapper, is we're going to look to do things like tax-loss harvesting within the ETF. What does that mean? Well, essentially, what we're doing is proactively realizing losses within our equity portfolio. And you can then use those, bank those losses to offset gains elsewhere in the portfolio. So, to give you an example, sell the call options in the portfolio. Let's say it generates a 2% gain in that year. If you're able to harvest and realize a 2% loss within your equity portfolio, those will balance off. And what would otherwise be a short-term capital gain on your call option gains is now neutralized and becomes kind of a tax neutral on that distribution piece. So, defer, minimize, offset gains with losses to have a better after-tax outcome. And compared to competing funds that aren't really focused on taxes, we think we can do 100 basis points or more in improvement per year on that return stream.
Bilal Little:
Yeah. And that's across the entire suite of products?
Alex Zweber:
So, the tax management is part of each. It's the primary focus, I would say, in PAPI.
Bilal Little:
Okay. Fantastic. If you had to leave guests to say who is Parametric, how would you sum it up in a simple way?
Alex Zweber:
Yeah. I would say what Parametric is really about is delivering customized investment solutions around improving efficiency, enhancing returns, and reducing risk in the portfolio. So, the types of exposure that you want, we can help you get there, and we can have it with an eye towards tax efficiency, controlling costs. And that's across, as I said, equity, fixed incomes, derivative exposure, kind of our one-stop exposure-management shop. And then we can leverage all those capabilities for sort of products, ETFs, things like that, that end users can use in their portfolios.
Bilal Little:
Perfect. And this is a part of the show where I ask our guests, what's the ETF underdog, is what I call it. The ETF underdog, I know you alluded to it earlier, but I want you to hit it really good for me here because this is the ETF that may not receive as much publicity as the income and the hedge strategy. And I think you mentioned this was the growth ETF. Just nail that one for me, because I think this is important.
Alex Zweber:
Yeah. I think underdog is a good word for it. And I'm, frankly, really excited about it. It's Parametric Equity Plus. The ticker is PEPS, P-E-P-S. And it fits squarely in the large-cap bucket. I think we can really... For investors that have maybe given up on looking for alpha in the large-cap space, it's a new angle towards that. We don't necessarily call it alpha. I think it's a unique risk premium that we found a way to isolate. But long equity exposure, the option overlay is kind of a simultaneous selling options, but offsetting that directional piece, that relative value trade, we're aiming for 1 to 2% long-term above the index. And yeah, I think underdog is good, but I do think this will be an underdog that will get there and we'll see it shine.
Bilal Little:
I love it. Alex, thank you so much for joining ETF Central.
Alex Zweber:
Yeah. Appreciate it. This is great.
Audio:
That's a wrap for today's conversation. But the ETF discussion doesn't stop here. For more insights, deep dives, and voices shaping the market, stay connected on ETFCentral.com. From the New York Stock Exchange, we'll see you next time.
Information contained in this podcast was obtained in part from publicly available sources, and not independently verified. Neither ICE nor its affiliates make any representations or warranties, express or implied, as to the accuracy or completeness of the information and do not sponsor, approve, or endorse any of the content herein, all of which is presented solely for informational and educational purposes. Nothing herein constitutes an offer to sell, a solicitation of an offer to buy any security, or a recommendation of any security or trading practice. Some portions of the preceding conversation may have been edited for the purpose of length or clarity.
