scarlet: i'm scarlet fu, this is "etf iq," where we focus on access, risks and rewards offered by exchange traded funds. ♪ scarlet: should you stay or go? the s&p 500 is enjoying its best run in six years. that sets up a clash between investors in etf's and mutual funds looking to stay put or flee. exploring the ecosystem. the crucial role of authorized participants and how they grease the wheels of the etf industry. and let's make a deal. one etf wants to cash in on the mma spree. it's looking at financial

services and luxury retail. love them or hate them, etf's are here to stay, and etf nerds get a read on the broader market trends. eric balchunas is very comfortable being known as bloomberg's head etf nerd. eric: every week we talk about flows going into etf's. and we talk about flows into active. if you add them together you get a negative number, 150 to 180 billion has flown out of the whole enchilada this year. that's what this shows, the cumulative flows into u.s. stock funds have been drifting down, and this year it has been $150 billion. that seems counterintuitive given the market is going up. people are wondering, are investors bailing on the stock market? the answer is no, here's why, let's look at the assets. this is the law of large numbers.

$10 trillion are in ets, index funds that mutually invest in stocks. the market is up 25% that's a $2.5 trillion asset gain. that's a good year. here's the outflow. $150 billion is put into scale by looking at this. essentially investors have sold 4% of their gains and kept 96%. let's take a look at the equities of households in america, you can see right now the percentage equities are about the same, it's very high. rebalancing is going on and you have to sell some of your equities to keep this low. if anything, i would not call this bailing. i think investors are staying all making sure their equity in and portion does not get carried away. scarlet: let's bring in dan and rachel. dan, let me start with you. eric makes the case for how investors are not bailing out of the u.s. stock market either through etfs index funds, or

mutual funds. from where you sit, what do you see? dan: i agree. we had a lot of strong momentum growth until a year ago, and a big q4 correction. coming into this year really with the continued easing of fed policy, interest rates, that we have seen, you have seen particular equity income areas like real estate with low volatility. those areas that benefit in lower rate environments in equities have done well. overall, smart beta, moving people out of market cap waited -- weighted momentum into more differentiated but equity strength continues. it's a bull market. scarlet: and rachel, it's the time of year where we want to look ahead. in 2020 there's a slew of active etfs. we should give you credit, you're the one who coined the phrase active nontransparent's. what are the latest developments

on the ant race? rachel: it's been a big week for these products. we saw the fcc the final order -- give the final order to approve will be out there, and these are all modeled on a proxy portfolio approach as opposed to an indicative value approach which was approved earlier this year. the final approval for these models, and we are going to see some filings to use these models. we have seen one hit the wire earlier on wednesday from two rowe.m t. they are looking to do a blue chip growth fund. they have filed with the regulator. scarlet: this leaves about five structures approved and ready to go. eric: and there's a few more in the running, including yours, dan, invesco. can you talk about why you decided to go on your own? dan: we are open to partnerships and we are having current

discussions with a number of firms that rachel mentioned. but we felt long-term, to own your own ip, and not only do we file our own application but we -- did we file our own application but we patented it, which we thought was important. what we have tried to do with their own application is a lot of the feedback market makers and aps, we wanted to build in the integrity of the arbitrage pricing to make sure you got the best of active management and low levels of transparency. at the same time, market makers want to support it. we think that's the difference. scarlet: dan mentioned smart beta. there's passive, active and smart beta which feels like an in between. eric: i wonder how many of these active managers coming over the are still in the 90's, do they understand it's not just vanguard anymore? there are smart beta funds that are active and are cheap. dan: active management has evolved over the past couple of decades. there's performance attribution going from i am buying the

market, and now being able to attribute down into factors and style. i think if you can get your beta in whatever form in an efficient way, having active managers who, through active share, can take more concentrated bets can really show more security and selection ability, those will be the managers who survive and thrive. those will be the candidates for the ant structures. scarlet: that depends on the return, that determines the ultimate winners and losers. rachel, there is a derivative rule that could make trouble for leveraged funds. what is the latest? rachel: this has long been in the works and we saw a version of it last week, a proposal came out which looks at lifting the moratorium on leveraged etf's, and going to new issuers but it comes with a catch.

they want to come out with sales restrictions which would make it harder to buy these products, require the brokerages that want to sell them to do more due diligence on their clients, you have to do more on the accounts before approval. there is some digestion in the industry, trying to figure out if this is good or bad or somewhere in the middle, but it's still a proposal. we will not see the final version of the rule until next year at the earliest. scarlet: and two are the current issuers? eric: this is why we have that rating system. the red light. if you don't have our system, i am curious, you don't have leverage, but what do you think of this rule or the etf rule in general about larger ones? dan: the etf rule itself, we are a huge supporter and we give a lot of feedback directly as well as through the ici and the other entities. we are pleased. and one really strong benefit that may not be as obvious, if you think about the previous

exemptive orders, that was really time-consuming for a lot of the staff. so now we are helping the efficiency of the approval process that more innovative areas like ant and others will have more time for innovation to come to the pipelines. rachel: the other thing we are looking at next year is if the etf rules encourage more debt related products. there is a whole wonky backstory about how custom baskets can be more efficient, and we might see more people issuing debt products which may capitalize on more efficient trading for fixed income. scarlet: we will look for fixed income etf's in 2020. thanks to our guests. coming up, the cohead of ishares market and investment will be joining us. she is at blackrock and takes us inside the ecosystem of the etf industry. one etf that caught our attention this week seems to be

more than its own reward. we are tracking jp morgan's index of bonds from issuers supporting socially responsible investing, delivering a 5% rate of return and a wider base this year. and a reminder that you can find all the charts we feature on the bloomberg at gtv this is etf iq. ♪

scarlet: i'm scarlet fu, this is "etf iq." let's take you through the etf lifecycle, which has three main stages. first is the filing. watch for the lgtbq+ etf, it's investing in 100 u.s. companies that score highest on three main criteria, promoting equality in the workplace, a track record with the lgtbq history or issues, and consistently strong financial performance.

step two is the launch, get ready for some juice. marijuana exposure with step two, the launch. a cannabis etf with ticker mjj and mjo are joining a crowded market. there are at least six weed of funds duking it out in the u.s.. and for some, the final stage is liquidation. the u.s. market neutral sized fund is winding down. they followed a long short strategy. the fund's heyday was back in 2011 where it peaks near $15 million, it's now closing with less than $1 million. it's time to get passive aggressive, where we track the tensions between active and passive investing. no matter if an etf's managed passively or actively it needs someone hooked up to the system. enter the authorize participate. blackrock recently published

about this. samara cohen joins us with blackrock's findings on the ap. what is this role and why is it so crucial to the etf world? samara: the authorized participant is the person who has a contractual relationship to create and redeem etf shares, why do we care? we care because without the authorized participant, etf shares might trade at premiums or discounts to the value of the underlying portfolio. the authorized participant has the ability to adjust the number of shares outstanding so etf's deliver on what investors buy them for. scarlet: so line command doesn't get out of whack. samara: that's right. scarlet: when you look at who serves as authorized participants, they are pretty familiar names, a few big banks. why? samara: because to be an authorized participant you have

to be an expert in security settlements. that's a traditional financial market settlement infrastructure. what is so exciting about the report we wrote, in the u.s., this is the first time we have had a rich data set to see who the authorized participants are, how much they are doing, and in what fund. scarlet: so it is surprising that these big banks have such a central role in this part of etf world? samara: we actually thought it was very validating to see this diversity and robustness in the etf ecosystem and also the consistency. we wrote a report that was consumable, because this is a huge amount of data. in two pages we show the top line data, but if you slice and dice it, you actually see a pretty similar story. on average in the u.s., an etf has about 26 contracted authorized participants and five actively creating and redeeming.

scarlet: compare that across asset classes. so how many aps does the s&p 500 have versus someone like hyg? samara: the numbers for these big financial instrument etf's look pretty similar. what drives differences in the number of aps is often how big the fund is and what the adp is. the number of contracted aps is probably more steady. what's interesting is how the number of active aps change based on how much business there is for them to do. the smaller funds which are not trading much may have fewer active aps, like three, and bigger funds may have seven or eight. scarlet: what's the main difference between an ap and a market maker? samara: that's an important question because people confuse them. sometimes you will have have the same institutions that perform both functions. the aps drive creation and redemption.

market makers make two-sided quotes for clients. they might do that on the exchange or over-the-counter, but that's fundamentally the difference. scarlet: as a result, aps are not always used, because a lot of the trading is natural and is done on the exchange. where you would use market makers. when do you use a market maker versus tapping an ap, where they have to buy and sell the underlying security? samara: that's mostly for the market maker to decide, they might focus on the spread they could make, especially with a high velocity etf on the exchange and not do any creation or redemption at all. to your point, we also see a ratio of secondary trading to primary activity is about 5:1 across the board. most of the time, exchanges happen in the secondary market with market makers not using an ap. a market maker might look at if

-- might look if an etf is getting hot, and they might decide it's a better idea to tap an ap. and then create more shares as opposed to buying them in the secondary market. scarlet: there's a backup plan, in other words. it's clear that the process hinges on intermediaries, whether it's market makers or aps. how confident are we that in a crisis, these intermediaries won't step around? samara: we have seen a lot of etf activity in stressed markets. you guys have talked a lot about it, it shows that not only do etf's hold up, they are the vehicles investors turn to and -- in stressed markets because they provide a quick way to pivot when something happens in the market. what is new about the data set is we can now see the richness of the ap ecosystem. across funds and asset classes, there's a lot of diversity of

ap, and what matters is how confident you can be that the etf will track the underlying portfolio value and that there is someone there to adjust the premiums and discounts? scarlet: that's what it always comes back to. thank you so much. coming up, 2019 has been a year of deals. globally, already the sixth best year in the past 20. next we look at an etf looking to take advantage of the wheeling and dealing. this is bloomberg. ♪

scarlet: i'm scarlet fu, this is "etf iq." for every etf that offers exposure to a sector, others are quick to follow suit. some treat reits as a distinct asset class. that is reflected in the 49 different real estate etf's in the u.s. fundamental income has launched the first to target reits and the cofounder is here with us. but before we talk to him, eric will give us a drill down. eric: this is the definition of a niche product, launched by an indie that's innovative. it's going after reits, which are triple net leads. companies that cover a lot of the cost beside the rent, maintenance, taxes, insurance. this way can keep more of the bottom line, and that's the

general holding strategy. 31 million is good, and it's higher than average for the industry niche product. let's look at the holdings. the top holding is stor. it leases to supermarkets, retail, distribution facilities. you can see some other ones, it's very concentrated. let's take a look at the holdings, this is the big boy in the category. obviously this is much smaller. little more yield here but much more concentrated, and look at the average size of the stock. much smaller. here you will get more zip and pure play towards this category and it is 7% overlap. the strategy is a little left of center. scarlett: with me as our guest -- with me is our guest

from fundamental income. can you explain the distinction between net and gross reits? alexi: the behavioral bias tends to lean toward traditional food groups like malls, multifamily, office, where the landlord is responsible for everything. everything is past in the wrench to the tenant. to the tenant. in net leases it's a single standing free asset which is looking to generate consolidated cash flows that are more sustainable. the tenant pays property taxes and insurance as well as maintains the property. because of that the yield is higher and more sustainable but there's also growth opportunity because you don't have the drag of re-tenenting empty spaces. scarlet: the vacancy rate is lower. alexi: generally. they have been able to maintain tenant rate through the downturn because you have leases that have 11.5 year average turns. -- average terms. so you don't have leases at the bottom of market cycles, these are much more imperative to revenue. eric: my colleague did a report on this, you lock-in for 10 or

11 years. we talk about reits and they are used for yield viewed is this like holding a bond for hydration? alexi: you are not investing in a bond, you are investing in the equity of the company. these are active companies out there growing consistently. last year alone they added $17 billion in assets and they are looking to offset that sensitivity with new leases. as interest rates move, so to cap rates, they are constantly shedding and adding assets. you do get the growth factor, like in equity, that you would not get in a bond. scarlet: you and your cofounder came from a warren buffett owned reit. the biggest holding. how does that shift and transition come about? alexi: my partner was the head of credit for capital markets. they did great things, warren took a look at it and one of his

partners took a look in may 2017, and decided to buy 10% of the company. that shows you the value in this sector. it is cash, sustainable, and it's all around us. grocery stores, etc. scarlet: alexi, thank you. we like to say the etf industry has something for everyone, including those on the year end spree of corporate takeovers. check out this week's animation. it's time to make a deal, one fund is looking to cash in, the iq merger arbitrage etf relies on a standard deal arbitrage playbook used by hedge funds and other investors. buying shares of firms much for -- marked for takeovers and targeting by partially hedging the market using sector etf's and flops. timing is key, it only buys and sells after a deal is officially disclosed, focusing on small, incremental returns coming between an announcement and completion.

assets have climbed to $900 million thanks to global dealmaking, more than $2.7 trillion in transactions have been announced. 2019 is shaping up to be the sixth busiest year in the past two decades. their current holdings are mainly in the u.s. and are focused on pharma and defense. despite the build in assets, the returns trail the broader market the past five years. they have an expense ratio 77 basis points and gets a green light in the traffic light system with a notice for hitting -- hidden fees because of the cost of short positions. the ticker is amazing but this sounds like a hedge fund strategy. eric: it kind of is, but it is built for advisors because they only partially hedge out the market. hedge funds totally hedge out. that leaves a little more beta . scarlet: and you always want the

beta. that does it for etf iq. be sure to check us out each wednesday. this is bloomberg. ♪

♪ lisa: i am lisa abramowicz. welcome to "money undercover," which provides valuable insight into alternative investment. we take you inside private debt, equity and real estate. let's get into burning issues, liquidity opening up in private markets after a start to 2020. getting ahead of u.s. elections, a flood of deals and plenty of cash in the coffers and million dollar hangover.