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Welcome to ETF Edge, your go-to place for all things exchange traded funds. I'm your host, Dominic Chu. Is the landscape of higher education investing changing? College and university endowment returns have typically been driven by traditional stock market exposure. Back in September, State Street launched a historic endowment strategy index ETF.
And that's just one example of how the space is evolving. Joining us now is State Street Investment Management's Chief Business Officer Anna Palia and Cap Trust Chief Investment Officer Mike Vogelzang. Thank you very much for being here with us both for this conversation. I'd like to maybe start uh with you Anna on this because the news earlier this September about the launch of the UCBG, that's what people are calling it, the UC Endowment ETF is one that launched with a lot of fanfare because it came with a massive anchor investment from the University of California endowment system specifically to the tune of $2.5 billion making it now the biggest launch of a US listed ETF in history here.
what exactly was the driving force behind it and how did those conversations get going? That's a really good question Dom and I would say that this is really an example of a very successful collaboration between different parts of the ecosystem. UCBG which is UC blue and gold strategy is an endowment inspires the strategy.
It is the strategy that uh has been uh really managed by uh state street investment management together with the UCI, University of California uh investments for a very long time and uh as it always as it always turns out collaboration and innovation go hand in hand. uh we sat down together with uh UCI and we really try try to figure out if there is something that is successful it's working is attractive how do we democratize that and obviously you're speaking with state street investment management so our concept of democratization is really making things happen through ETFs and it took uh it took different partners here to make it happen.
We had on the one end we had the say street investment management which really knows how to do ETFs. So the infrastructure, the ecosystem, the liquidity, we had UCI and uh their investment management team, Jag Dip and TM really focused on how do we rebuild a similar strategy with a different legal wrapper and S&P which is one of our index partners who became really helpful in putting a strategy which is an active strategy into an index format.
at so that it's predictable, it's repeatable, it's scalable, and ultimately we combined all of these three different factors to put together a product that democratizes that endowment. Again, this is uh this is not about reinventing something or building something new, but it's opening access to a strategy that is actually working outside of the endowment, outside of what would be the traditional way of getting exposure to it.
Sure. So this is interesting Mike because if you take a look at the way endowments are structured these are big bigsiz vehicles and they have all different types of investments and different types of silos and sleeves and kind of uh portfolio moves that are being made. The stock and bond aspect of it is one that's more traditional in nature alongside hedge fund strategies, managed futures kind of you know uh private equity or private capital type investments.
But I wonder from your side of things, if you are a chief investment officer looking to advise endowments, college or otherwise, how exactly then do you view the traditional stock and bond investments versus some of the traditional ones that we've thought about in the past like hedge funds or private equity or private credit?
Um, yeah. Well, first of all, you start with expense and expected return and uh you know, hedge funds particularly when interest rates were really low uh didn't provide much at all. So we we have a pretty light book on hedge funds actually for our clients. Um you know this is an interesting strategy because it takes uh very direct and simple uh exposure the S&P 500 and 90% and 10% to uh a 1 to threeyear core uh investment grade bond portfolio.
Um and and allows sort of sort of the easy button if you want to hit that. Um, the one difference I I would I would have or make is that, you know, endowments aren't uniform. Uh, we have all of the big guys, the Ford Foundation, all the Ivy League endowments and and others that are large, huge organizations, Lily, Ford, etc.
Um, there are many, many, many, many more smaller endowments that are 20 to 50 to 100, $150 million that, you know, need to be invested as well. And that's where we specialize. We spend a lot of time on that sort of sub $250 million endowment where we provide advice and we use lots of the same components uh in UCBG um but individually right so we we build the we build the components directly for our clients
okay so that's one of the things you can either do when you have that kind of scale though right if you have you know 10 50 100 250 maybe up to a billion dollars you have the ability and the size and scale to be able to transact more efficiently, cost- effectively. The ETF rapper is something that has developed and evolved a lot over time, Anna, to be one that is driven not just by the kind of transactional efficiency that it gives certain types of investors, but also the cost aspect of it.
So, we're talking about lowerc cost transactions, which by the way ultimately lead to compounded over time superior returns. It's the reason why index funds were so good. I guess my question to you, Anna, is if you look at the way that these particular products are structured and you look at the traditional things that we've talked about like hedge funds or private equity type investments, what exactly does this do the ETF wrapper for this kind of core part of a college endowment portfolio?
What does it mean to have it in an ETF wrapper and to have a UC system like them buy into it specifically for that exposure? Well, it combines this one. This one combines a number of element of the ETF ecosystem that Dom you mentioned already. Uh low cost the fund charges six basis points and uh within within the portfolio there is a disciplined approach to the 9010.
We really needed to make sure that there was a lot of rigor not only in the selection of the assets because this is not an exact replication of the two indices. This is not the 500 securities in the S&P 500 plus another 10% of the fixed income allocation. There is a rigor in the stock selection even if even if it is a role based.
So on the one hand you have cost effectiveness of the EDF wrapper which means a small endowment does not have to recreate the will does not have to make a single equity or fixed income investments. with one trade it can get this 9010 allocation that hopefully is going to meet its investment needs. Uh then the portfolio itself is really effective.
Now tax efficiency may or may not be a priority for this type of investors. However, reducing trans transaction costs is and the ability of the portfolio to structure creations and redemptions in cash or in kind based on the best the best potential outcome of the transaction. It is definitely an element that is really attractive for ETFs.
It decreases transaction cost. It keeps spreads tight and in the end the com the combination of low fees and low cost makes it a very compelling investment vehicle investment tools investment tool for maybe the smallest endowments that do not have the ability of the luxury to bear those expenses by making a single stock or fixed income allocations.
All right. So Mike, I mean Anna brings up a very interesting point. this type of product at launch here. We talk a lot about the the headliner which is the University of California Endowment System, UC Investments. But there is also now this ability for retail investors like me or or my my parents or my my family or even smaller endowments and institutions who are looking for that kind of sleeved exposure to go into something like a UCBG.
I'm using it as an example only because it's really the only one out there right now. But in your experience in advising some of these types of endowment and foundational type clients, what exactly is the kind of investment philosophy and how has it evolved? Right. I mean are they going to use this type of product I guess is my question.
Yeah, that's the question. Um you know again do you do you different disagregate it and and and use it use the pieces or do you build it? Um, most endowments have a core chunk of the US large cap equity market. It can be the S&P 500, although we think that's a little growthy. It's dominated by the MAG 7.
There's some there's some sort of factor systemic risks there. We would broaden that out to maybe even the Russell 3000 followed by uh some some decent u highquality index uh investment grade bonds. Um, this this is a little shorter uh for most endowments, right? Endowments have a long-term uh effectively perpetual life.
And so I I don't think we'd be limited by the one and threeyear uh frame time frame. It's really about a longer term time frame for that. Okay. Now, Mike, if I could just follow up then, what in what way do you think an endowment or foundation could use something like this? And if it is something that could catch hold, do we expect to see other types of endowments or or large kind of college education type systems go and look towards this kind of investing on their own?
So instead of a UCBG, could we see a Harvard ETF, you know, in terms of its endowment strategy, or could we see a Yale or a Stanford? And the list goes on and on. Yeah, I think the problem with that, it's interesting. Um and and what we've seen in some examples are um mostly mostly that idea but on the private allocations.
Uh so um I know there's there's an Ivy League uh fund that that sort of cherrypicks uh for um individual and and and institutional client bases and it uses some of the private allocations that are going on from from the Ivy League schools. You can actually pick your school, right, and say, "Hey, I want to buy some alternatives that they're buying." Um the problem with with uh traditional or liquid public assets is it's not that complicated and almost everybody has these pieces.
This is a nice core piece uh with with some modifications in in our opinion. But again, most people don't have have an adviser. They're looking to do it with their local committee or something like that. Um this would be an interesting way to build a core piece around it. Um, I don't think we're going to see the Yale Endowment uh issuing an an ETF for their traditional pieces.
Uh, it'll be interesting to see how how State Street does with this fund. Um, I don't think there's been a ton of flow yet. Is it has there Anna? Um, around around this generally? Well, that that's a good question. We have not seen a lot of flow yet which is not really unusual for strategies of this kind because uh in normal market conditions you have to wait for the ETF to get a little bit of a track record before you can actually see flows coming from the street coming in.
Uh but in this particular case, some of the first barriers to entry, the first barriers to scale have been overcome because uh the big investment by UCI which is two and a half billion dollars making it the largest seeding for an ETF coming to market has already helped to overcome some of the obstacles that you would see with new products coming to market.
small scale, higher expenses or wider spreads. So this this fund if you like has already overcome some of these uh early entrance barriers. So I'm confident about the fact that the track record is good, the performance is good because this is not a new strategy. This is something that UCI has already been running with a really good track record.
So the more we can get historical and performance track record into the ETF, the more attractive this is going to be into the marketplace with clients outside of UCI and outside of other other endowments. Again, if we go back to basic, if we come back to the principle, this was an attempt to democratize a strategy that has proven to be successful over time.
Okay, Mike. So, so I I I just want to follow up there because the interesting points are there with regard to just the track record, the trading aspect and whether people want to get in and out of this particular fund. And yes, we do see more mature funds get it. I I think my my focus and my question to you is if if we have these types of products, Mike, that are that are exchangeraded that are there mimicking liquid type strategies, short-term bonds and kind of liquid S&P 500 type stocks, and we could do it for a lower cost.
That's one thing. Do you feel as though there is more of a tilt in your client base, the the the customers that you have around endowments and and foundations? Do you feel as though they're tilting a little bit more towards liquid type exchange traded products or are they still kind of moving towards hedge fund, private equity, private credit and and other real estate type investments as kind of more around their portfolios than say the liquid stuff?
Yeah, that's that's a that's an exact um that the answer to that question is a is a is is a function of how large they are, right? It's really hard for a for a $50 million endowment to dig in fully into the private markets and have have what we call the full monty, right? Where you're doing vintage diversification across private credit, private real estate, private uh equity, uh infrastructure, um and then a hedge fund portfolio as well.
It's just impossible for smaller endowments. really need to get above a significant size to be able to have that that full implementation. So, what we're seeing is in some of the smaller ones, particularly there's the use of of what we call semi-liquid vehicles. Um, that is they promise some liquidity.
Uh, they're easier to get in. They're already existing books of of alternative investments being invested on behalf of clients. So, you're getting in and and you're you're effectively buying into an existing pool of private assets. And that gives um the smaller endowments a little bit easier way to get in, although they have their own drawbacks.
Okay. Anna, the way that these are moving, you you specialize and states does in liquid type products, exchangeraded products. When you look at the way that your products are developing here, it's not maybe difficult to imagine a world where we do see more and more private or semi-liquid investments come to an ETF rapper.
We've already seen it in in many ways. Business development companies are like that. Certain private uh credit type uh ETFs and mutual funds are like that. You know, those backed by CLLOs's, collateralized loan obligations and floating rate securities. How is the ETF market going to kind of take what endowments are doing and evolve that next level of product?
or do we think that everybody's okay on their own developing their own expertise and then the investment advisor is the one left kind of doing the heavy lifting on how to allocate those particular assets. Well, Dom, our job as an ETF sponsor and ETF manager is really to make sure that our clients understand that we can do most of the work for them that we can do most of that lift for them.
I will give you an example. Almost two years ago, we launched our first of its kind public and private credit ETF in partnership with Apollo. Uh that fund right now invests about 20% of the assets in a private credit. Now, it's all investment grade. It complies with all the liquidity provisions of the 40 act but it does it in a way that is very thoughtful meaning we do believe that public market and private markets are converging are converging right now and for anyone who believes that this is a 10 years ahead that private markets are going to remain private for a very long time uh we kind of disagree with that uh I think we are in in the middle of that transition.
We are in the middle of that convergence right now. The only thing that is stopping the convergence is one lack of price discovery, price transparency and two uh lack of liquidity in certain cases. But when you bring an ETF into the mix, when you bring companies like Apollo into the mix, uh you are creating a market, you are building liquidity.
When we brought this product to market, the one thing that changed in the ecosystem is a transparency, we um we disclose the price of each one of these assets every day on our website. So, anyone who is working with Apollo or working with others to get access to the same security, to the same asset class, to the same piece of private credit now knows exactly how we are pricing it.
either because we have acquired the asset today from Apollo or because we acquired it in the past and we are pricing it every day. So the combination of these factors is bringing more transparency to the market. With more transparency, liquidity comes. We have seen creations and redemptions coming into these funds with no issues whatsoever when it came to liquidity to either purchasing new assets or relinquishing and selling assets that were already in the
Could I just follow up Anna with that point? Sure. Does that then mean that even if I look at an ETF of those sizes for your private public kind of, you know, fund or for your UCBG fund, even if I don't see a ton of trading volume, does it mean I can feel safe as an investor to buy into it or withdraw out of it without causing gaps in the marketplace?
Has the ETF uh infrastructure evolved enough to where people can feel as though they can go into these products that are supposedly liquid even if they don't have a lot of trading volume and feel like they're not going to gap it based upon the fact that there's not a lot of trading volume in these particular products?
Well, you know, you use the word that you hear very rarely in this industry, which is safe. I don't think that I don't think that we can say that anything is absolutely safe or give a guarantee. I think that if you do this with rigor and with diligence, you mitigate the most of these risks. So for example, when we launched, we didn't launch, we didn't just launch this product.
We worked for I would say over two years before we felt comfortable enough to bring this product to market. And up to now uh we have experienced the creations and redemptions and uh uh we did not experience any glitches in the portfolio. Now can it be a guarantee that this is not going to happen in the future?
No. But right now the product is behaving as expected. We are actually really pleased with regard to the liquidity of the portfolio, the quality of the assets that we have included in the portfolio. a couple of months ago, the big headlines about private credits. Um, you know, it's one of those times where you look back at the strategy and uh you pat yourself in the back saying we did the right thing.
It was not an accident. It was not a coincidence that we decided to really stick with the investment grade segment of the market because we thought when it comes to private credit, quality matters. And as a matter of fact, the issues that we experienced in the private credit market were not associated with the investment grade segment of the market.
So if you do it in a way that is very rigorous, uh the product should continue to work as expected. We wanted to reinvent fixed income investing. We did not say oh we are going to bring a private credit into the market and then let's cross our fingers that liquidity is going to be there. We had we had a belief and the belief was we want to bring high yields so the higher yields associated with private credit into the fixed income allocation of a client portfolio.
And we want to make sure that investors can benefit from these higher yields. And if you look at the performance of prime for example right now at any given point is delivering about 100 basis points of returns in addition to uh the benchmark. So is outperforming the benchmark by roughly 90 or 100 basis points which to us is a delivery of the promise we made about reinventing the plus element into core plus.
Okay, Mike, I'm going to give you the last word here. Anna had mentioned the kind of convergence of public and private investing. From your standpoint, are you seeing trends develop right now that are tilting investors towards your client base more towards one or the other? Or have ETFs maybe kind of democratized the market enough where anybody can feel as though if they want to take a view on some private or public investment vehicle, they can find an ETF that matches it.
Yeah, I I think ETFs are an interesting way to to sort of continue to stress test how this works. Um, and and I think State Street's done a nice job with that. The issue still remains and it hasn't been solved for yet that you're putting illquid assets. Now, if you go to the investment grade credit and p the investment grade credits inside a private credit uh strategy, you're getting pretty close to liquidity.
But if you if you take a fundamentally illquid asset like private credit, venture capital, private infrastructure, etc., and you put them inside of a liquid vehicle, there will be, as we've learned now from private credit, private real estate over the last three or four years, there will be tension between the pricing inside and and being able to sell at what's considered NAV.
I'm just not sure that that's ever solvable. We've been telling our clients to to to put illquid assets inside of illquid securities. Right? If you if you're buying something that you expect to be three to five years, uh put it in a three to five year wrapper. Um and so again, we're not we're not manufacturing these products.
We're advising our clients on how to make it happen. Um there's a lot of interest uh in the institutional business. I think what we've seen is that uh over the last five, seven, eight years, ETFs came into the industry uh as really a retail product and uh the larger and more sophisticated institutions viewed them that way.
That is they didn't really want to use them. Uh but we've seen a broad acceptance over the last 5 years or so with with ETFs generally particularly in traditional securities um in the in the endowment foundation space in the what we call other institutional asset space to find benefit and other things like that.
So you know ETFs have come a long way. They're a terrific vehicle. We use them a lot. We're one of the largest owners of ETFs in our client bases. Um, and so, you know, we we spend a lot of diligence trying to understand how ETFs work, what works for specific clients and what doesn't. Um, I still don't think I disagree with Anna just a bit here that uh, you know, the the the illiquidity features inside an ill a liquid vehicle um, are are just going to end up being problematic at some point down the road.
All right, Anna, I'm going to give you one final word to respond to that if you want to on that and then we'll we'll call it a day. Yeah, I I don't think we are in disagreement. I think that I agree with that and this is why you have not seen from us or from others uh 100% a private credit ETF and I don't think you are going to see uh an ETF today that invests 100% of its assets in infrastructure or real estate or in ventures because there is a liquidity mismatch but I do think these markets are converging and as soon as one piece of those asset classes will show that level of liquidity that makes us comfortable about striking striking a daily nav.
We are going to put it into an ETF and make it uh make it really easy for our investors to do oneclick buy and get exposure to that. All right. Okay. The easy button works. The easy button does work. Uh I want to this is a huge conversation. We we'll continue at some other point here when we have more time.
But my thanks to Anna Palia over at State Street Investment Management. Also, Mike Vogles at Caprust. We appreciate it. I've asked Anna to stick around for the ETF Edge podcast. You can catch all of our other content over at ETFedge.cnbc.com. Thanks for watching and we'll see you next week. Get the ABCs of ETFs with the ETF Edge newsletter, your weekly update on the hottest trends, expert analysis, actionable ideas, and exclusive insight from top industry experts. Sign up now at cmnc.com/etfedge newsletter.
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