How Explosive ETF, SMA Growth is Changing the Buy-Side

The tremendous growth of separately managed accounts and exchange traded funds in the municipal market has been spurred on by lower fees, the desire for deeper customization along with improvements in technology.  What impacts does it have on mutual funds? How do deal teams look at deal structures amid these shifts? What does this mean for issuers, underwriters and investors alike? What do these shifts mean for the buy-side broadly?

Transcription:

Lynne Funk (00:15):

Hi everyone, and welcome to our last panel today for the Bond Buyer's Buy-Side Virtual Summit. It's been a great few sessions so far. I'm delighted to welcome the next panel on how explosive ETF and SMA growth is changing the buy-side. Before we get started, though, just a few quick housekeeping notes for those seeking CPE credit: you must remain for the full duration of each session and respond to all questions. You also need to complete the CPE plus evaluation form by Tuesday, August 5th. If you have any questions on that, you can contact us. But on that note, let's get started. I'm delighted to welcome our panelists for our final panel: Sean Carney, Chief Investment Officer of Municipal Bond Funds and Head of Muni Strategy at BlackRock; Mark Paris, Chief Investment Officer, Head of Muni Strategies, Invesco; Sylvia Yeh, Partner, Co-Head of Muni Fixed Income at Goldman Sachs Asset Management. Our moderator today for this session is Morgan Fahy, Vice President, Capital Markets at BAM Mutual. Morgan, I will let you take it away. Thank you so much everyone.

Morgan Fahy (01:25):

Thanks, Lynn. Good afternoon everyone, and thank you for having us. We're very excited to be here today. The overall size of the municipal market continues to increase, with the total par outstanding surpassing $4.2 trillion in the first quarter of this year. This panel will discuss how that increasing supply can be met with demand from the most dynamic, growing sectors of the market, focusing on ETFs and SMAs. ETF assets have increased 71% since 2021, and SMAs now account for almost half of all retail investments in the municipal market. Now, let's turn it over to Sylvia, Mark, and Sean to dive a little deeper. Thank you each so much for joining us today. Sean, I'm going to start with you. Would you explain the benefits to investors of ETFs versus traditional open-end mutual funds?

Sean Carney (02:34):

I'm happy to, Morgan. Thanks for the introduction. I think benefits to investors of ETFs over the traditional mutual funds, first and foremost, the most obvious probably being fees. I'm hoping that in a higher interest rate environment for a long period of time, perhaps fees won't be such a key decision-maker. But coming out of zero interest rate policy and very low rates for a long period of time, fees are obviously a big one. Transparency is very important. If you want to raise assets, getting involved with model asset allocators, they want to see holdings not on a monthly or quarterly basis, but like to see them daily. So more of the ETF wrapper will allow for better transparency. I'd say tax efficiency as well. Mutual funds can often pay capital gains; ETFs less so. We are seeing improved liquidity during market stress. I'm sure we'll get into the difference between passive and active in this space, but we are seeing improved liquidity during some periods of market stress.

(03:41):

And you can own the market beta in a moment's notice. Institutions like this avenue, but I think what's most important is ETFs and mutual funds are not an "or," they are an "and." They often complement each other very well. It's all about the experience you're looking for out of your allocation, and that's often dynamic. For instance, we often own ETFs inside of our mutual funds. If you have a mutual fund that you'd like to get some high-yield exposure to, and you don't want to do it on the QIP level and you want to do it more systematically, you can buy a portion of an ETF. Or if you're long duration, and you don't want to have something like a basis risk by hedging, you can buy something like SUV or MUB and bring your duration in. So, being able to put ETFs inside of mutual funds. Again, it's not really an "or," it's an "and." I think they complement each other well.

Morgan Fahy (04:33):

Great, thank you. I think you mentioned it quickly as well, but historically, the majority of ETF assets have been in index funds, but there has been a growing number of actively managed ETFs in the market. What do you think is driving this growth?

Sean Carney (04:47):

I think a couple of things are driving the growth. One being the conversion of traditional mutual funds into active ETFs, such as what we did with our high-yield mutual fund earlier this year, having converted into an active ETF. So, this is a quicker way to market, so I think this is driving the trend a little quicker. But growth in active ETFs is ultimately about bringing together the efficiency of the ETF wrapper with best-in-class insights from leading portfolio management teams. If you think about current geopolitical and macro uncertainty that's driving volatility, it's creating some dispersion within our asset class, specific sectors as well, and that creates a rich opportunity for skilled active managers to seek out best opportunities and deliver alpha. We also see some sectors or exposures that are harder to index and more in an active approach. If you think about sub-sectors of sectors, whether it's prepaid gas, which has been very popular over the past couple of years, or AMT, being able to reach out and put those into portfolios in an active manner where you won't see them in a lot of passive structures, I think is ultimately what's garnering a lot of attention.

Morgan Fahy (06:09):

Great. And Mark, in your opinion, is that growth sustainable, and how have you seen it affect traditional mutual funds?

Mark Paris (06:16):

Yeah, thank you, Morgan. Great to be here with Sean and Sylvia. Love to have conversations with them. Absolutely, the growth is sustainable. Look, we've certainly heard from the retail investor over the last decade or so; they want intraday trading. They don't want to wait until the end of the day to find out their NAV. However, I totally agree with Sean, this is not an "or." It is an "and," and mutual funds have a space. Remember a lot of mutual funds have been around a long time. They're large. They usually have a lot a higher distribution yield than some of the ETFs unless you're starting to convert a fund. So I think that the trend is going to continue. I think that this is not a trend you can ignore. All three of our shops certainly are wrapper agnostic. We want investors to pick the vehicle that works for them, but as we start to see conversions, you're going to see some older mutual funds with higher distribution yields that might work for somebody with a different type of credit profile.

(07:19):

Yes, if you convert something, then you kind of own it. I think what's really interesting also is the change in share class. Certain firms have applied for an additional change in share class. There's going to be more to say about that, I think, at the end of a year. So you could actually have a mutual fund that has A shares, Y shares, and an ETF share, and we'll see how that kind of changes the dynamic of the market. How has it affected the market? Look, in my mind, I never really saw passive muni funds as passive. They were following an index, but how hard is it to follow an index in our world? It's very tricky. So you've got to add some part of, "Do I want to own a little bit more of this?" or, "Can I find a bond that looks similar to that?"

(08:06):

I think that that's a big driver in the marketplace that we can have investors say passive is good, and we have passive funds here as well. But active management in the muni market—I think what you'll hear throughout this thing from Sylvia and Sean and I—you want someone who can make decisions quickly in the muni market. You want someone who can know how a bond trades, how supply affects that bond, how a particular seller affects that bond. So my usual saying in the muni market is, "The more things change, the more they stay the same." I think this time around, the more things change, they are going to change a little bit more. But I think it's up to the retail investor to decide how they want to position themselves. Liquidity does add up in the muni market as there are more assets, more players, and more things going on. It's our job as professional investors to figure out what the best part of the curve is, what is the best kind of credit exposure. So I think that's a great theme to start off with what Sean said: this is not an "or." This is clearly in my mind an "and," and I think the muni fund business can be there for folks. I think that as three large muni asset managers, we're going to offer SMAs, ETFs, and mutual funds to our clients, and then they can decide what they want to do.

Morgan Fahy (09:28):

Great. That makes complete sense. Sylvia, I think we're going to shift our discussion to SMAs for a moment. Would you explain the benefits to investors of SMAs versus traditional direct holdings?

Sylvia Yeh (09:41):

Sure, and equally happy to be here. Thanks for bringing us all together, and it's actually pretty neat. Sean and Mark, I'm going to put you in my age category, but how cool is it to look back over our career and see how much our market has progressed and evolved, and the fact that there are so many different ways that you can access the muni market? Growing up in the business, it's just kind of neat to see it and to be along for the ride. I will say Mark, saying the word "passive" to me is personally a four-letter word, and we should have a shame jar because SMAs are very often tagged with being passive. I agree with you with your comment on passive ETFs or other passive funds; they're actually very far away from being anything related to passive, in my personal opinion, and I'm actually sure you would agree. If I look at the SMA market or industry as a whole, tons of benefits for investors when you compare them to holding and directly purchasing individual bonds.

(10:39):

You think of a platform, which we all offer on the SMA within the SMA business, and you think of just being at your desktop and buying bonds from your brokerage account or path. First and foremost, also similar to what the guys have said, professional management is key and expertise. I mean, we can again date ourselves, it won't make fun of us, but the longer you're in this business, the better you are at this business, whether it's conviction, opinion, or avoiding mistakes and potholes, you want to make sure that your money is being professionally managed this day and age, what we've been through, and we can name our crisis. Even in benign periods of time, there's a benefit to having the experts in the marketplace on your behalf. Customization—even there, you look at a few years back to where we are today—and we'll get into this, I think, a little bit later as well, but data technology has really allowed us to offer more and more customization to clients, and the more we speak to clients, most work so hard for every penny that we have. They have a view, and we can express that view for them.

(11:45):

So to me, that's an added benefit too. You name your customization at this point. Diversification I think is equally important. Having broad exposure in an SMA diversified portfolio, a mixture of holding, spreading your risk across the different issuers. I think again, it's a value add. Sometimes that kind of gets overlooked, especially when we're in a benign or a sleepy environment, but it can point to a couple of situations that have happened recently where it's super important to have diversification under the hood. Then tax efficiency—like other vehicles, SMAs can be and are very often tax-efficient, whether it's aligning the portfolios with where a client lives and pays taxes, or so recently in the rate environment that we've been in, tax-loss harvesting. We actually had the opportunity to tax-loss harvest, and that has become an inherent component to these SMAs on behalf of clients.

(12:38):

I even take it a step further, and I consider optimization, right? Yes, it's largely a tax-exempt market, but we forget that we do have taxable bonds and AMT bonds, and we are permissible buying Treasuries and the like in these portfolios. There's a way to optimize. So we're really maximizing every basis point and every dollar that you can generate and keep within the portfolios. Obviously, benefit to the transparency. I think that was the biggest plug and movement spearheading via the development of the SMA market post-financial crisis, the ability to see what you own—huge. The last thing I would touch on is really economies of scale. The benefit of having a massive research team, access to that expertise. Again, we're all in the muni market, so don't really need to spend a lot of time on this, but the fragmentation of our market has only gotten worse, not better. Having the ability to tap into all of that and bringing that all together, gaining efficiencies with trading and research and the like, is super, super important. It really is that professionalism. This is not a DIY, do-it-yourself type of business anymore than it was back in our heyday. I'm really encouraging all of you to consider SMAs versus doing it yourself.

Morgan Fahy (13:55):

Great. And regarding the growing SMA demand, are there areas of the market that you are more constructive about than other areas? Whether that's certain rating categories or areas on the curve, just kind of areas that you're constructive about?

Sylvia Yeh (14:09):

Yep. Liquidity, really constructive on liquidity. The amount of liquidity that the SMA community provides to this market on a daily basis in lieu of what traders used to provide over the course of the years is tremendous and very often overlooked, right? These are not sleepy dollars. We are trading hundreds of million plus on a regular basis, let alone during pockets of volatility. Inside of 10 years, even 15 years on the curve, you're seeing everything in the high-grade category really well bid for. The curve ratios are supporting that. High grades, 5% coupon, those really healthy defensive structures continue to be well bid for. High tax states—we've seen an increased issuance in California, Mass, Connecticut—again, well bid for. That uptick in supply has just been gobbled up, and there still is a bit of a scarcity factor there.

(15:06):

What concerns me is also liquidity, by the way, on the flip side, and demand. I think everyone's been spoiled by this marketplace, both the dealer community and issuers, just because they both benefited from the stability that SMAs provide and the growth. Sorry, Mark, I'm making you laugh. Hopefully, you're laughing with me and not at me. We've created a really nice environment here. If this yield environment persists, there could potentially be pockets of illiquidity for those smaller deals or not-so-great structures where we all may have reached when rates were lower, yields were lower, and we needed to provide a little bit more income and sexiness into these portfolios. So, I can definitely see liquidity becoming a concern, similar to outflows. If the client is looking to reposition, the depth of that bid is going to be a question mark, whether it's rates, whether it is a credit event that we can foresee coming, or by the way, credit events that we've had come to market, whether it was the beginning of the year out with the West Coast and LA fires, by the way, the volatility we saw during Liberation Day. I think for big, well-known names that are in indices and the like, we're seeing broader appetite for, but everything else that falls in between lines up very nicely with SMAs, and we want to make sure that we continue to allow them to dominate and really provide an equilibrium to this market during those times.

Morgan Fahy (16:31):

Great. And then Mark, I'll turn it over to you. How have you seen SMAs evolve to keep up with the growing demand there?

Mark Paris (16:38):

Yeah, so I think it's been fascinating to watch, and we've all seen it, and not to hit on our ages again, but you've got times where people talked about ladders, and people talked about rolling off an eight-year, 10-year bond, and then buying the next short bond, to now duration management, credit management. I think we were one of the first players to buy gas bonds backed by financial institutions in SMAs. That was a hard thing to talk to management about, but we actually got great reception from our retail clients because they realized they could get a lot of yield with a pretty low duration. I've seen a little bit more of AMT paper be put in here and there. Obviously, the customization has been really amazing. You can't really tell someone who lives in New York or California that they need to own a national portfolio.

(17:33):

They're going to want to have the gross up of their individual states. So, there's been a lot more work being done there. But then again, we can do different things with SMAs. If you live in a state where there's not a lot of issuance, but the tax benefit is to your favor, we can do a 60/40 portfolio where you can still have exposure to the national stuff. These are all things that Sean and Sylvia do as well. So, I think it used to be a pretty straightforward product where we kept things very, very high grade, very, very short, and kind of rolled things around to the retail client, saying, "No, I want you to use your research staff. I want you to use the benefits of the size of your portfolio to get us liquidity." When we do a trade on our SMA platform, the counterparties that we work with on the street know that we're a $70 billion institution, and Sean and Sylvia have big institutions as well.

(18:35):

Sean's a little bigger than me, but at the end of the day, they know who they're dealing with. They're dealing with one platform, and that's a big benefit, as Sylvia was saying, for liquidity. Sylvia, I'm always laughing with you, please know that, but I think that some of the things you made points on liquidity—these are the things that we struggle with and work with, but these are the advantages of things going on. In my mutual funds, I want to own—in my ETFs, I want to own—bonds that the SMA buyers will eventually buy. So, that is a pocket of liquidity for me. I think the change has been drastic. I think it's going to continue to be longer. We look now at the yield curve in the muni market, and the 20-year part of the yield curve is starting to see a tightness in percentage of Treasuries because SMAs have gotten longer on the curve. So, I don't think AMT is going to be a huge place for SMAs to be, but it's good to see them dabbling there. I think we've seen a full transformation on things like gas bonds that had some credit to it or perceived credit to it, that people realize there's a lot of yield there for that short part of the curve. But it's about retail, understanding it, grasping it, and then we can do our job and give them a strong managed, well-balanced portfolio.

Morgan Fahy (19:54):

Great. And Lynn, I think this will be a good spot to take a pause for our first CPE audience question.

Lynne Funk (20:02):

Excellent. Thank you, Morgan. All great. We are going to hit a question on supply. We've asked this at every panel, but I think it's an important question to ask, particularly as issuance continues to be on a tear this year. The question is, "Do you expect supply to: A, be about the same as last year; B, break last year's record; C, issuance has been front-loaded and will come in just shy of last year's record." A little tidbit: today, actually, I think I just got the preliminary numbers for July, and I think the total through July 31st or this morning is $333 billion, about 16% higher than last year. Alright, let's give it another couple seconds here so we can get a few more responses. We need the music. I won't sing, don't worry. Okay, let's close this poll. Okay, so the answers are: A, about the same as last year, 18% say that's the answer; B, will break last year's record, 70%; and C, issuance has been front-loaded and will come in just shy of last year's record, 12% say that one. Alright, hand it back to you, Morgan.

Morgan Fahy (21:25):

Great. So Sean, on the topic of the primary market, the new issue calendar has been extremely busy the last two years. Have you seen ETFs and SMAs be an important demand source to meet the growing primary issuance?

Sean Carney (21:40):

Absolutely. Without a doubt, look no further than the shape of the curve. Whether you want to look at the ratio curve or the yield curve, both incredibly steep. The ratio curve continues to be attractive more on the long end. If you take a look, for instance, at the first 10 years of the curve, the average MMD move for the first 10 years is 17 basis points lower in yield. If you look at the back portion of the curve, so call it 20 to 30 years, the average MMD move is 82 basis points higher. So, I think you can really kind of see where the demand is coming from. But it's important, and I think Sylvia touched on this, but in 2022 and in 2023, when mutual funds lost $165 billion in fund flows, it was SMAs and ETFs that stepped up, bringing in by our calculation about $85 billion.

(22:35):

Hence, performance was only down 2% in '22 and '23 combined. Without that type of activity, without that interest, who knows exactly what the market goes through. But Mark touched on this; I think he said it very well. Every investor type has a different order of priority that's important to them. They're looking for different experiences. These folks tend to care less about price and more about getting invested. Retail cares about income, "Get me invested, keep me invested so I can clip the coupon and accept my taxable equivalent yield." I think this helps issuers and is likely something that is aiding this spike in gross issuance that we've been seeing recently.

Morgan Fahy (23:18):

Great. And Lynn, not to double up, but I think it would be a good time for our second CPE audience question if that's okay?

Lynne Funk (23:26):

You got it. I think that is a good time. Alright, let's open it up. Here we are. Okay. "Have you or your deal team altered your deal structures (i.e., maturity schedule, coupon structure) due to the retail investors' shifts into SMAs and ETFs?" The answer is "Yes," "No," or "I'm not sure." I think this is an interesting question to ask, considering the nature of at least the short interest through SMAs and ETFs. We'll give these folks some more time here to answer.

(24:29):

Alright, I think we have a quorum here. I'm going to close the poll. Okay, so the answers are: A, Yes, 22%; B, No, 50%; and C, I'm not sure, 28%. Alright, Morgan, back to you.

Morgan Fahy (24:46):

And Mark, I'm going to turn to you now. In your opinion, should issuers, underwriters, and municipal advisors be thinking differently about how to structure their issues to make them more attractive for ETF and SMA buyers?

Mark Paris (24:58):

I was hoping for a little better answer there on the poll, quite frankly. But look, I think that there is a symbiotic relationship between issuers and investors. This is why it upsets me sometimes when an issuer has credit concerns and doesn't come back to the bondholders, or when the bondholders don't try to do the right thing. We want issuers to succeed; we want them to have good borrowing costs, fair borrowing costs. We want to be able to invest in bonds with the least amount of volatility, and we want to work with them so that when they price a deal, it comes at a time that's right, at a structure that is right. So, I would urge the issuer community to work hard with their FA, work hard with their underwriters. The really good underwriters are going to contact Sean and Sylvia and I and are going to say, "What's your capacity here?

(25:52):

How do things look in this particular credit, in this particular structure? What are you demanding?" And it's on the three of us to go back to the underwriter and say, "I'd really like a five and a quarter percent coupon instead of a 5% coupon." But I think it's very clear that when you have a market like ours that now has the entry of both ETFs and SMAs, you want to put paper in that deal that the SMAs can take on, and that makes for a much more efficient muni market instead of taking ratios all the way down, maybe on the short end because there's a dearth of supply. I think it'd be good, healthy for the muni market. I think it's healthy for the issuer, but I always say on these kind of panels when there are a lot of issuers around, we care about you, we want to work with you. There is that symbiotic relationship between the two of us, and I think it's important for us to both share information with the FA and the underwriter so that we can get the best results for you while still making good investments for us.

Morgan Fahy (27:02):

Great. And Sean, I'm going to ask you, what does the growth of ETFs mean for volatility in the market, specifically during periods of dislocation? And I think that this tied into one of the questions that was submitted from the audience as well.

Sean Carney (27:16):

Yeah, so I think it means different things for active versus passive products. We need to recognize on the passive side, we're indexing a large common position within the marketplace, in which the market may or may not want at a given time. Liquidity is situational, and in the muni market, it can dry up rather quickly. So, you have this scenario of index versus non-index eligible, and index-eligible bonds. Obviously, you can find some sizable pieces that go out for the bid and so on. I think the math is rather simple. If it's in the index, it's going to be in the ETF if it's passive, and if it's a large ETF, it's going to be a large weighted position. So, I just think that in certain instances where liquidity is going one way, it's easy to see a lot of these positions kind of come out, be out for the bid, and can put a bit of pressure on the market at times. On the active side,

(28:16):

as these continue to grow, you can manage them a bit differently, especially when liquidity starts to dry up. You can increase your SAC rate, for instance, as liquidity or the bid-ask spread becomes more challenged, so you have somewhat of a self-correcting mechanism on that side of the equation. I'd say for the most part, the ETF wrapper itself is helping with liquidity of the markets. However, there are times when things go sideways, and they can actually press on the liquidity of the market. So, again, a little bit two-sided, but I think as the active side of this equation continues to grow in size, it will actually help with liquidity during stress times.

Morgan Fahy (29:05):

Great. And Sylvia, can you talk a little bit more—I know you touched on this earlier a bit—but about liquidity in the market and kind of how we've seen that change with these shifts that we've spoken about towards SMAs and ETFs?

Sylvia Yeh (29:20):

I mean, so much is at play, and so much has changed over the years. I remember when SMAs had just started, and it was like, "Oh, I don't want the singles and doubles," and it was hard to get the attention of the trading desks. SMAs cannot be ignored now, right? The SMA market, and I'm sure we'll talk about this too, is larger than the mutual funds, which dominated all of the attention and balance sheet, by the way, of a lot of these platforms. So, just that natural approach and acknowledgement of the SMA market has had a huge impact. You can see that with sales coverage, which has just changed and become that much more important across all of the different platforms out there. I think Mark hit the nail on the head with issuer engagement. Could I ping you, Mark? That was so well said, and I completely agree with you. There has to be more connectivity with SMA platforms and issuers. There are certain shops and underwriters out there that do a really good job at that. There are some that just make the assumption that if it's a AA, 5% coupon, well-known name inside of 10 years, all of the SMAs will be in for it. It's not dumb money, actually. We have performance that we have to stand by as well. We are fiduciaries as well. We do have a view, we do have a choice,

(30:38):

and I think that gets lost a little bit. We have an opinion, and to Mark's point, we do want to work together. We all win when this works, and whether it's all the things that I mentioned for a client at the initial investment or just ongoing liquidity, the more we work together to understand your needs, wants, credit profile, and the like, in the long run for the totality of an investment for a client, there will be natural attention and liquidity that evolves, and that's something that we all strive for and need to work towards. Between the dealer focus and the issuers that actually care to speak to us on the SMA side, that's naturally creating additional demand, as we've talked about, and that's really helped to push for efficiencies through automation across all of these broker-dealer platforms, which has been great. We see it with—we're not writing tickets anymore.

(31:32):

Trading is happening quicker, which has been great. The development of algos has been amazing. A bit of a double-edged sword there, but amazing, right? It's really lessened the need to have so many eyes on the market on a regular basis. Liquidity has increased because a lot of these shops are starting to depend on the accuracy and the velocity at which these algos are able to have their arms around our marketplace. The negative—because they always have to remain balanced—the algos, which have really provided liquidity, is during times of stress, it's really easy to unplug the damn thing, and we take notice of that too, and that's where we really are leaning into our broker-dealer counterparts to remember the role that they play in keeping efficiency in this marketplace. So, liquidity has gotten better because it's been forced, just given the size of the SMA market and the velocity at which it's grown, but it's going to continue to evolve and especially during times of stress.

Morgan Fahy (32:33):

Great. And then Mark, I'll ask you as well, is there anything from a liquidity or a volatility perspective that you are particularly concerned about?

Mark Paris (32:41):

Yeah, so I think you can ask both Sean and Sylvia and myself, when you manage the amount of money that our departments handle, we're always worried. This is our client money; we are fiduciaries first and foremost. I think it's important to note that the muni market has had some big wins this year. We started off the year talking about where the tax exemption was going, what was going to happen with different types of bonds, and what would be more taxable and less taxable. That's the good news. But we do have a double-edged sword. We had a couple of big players that are not in the muni market anymore on the liquidity side of things, and we all know that when the muni market gets really volatile, everybody's running for the same tiny door. That's why really good managers like ourselves—and I consider these two great—we are going to build liquidity in an SMA portfolio, in an ETF, in a mutual fund so that when we have to sell bonds, we're not selling what we have to sell; we're selling what we want to sell.

(33:45):

So, the "taper tantrum" was ugly, but I think good managers actually positioned themselves for it going forward. My portfolio managers always tell me, "I know, Mark, I know, Mark. I don't want you talking to me about liquidity when you need it. I want you talking to me about liquidity as you're building your portfolio." So, look, there's still going to be some concerns about where the Fed moves, if they do move. Could inflation spike again? But I actually think the muni market got some very serious wins this year. We now know we can handle a large amount of supply, not just one year, but two years in. So, while I worry about these sort of tail events, and you never know when the next one is coming, I also feel like the muni market's in really good shape if you were to start worrying about a recession, if you got more noise out of Washington. I think we're really well positioned in the tariff story. So, good managers are always going to do what they need to do to make sure that they're at least quasi prepared, prepared for a tail event. But I really want to stress the fact that we got some really good news this year in munis, and that's going to be a continued, in my opinion, tailwind for us.

Morgan Fahy (34:59):

Great. And another topic that we had touched on briefly earlier, but I just wanted to kind of dive a little deeper on was technology. So, advances in technology continue to be critical for the growth and development of our market. Sylvia, what innovations in technology have you seen help the broader utilization of ETFs and SMAs?

Sylvia Yeh (35:22):

Yeah, I mean, enhanced data aggregation and analytics first and foremost. With 50,000 issuers, there's so much information and detail that is needed in order for us to make the proper decisions. To now see the progression where a lot of this information is at our fingertips has been a huge development, and not an easy one—it's been slow—but we can definitely see the benefits and the foundation that it's really created for us, whether it's real-time pricing and transparency or the ability to create better credit analytical tools for our research teams. Again, to get our arms around this beast of a market on an individual basis, on a portfolio basis, has been changing drastically for us. We talked a little bit about this too, the algorithmic trading. I think automatic trading and portfolio management systems and the enhancements made there also has really helped us scale these businesses to manage thousands and thousands of positions from thousands of accounts as if every single one was getting that personalized attention is phenomenal to see in practice. The trading again, as we're facing off to our counterparts, and we're looking for liquidity or looking to get invested, the portfolio of rebalancing that we can do fairly quickly versus blocking and tackling things on an individual basis.

(36:45):

Even when I think about tax-loss harvesting and the automation that has come to be there versus the individual trades that we were able to get off from time to time, there's just a streamlined approach that is now embedded within our market, which has been pretty cool to see. Then I think of all of our—and I'm sure the guys can speak to this too—our individual platforms and how we've developed them, both from a product offering perspective and again, the underlying infrastructure that allows us to build these portfolios and manage them from a risk perspective as well has been pretty neat to see all of this coming together. When I think about innovation in our marketplace, just look at X amount of years ago, the minimums for separately managed accounts were like $3 million to $5 million, and now they're like $100,000, and sometimes even lower. You can't offer that, by the way, with all the customizations that we've discussed earlier on. We can't offer any of that to meet all of this growing demand. If we're not collectively investing in technology, that will be the major differentiator between the massive SMA platforms and those that are trying to enter the SMA market is going to be how much they're willing to invest in technology to offer the tailored experience to our clients. Great.

Morgan Fahy (38:03):

And Sean, is there anything from your view that you wanted to add in terms of technological advances that have helped drive the growth?

Sean Carney (38:10):

Yeah, I think I can add a couple. Sylvia has already touched on many, but ultimately you're scaling speed and efficiency. So, whether you're building smart algorithms that can help make you faster and more efficient with obviously a very nuanced and even more fragmented market than maybe we've seen in the past. Things like click-to-trade capabilities, direct connect with broker-dealers where we can pull their inventories in via Aladdin, optimization screens that run overnight on SMAs. So, if a bond matured or a bond was called in an SMA, and now it's out of line from a duration standpoint or where it should be, you can be alerted to that in the morning when you first walk in. Having those types of things is absolutely amazing. I think on the ETF side, in-kind capabilities, not only for redemptions but also on creates, is a great move in the right direction for their efficiencies. Then one more: maybe more full-service APS with muni backgrounds instead of relying specifically on just ETF backgrounds, which is what we've seen so much in the past.

Morgan Fahy (39:23):

Great.

Mark Paris (39:25):

If I could just add to that real quick. Absolutely. I think, look, you cannot sit back with technology. We've learned this over the years. Whether you talk about ignoring the internet 25 years ago or AI in the last couple of years, this technology is not just good for SMAs and for ETFs; it's good for mutual funds as well. It's good for the entire platform. It makes us think about better ways for portfolio managers and analysts to interact. It makes us think about better ways to position a fund, an ETF, and a mutual fund with a similar bond. So, I think it's really important to note that technology is evolving. We get a bad rap in the muni market: "We're just muni folks. We don't know any better." We're doing a lot of technology across all of our three platforms, and we're doing it for all of our products and all of our customers.

Morgan Fahy (40:16):

Great. And as we finish up prior to opening it up to Q&A from the audience, I just wanted to pause for our final CPE audience question.

Lynne Funk (40:28):

Excellent. Okay. Let me get this out and open for you all. Great conversation so far. Thank you all so much. Alright, so the next question is, "The Muni ETF universe is about $142 billion as of Q1, a 71% increase since 2021 per Fed flow of funds data. What do you expect it to be by the end of 2026? A, $150 billion; B, $175 billion; C, $200 billion plus." Alright, give it a couple seconds.

(41:26):

Okay, I think I'm going to close this one up now. And your answers are: A, $150 billion, 17%; B, $175 billion, 52%; and C, believe it'll be $200 billion plus, 30%. Alright, Morgan, back to you.

Morgan Fahy (41:50):

Great, thanks, Lynn. And finally, I thought it would be interesting to ask each of you the same question. So, predictions for ETF or SMA assets at the end of 2026?

Sean Carney (42:03):

I can start. I would take north of $200 billion. So, we're currently around $150 billion. If we continue at this rate, we'll finish out 2025 around $175 billion. ETFs tripled from '20 to '25. I believe they will triple again, '25 to 2030. So, that would put us at the end of '26 somewhere around $240 billion, give or take.

Sylvia Yeh (42:31):

Super bullish, Sean. I was taking the under on that one. I was like $190. All right, I like a lot more now. Let's do this.

Mark Paris (42:39):

Yeah, I hate to be right in the middle, but I'd probably take the middle. Maybe just above $200 billion is sort of where I'm at, but I agree with Sean's longer forecast. Absolutely.

Sean Carney (42:49):

You stand in front of so many FAs, and you talk to them about different products, and they'll say to you, "Do you have an active ETF that looks like that?" You just realize that this is the way things are going, and you have to get on a lot of planes, trains, and automobiles to write tickets that equal the size of getting in the Ethernet of a model allocation. So, I just see that the model folks are just coming to this asset class in such a great way, looking for the active ETFs now that they have the transparency and the fees have been brought down to where they like that. I just really see that as kind of the transmission mechanism that gets us going, that keeps us kind of on this CAGR, if you will.

Mark Paris (43:27):

Yeah, I totally agree with the model point. Yeah, absolutely.

Sylvia Yeh (43:31):

Can I ask you a question then? What's your thought on mutual funds? If we're under a billion trillion now, where do you think that is the end of '26?

Sean Carney (43:40):

You're asking me, Sylvia, even

Sylvia Yeh (43:42):

though it's not my job. Sorry, Morgan. I'm curious. It's going to come from conversions, right? So, how many do we think we're going to convert?

Sean Carney (43:50):

Yeah, it's a great question. Mark said this earlier, we're somewhat product agnostic, right? We do run mutual funds here, both closed-end and open-end. I think they've had—you have to look at the yield curve. I mean, they made a lot of sense as rates were falling, and then as rates stabilized and have been rising, it makes sense why ETFs and SMAs have garnered the assets that they have. I don't believe that mutual funds are dead by any means. They've obviously slowed down. Someone much smarter than me mentioned that they felt that the mutual fund complex was a melting iceberg. "We just don't know what the temperature is," right? I think that's a good way to put it. I come in in the morning, the first thing I always look at is flows, and I'm amazed at the amount of flows that I see going into active ETFs and then flows coming out of mutual funds. I think we really need to go through a cycle where rates fall. Again, people are looking out longer on the curve. We get a series of traditional mutual fund inflows and see what those flows look like before we can really diagnose it. But it feels like we're going to continue to see mutual funds dwindle, and on the backside, we're going to see ETFs, SMAs, active ETFs pick that up.

Mark Paris (44:55):

Yeah, I think the rate portion is totally key here. I think that if you get in a more normalized rate environment where buying individual bonds is not going to match the yields of some of the older, more longevity funds, then people are going to want to own the long end. People are going to want to own the higher yield. We know exactly where tax policy is now, so it's great that SMAs, ETFs, and funds are kind of floating around the same yield, but there's going to be a point here where the next marginal dollar is going to have to buy a lower yield. When that happens, I think we do have to go through that cycle, Sean. Absolutely, and see where we end up. I don't know if the question has a solid answer to it, but I think we have to get through the cycle and find out.

Sean Carney (45:39):

As an indicator, keep an eye on the premiums, discounts of closed-end funds, right? We've been at record discounts, double-digit discounts, for a very long time on closed-end funds. Think about that: that's your open-end fund that's closed with leverage on it. People tend to want to go there when they want duration, so keep an eye on those. If they start coming in, that to me says you're going to start to see some longer-end demand and so on.

Morgan Fahy (46:06):

Great, and that kind of brought us to our final question, which was we've spoken a lot about the growth of ETFs and SMAs, but were there any potential catalysts that could slow that growth?

Sylvia Yeh (46:16):

I think the yield curve. Taking the other side of it too, to Mark and Sean's point, it was really hard to have conversations with clients when we were in a really suppressed yield environment because the fees on these separate accounts stuck out like a sore thumb, that and just to get clients—any individual—off the sidelines to actually buy something, given how depressed those levels were, that was a challenge. Again, I think we're far ways away from that environment that we were in, and the yield environment that we're currently in is actually encouraging a lot of movement out of cash, out from money market funds, and just putting on some type of duration. So, grateful for that opportunity. Absent that, to Mark's coverage earlier on, tax policy—that was hard and took a lot of our—I mean, I feel like we talk about this every time there's a new administration, but that was very distracting, and I dare say maybe more concerning than other times that it was really on the table this go around for the better part of the beginning of the year. So, to have that behind us, I feel pretty good where we are from a perspective.

Morgan Fahy (47:30):

Great. And any other final thoughts that anyone would like to add in prior to turning it over to Q&A from the audience? Okay, let's see what the audience has to ask us. One of the questions that came in was, "An earlier panelist noted that credit is past its peak. Do you all agree, and have any concerns?" Sean, I don't know if you want to start with that one.

Sean Carney (47:56):

Yeah, I'm happy to. I choose my words very carefully here. I agree that credit has peaked in a way, but I'd rather say that credit has plateaued. I don't think that we peak here and then fall off of a cliff by any means. I think we know why we've peaked. Coming out of COVID, the amount of fiscal stimulus that was put to state and local governments really aided them. So, I don't think that we're going to get to an area where we have the rainy-day balance sheets, the pension-funded ratios that we particularly had there. So, I now think you're going to see a greater dispersion, which is good. I mean, that's what Mark, Sylvia, and I are paid to do, right? You want to find these dispersions; this is where opportunities exist. That's why I love this market, that and the fact that rates are as high as they are. So, yes, we've peaked to an extent, but I'd rather use plateau in the sense that I think we can stay here for a good period of time, and it doesn't want to suggest that we're going to fall off a cliff here.

Mark Paris (48:57):

Yeah, I love Sean's choice of words. Plateau, I think, is a great way to explain it because there are so many different names in the high-yield market, and everybody says, "Well, spreads are tight." I haven't bought a bond at or through the spread on a non-rated or below Triple-B bond in a couple of years here. So, we're always buying usually bonds in different situations, different types of bonds, different types of structures, and risks that are usually wider than that spread. So, I think in general, while you've seen the overall average of things plateau, I think there's still a lot of opportunity for really good investors like the three of us to find our spots where we can get extra yield out of things with a reasonable amount of risk.

Sylvia Yeh (49:42):

And the fact that we have different venues and different vehicles that we can express these views in, again, to meet all the various types of clients that we have, is also super exciting.

Morgan Fahy (49:55):

Great. And then another question from the audience, which we touched on a little bit earlier, but was, "Was there anything unique about the ETF product that led to the market disruption in April around the Liberation Day tariffs? Did the ETF product contribute to the tariff-related disruption?" Mark? I don't know if you want to start.

Mark Paris (50:16):

Yeah, I'll start. Look, we know that there are always arbitrage accounts in the marketplace, and we know that they're looking at the INAV versus that day's price movements. If you are a smaller ETF, you could have really been whipped around by that. If you're a passive ETF—and this, I think, goes back to we talked about active management—I think you also want to be with a large muni bond shop that has some of these ETFs because we trade a lot of bonds. We rank up there with the major players on the street. So, when we want liquidity, regardless of whatever product, we might have matches in other products, or we might just have a really good relationship to manage through that. I think what you saw there during some of those early days with some of the smaller ETFs, more so on the passive side, get hit with—there was a difference between their INAV and where their price was going. Some arbitrage accounts came in for selling, and then in the same day, we actually saw some amazing buying going on on the same side. So, I'm not saying to pick any of the three of us, I think you should pick your manager carefully. I think you should think about the depth and the breadth of their platform, the amount of research that they supply. I think those things are important whether you pick a mutual fund, an ETF, or an SMA. I think some of that got exposed in the taper tantrum.

Morgan Fahy (51:44):

Sean or Sylvia, anything that you would like to add on that point?

Sean Carney (51:47):

I don't have a lot else to add there, Morgan. I think that there were a couple of things going on during that period of time, and this market is heavily reliant on scale-setting capabilities that kind of lack on days where there's large amounts of volatility and liquidity concerns. Pricing of bonds is sometimes a difficult thing in a market as large as this. So, I think there were a couple of things going on at that time, but I'd agree with Mark. I mean, the ability to be with large managers that can provide a lot of liquidity and are often buying and selling at high volumes can certainly help dampen the volatility you'd see in those types of markets. But I don't think a single product was responsible for much of what we saw.

Sylvia Yeh (52:32):

No, just to piggyback off of that, and we touched upon it a little bit too, just broader market liquidity. I think the muni market was caught off guard because we were humming along for a good period of time, and here was an ask on liquidity when we just finished talking about the fact that the liquidity landscape has broadly changed with how much dealers are participating on a regular basis. So, I think this was—what was the last disruption prior to this at this pace? But we hadn't seen it, right? So, I think we were caught a little bit off guard as well and tested. But true to munis, we had disruption for a handful of days, and it ripped right back.

Morgan Fahy (53:10):

Exactly. Okay, so we are running up against time a little bit. So maybe one or two more questions before we finish up. There was a question from the audience, "Do you see any other demand interest for the long end from any specific buy-side accounts, or how does the market absorb more product?"

Sean Carney (53:29):

I can start there, Morgan. I mean, we're lucky here in our room. All of our munis are traded here on one floor, so we can see everything from money markets all the way out the curve. We have been seeing more interest for the long end, I think with 30-year ratios in the 99th percentile over one year and in the mid-90s over three and five years. You're starting to see crossover buyers pick their heads up: banks, insurance companies. I think the experience could be a little bit different for them this time. I think that the crossover buyer or the "renter" of the market traditionally came in when there was dislocation. They bought at a hundred or a hundred plus ratio and then transferred that risk back to retail when it came in to call it 90 ratio. We're not in a period of distress this time.

(54:15):

So, it looks a little bit different. I think that the folks that come back in are probably either underweight the asset class because of the Tax Cut and Jobs Act tax change on the corporate side and want to cover that short, or just look at the all-in yields and say, "Hey, I realize I don't benefit from the tax-exempt yield, but this is really starting to look attractive versus corporates, versus whatever else that you're benchmarked against." So, we are seeing more interest. I mean, there's a reason why on any given week, oversubscriptions are still four and five times, and that's pretty incredible considering the type of issuance that we're seeing this year on a gross side. So, there is demand. I'd say on the long end, it doesn't always outpace the supply like it does in the front end where ETFs and SMAs are obviously gobbling up, given the amount of demand that they're seeing on a weekly basis. But there is demand; it's increasing, and I think that the relative value of the long end is certainly being noticed by all kinds of players.

Morgan Fahy (55:15):

Great. And then just one final question, Sylvia. A question came in about technology, which we spoke on a little bit, and how you're seeing technological advancements, particularly in AI, rather shape the active ETF environment over the next five years.

Sylvia Yeh (55:36):

I mean, AI is going to be transformational, too. Whether it is within ETFs or more broadly across the platform, when it helps us get to market, have an opinion, develop that conviction a lot faster just by bringing all of this fragmented information to us at our fingertips. I don't really see it specific to a vehicle—SMA, mutual fund, or ETF. I see it more specific to the functions that fall within each of those vehicles. I see AI having a tremendous impact on the future of our credit research teams across any shop. Again, because there are over 50,000 different issuers. How do we get all of that information to them, make it digestible so that we can collectively come up with a view that we want to act on? I see that being very helpful. I see AI being tremendously additive to the client experience. Again, depending on what vehicle you're in, the client is expecting—I think Sean started off by saying that's a different experience, and I think AI is going to allow us to provide that to clients in a more timely and more thoughtful way as well. So, I don't know if I see it specific to vehicle versus function, and that's super excited about that. A lot of resourcing and time being dedicated to working with AI.

Morgan Fahy (57:00):

Great. And unless Sean or Mark have anything to add to that point, I'll go ahead and say thank you everyone for joining. Thank you to the Bond Buyer for hosting and for all the participation in our discussion today.

Lynne Funk (57:24):

All right, thank you so much, Morgan, and Sean, and Sylvia, and Mark. Thank you so much for this panel. It was excellent. Thank you to everyone for joining us today. A big thank you to our sponsors, Assured Guaranty and BAM Mutual. If you did apply for CPE Credit, you need the form filed by August 5th. Again, thank you so much for joining us, and we look forward to seeing you next time at our live and virtual events. The next live one is the Infrastructure in Boston, so looking forward to seeing you all there. Thank you again, and have a wonderful rest of your afternoon. Take care.