Jul 30, 2019
Raj Lala – CEO of Evolve ETFs
Rob:
Good Day folks. I'm Rob Tétrault from robtetrault.com, head of the Tétrault Wealth Advisory Group here at Canaccord Genuity Wealth Management.
Pretty excited today who we got here today. Raj Lala. He's CEO, president and founder of Evolve ETFs. Really glad to have him in our office here in Winnipeg. Thanks for coming, we are excited to have you and we're going to talk ETFs today.
Evolve. You guys have really kind of evolved from, I'll say a
niche player, to now becoming more mainland with some of the line’s
you guys have on the ETFs. First of all, I'd love to hear about how
the company started, and why ETFs.
Raj:
Prior to putting a evolve together, I ran Wisdom Tree Canada, which is one of the world's largest CTF providers.
Prior to that, I ran the retail business for Fear of Capital, which is one of the country's largest asset managers. Before that, I ran a company with a couple of partners and actually sold that to Fiera.
Going all the way back, I worked at Jovian capital, which was a mid-sized financial services company. Jovian was actually the company that helped incubate the horizons ETFs. I intersected into the ETF business a couple of times.
When I left wisdom tree towards the end of 2016, I decided I wanted to go out and build one. All my friends said I was nuts. How are you going to build something?
It's way too competitive. You've got the banks, you've got the large asset managers. How are you going to compete? We already have 500 ETFs, today we have over 800 ETFs, but back then, 500 ETFs in the market.
Rob:
This is in 2016?
Raj:
This would have been at the end of 2016. And how are you really going to get traction?
I said, you know what? You're actually right. If I was going to go and create kind of another XIU or another SPY you know, I think that those are very well covered by the big firms like the iShares and the Vanguards, but I believe that there's a couple of areas of the market that are either underserved or unserved.
I'm a big believer that in certain asset classes you really need good active management because good active management can make a big difference on a risk adjusted return basis.
What we did was we put together a lineup of asset classes, and
specifically in fixed income for sure, that we felt truly do
benefit from good active management.
And then how we differentiate ourselves a little bit is we went out
there and went across the globe, and of course folks here in
Canada, to identify the kinds of portfolio managers that we could
partner up with who had a great track record in that specific asset
class.
Oftentimes our competitors, what they'll do is they'll internalize that portfolio management, but sometimes the portfolio management team doesn't have a great deal of expertise.
For us it was more important to find a manager with a brand, and that actually had a great track record.
We've partnered up with Voiced and Gordon Pain to run a couple of funds for us. Our biggest fund, which has emerged somewhat of a flagship for us, is a Canadian preferred share fund that they run full as …
Rob:
That’s DIVS?
Raj:
That’s DIVS, yeah.
We've partnered up with Voiced In also to run a Canadian core fixed income fund. We partnered up with Nuveen in the US – for those of you not familiar with Nuveen, Nuveen runs part of TIA, which is effectively the US version of Ontario teachers.
Rob:
Okay, yeah.
Raj:
They run about a trillion dollars.
They're running a couple of funds for us, a US equity as well as a short duration yield, and the biggest manager that I've ever worked with in my career. About eight months ago, we launched a fund with Allianz Global Investors. Allianz right now runs about $2.2 trillion.
The portfolio manager of our fund is the sister company to PIMCO. So really, these are segments of the market that we believe really benefit from good active management.
Then the other pillar to our business where we've gotten a lot
of press and a lot of attention is our thematic, primarily
index-based ETFs.
So focused on long-term trends, focused on strategies or sub
sectors that you can point to that are really changing our world
over the course of the next 10 years.
But most importantly from an investment perspective, that they have a strong investment thesis behind them, and that they could never be confused with a fad.
For example, we launched Canada's first cyber security ETF. Can't be a fad; everybody knows, all of your clients will know. I'm sure everyone has had an attempted breach.
They have gotten an email from a bank that they don't bank with asking them to verify their account details, or a Microsoft email to verify their account. We're clear we're getting barraged by attempted hack in our world today, and it's only going to increase.
Rob:
Let's talk about that one. So that is the cyber security ETF launched in the last year or so, right?
Raj:
A year and a half ago.
Rob:
So specifically, what kind of tech, what kind of companies are you targeting, what goes in there? How many names are in there?
Raj:
That's an index based, passive ETF.
Rob:
Okay.
Raj:
What we do is, our typical index provider is a Frankfurt based company called Solactive. They're doing a number of ETFs in Canada as well, and what we do is we put together the methodology. They put together the methodology with us.
I would go to Solactive and I would say I want to build a cybersecurity ETF. They would go and take a look at their entire list of indices. If they say, actually we don't have a cybersecurity index, they would go and build it.
There's an organization called Factset. Factset creates the
methodology. Effectively, every company that would be classified as
a cybersecurity company that's publicly listed, that also has a
minimum market cap of 100 million for that fund.
Depends on the fund, but for that fund – Minimal Heart Capital –
100 million. And then minimum trading volume of 2 million a day
makes it into our portfolio.
So right now, that's about 37 companies.
Rob:
That's globally?
Raj:
That's globally.
Rob:
How many of those are in North America?
Raj:
About 75% is US based. There's nothing right now in Canada. And then you've got a little bit in Europe and you've got a little bit in Asia, but still it's been dominated.
One of the interesting elements of Cybersecurity is that there's such a massive shortage of human capital in the cybersecurity world.
I'll give you an example. When I take a look at this space in this sector and think long-term, here's what I think.
First, we all know cyber-crime is going to continue to increase. Second, we all know that companies need to continuously increase their spending on cybersecurity.
What's really interesting is that it's a nondiscretionary spend. You're never going to have a CEO of a major fortune 500 company after a terrible financial quarter stand up in front of their shareholders and their board and say, we've had to cut our spending on cybersecurity.
Rob:
Right.
Raj:
They will say that we've decided to close some offices, or that were the first certain initiatives, but they're never going to reduce their spending on cybersecurity because it's death if they get breached. Equifax, about two years ago, got a breach of 143 million records, right?
Rob:
Stock dropped like crazy.
Raj:
35% drop and still hasn't recovered. Why hasn't it recovered? Because everybody left Equifax and went to companies like Transunion and never went back.
Rob:
They don't have the confidence, right?
Raj:
They don’t have the confidence.
You can imagine what it would be like for, let's say a bank, where if you lose that customer confidence they'll just go to another bank. They may never come back, and you spent all that money to acquire that customer, and tens of years to get there, you never want to lose it.
It's really important.
Then the third part to it is that a lot of people don't know that cyber security is one of the very few sectors today that actually has negative unemployment. There is a shortage of about 3 million people, meaning there are 3 million job vacancies in the cybersecurity world.
What has happened is a lot of the largest companies, government agencies, fortune 500s or banks, contract out a huge portion of their cyber security work. Typically, a Canadian Bank for example, might have between 3 to 5 million attempted breaches per day.
They need a cyber security company to help them weed through the
real threats and the artificial threats as well. When you look at a
product like that, the investment thesis behind it is yes,
cybercrime is going to continue to increase.
Companies need to continuously increase their spending on
cybersecurity, making it somewhat recession proof.
Finally, there's a shortage of human capital, a massive shortage of human capital, which means most of the work needs to be contracted out. If you're CEO of a fortune 500 company, are you going to contract out that work to a small private cybersecurity company or are you going to contract …
Rob:
Publicly listed.
Raj:
Bingo. So that's that fund. So that fund …
Rob:
How’s it done?
Raj:
First of all, it ended up being the top performing equity ETF from Canada last year.
Rob:
Wow.
Raj:
Right now, we launched at the end of September, so we're, what, call it a year and eight months, and we're up over 50%.
Rob:
Wow.
Raj:
From point to point and not been an easy market the last year and a half …
Rob:
Right.
Raj:
… it's performing incredibly well, but what I love about it is the long-term investment thesis is strong. And then another example of that would be our Future of the Automobile ETF.
Rob:
Yeah. You know what, let's talk about Canada's first future car ETF. I'm here with Raj Lala, CEO of Evolve ETFs. Raj, why would someone launch a future cars ETF?
Raj:
I think that the next 10 years will be the biggest transformation in the automotive industry, not just of our lifetime, but in history.
Rob:
Do you think oil is going to eventually not be a player at all?
Raj:
I think what's interesting is the misconception as to how much of oil demand is derived from automobiles. It's not as much as you think it is. It's about 20%.
Rob:
Right.
Raj:
Oil is used for so many other things, right? So, yes, I believe that in the next 10 years, that 20% will shrink dramatically for sure. Because we have countries today like India and China who have both publicly declared that they will ban the combustible engine in the next 10 to 15 years – China in 2030, India in 2035.
Rob:
Okay. So, this ETF, how does it play that?
Raj:
When I looked at – again, the long-term trends are shaping our world – the long-term trend, I'm a firm believer that in the next 5 to 10 years, we will have self-driving cars on the road, autonomous cars.
I'm a firm believer that electric vehicles will continue to rise in popularity, especially as the cost comes down and it is coming down. The cost of manufacturing the battery is coming down, countries are putting in place policies ...
Rob:
Infrastructure’s improving.
Raj:
… Infrastructure’s improving, the auto manufacturers are moving
from combustible engine, to hybrid, to eventually full
electric.
You're seeing all of that. I mean, more electric vehicles were sold
last year than all other years combined. China's producing about 39
million electric vehicles right now. They have that much demand at
the moment.
You're seeing all of this taking place. On the electric side it's firmly embedded. It's firmly going to continue on the self-driving side. I do believe that you're eventually going to have self-driving cars.
In fact, I was just talking to a couple of other people about it, and I said I think in the next 12 months, most people here in Canada will actually have their first experience in a self-driving car.
Somebody will be sitting at the steering wheel, but they won't
be touching anything. They'll just be there to make sure that the
car is safe. But we are definitely getting to the point where the
technology is there.
And I'll give you an interesting stat. In order to power a
self-driving car, a semiconductor chip needs to have the ability to
make 10 million decisions per second.
Rob:
Okay.
Raj:
That's how many decisions you and I are making per second when we're driving. Now you could think that doesn't make any sense, because I know I'm not making 10 million decisions per second.
You are, it's just subconscious. Right now, the best something semiconductor chips can power about 4 million decisions per second. So, we're still 40% of where we need to be to power a self-driving car.
Rob:
There's not enough computation power right now to drive, is what you’re saying?
Raj:
Right. The way it works in self driving cars is level 5 would be
a fully self-driving car. Today we're at about level 3.5, so we
still have a ways to go to get there, and then we’ve got to deal
with legislation, and then we’ve got to deal with insurance.
If you get into an accident, who has the insurance claim? You're
not driving the car, so it was that the auto manufacturers.
That's all the stuff that still needs to get sorted out. But I believe that we're getting there, and that the amount of increase in safety that it's going to create, and also decrease the amount of traffic and congestion.
I live in Toronto and I know how bad the traffic is, and
self-driving cars would be great. Then the other side to that
business is also the shared. Shared is a super interesting side of
the business. when I'm talking to 65 or 70-year old’s, and their
grandparents, I say to them, if you're thinking about saving money
for buying your grandchild a car, go on a trip.
Don't waste your money. Because as kids are getting older, they
actually don't want to drive. Most kids don't want to drive, they
want to be Ubered or Lifted around. Or they might even consider a
shared a model where they have a partial ownership of a car, but
they don't actually even really want to own a car. Very different
than when we grew up.
Rob:
I couldn’t wait to save money to buy my first car.
Raj:
Right. I couldn't wait until I could get my driver's license and drive my Dad's Monte-Carlo around, and eventually get my own car. It's different. Younger people are different today. They don't want it.
The shared side is also another aspect of this. That fund really kind of encapsulates what is actually like
Rob:
What are the companies that we're buying? Are we buying like Waymo and those kinds companies?
Raj:
Great question. Well, although Waymo is making a lot of progress and …
Rob:
And Waymo is Google’s self-driving car.
Raj:
Yeah. Although Waymo is making a lot of progress and some people think they're the front runner, the challenge with Waymo is, unless Google spins it out, we would have to buy Google. And so how do you do it then? What are you actually buying?
Typically, you would have to generate between 25 to 35% of your overall revenue from these aspects 25 months ago. And Waymo is not generating. Waymo is not making up 25% of Google's revenue as an example rate.
It has to be more of a pure play. And what we also did was we
equal weighted this fund instead of market cap weight. And the
reason we did that was because if we market cap weighted it then
investors would basically just have a lot of exposure to the car
manufacturers.
Rob:
Right.
Raj:
What we wanted was to give investors the experience of having exposure to the supply chain, the companies that are creating the batteries, the companies that are creating the semiconductors, the technology that's going into self-driving cars, electric vehicles.
Rob:
So is this one an index or is this one …
Raj:
It is.
Rob:
It's an index as well as, and there'll be some supply chain, there'll be some car manufacturers, there'll be some battery makers, there'll be all of that.
Raj:
You got it.
Rob:
Nice, very interesting.
Raj:
And then one other fund that ties into those two, which I think is always relevant is the Innovation Fund. The TSS ticker for that is edge.
The reason we created that was because when we were talking to a lot of advisors, and we're talking to a lot of clients, you know, we, we heard them say to us that I love your cyber security ETF, I love your Future of the Automobiles ETF.
Don't know how it fits into my portfolio. So, could you create something that becomes kind of a catchall to all the disruptive industries and companies that are really shaping our world over the course of the next 10 years?
We created Edge to basically be that proxy. So effectively, it has six buckets; in in a week from now, we'll actually have seven buckets, but six buckets. One bucket allocates to our cybersecurity ETF, one bucket allocates – and it's all equal, so, one sixth in each – one allocates to the Future of the Automobile.
Then it also allocates to Robotics and Automation, and also to Data, Genomics and Social Media. All of the industries gives you a more diversified way to invest in everything that is shaping our world. And you know, it's a super interesting world, there's a lot of things that are going to change.
I'm actually a firm believer that in the next 10 years most of us will have robots living in our house. We'll have cars and …
Rob:
Not just doing our vacuuming,
Raj:
No, not just doing our vacuuming. First robot was actually the dishwasher. That was the first official encounter with a robot. And now it's the vacuum or the Roomba. Now we're migrating because artificial intelligence is becoming so strong, which is super important.
We will have robots performing surgeries on us without that nine month wait list. It's a super exciting world. And these are all the industries and the companies and sectors that are changing it, and making it better.
Rob:
I'm here with Raj Lala CEO of Evolve ETFs. Let's talk briefly about cannabis ETFs. There's a lot of talk that's been about HMMJ, kind of the first ETF that came out. You guys approached it a little differently. Tell me about the two that you have on the shelf now.
Raj:
Yeah, good question. When we started looking at the cannabis space, I started looking at it actually a few years ago and decided not to launch a product because I just still didn't feel like the social stigma was positive enough towards cannabis. This was pre legalization of course.
Then we started getting more comfortable and started taking a
closer look at it. What we decided as a firm is that we felt that
it made a lot of sense to take an active approach to this market,
because there's a lot of things at play that are a little bit
unique to the space, legislation, momentum, things like that.
It's a niche play. We have two – as you mentioned – we have two
cannabis funds. One that's kind of Canadian/Global, and then one
that we launched just about two months ago, which was actually the
first in the world focused on the US space. I'll talk really
quickly about both.
The Canada global one has been around for about a year and a half now, and over the last year, the top performing ETF actually in Canada.
Rob:
It was up like 40% or something like that?
Raj:
Yeah, up about 43% for the one year. It's done incredibly well, and our management team has done a fantastic job of managing it.
Rob:
How many those names would be in that one?
Raj:
There’re about 35 names in it.
Rob:
So that's an actively managed ETF. Management is picking stock selection that's happening in there. Arbitrage, you're trying to find deals that are going to come. Overprice; is it long short or is it strictly long?
Raj:
Strictly long.
Rob:
Strictly long, and you’re trying to find value.
Raj:
Very little in privates. Like you know, we can only allocate about 10% into privates. But what the guys did, I think where they really generated some strong alpha would have been in Q3/Q4 of last year.
Leading up to legalization in October, we took the view about a
month and a half prior to legalization that the euphoria that was
going to go into the space was going to go into the big names, the
Aphrias, the Canopies, the Auroras of the world. We went overweight
into those names, a week and a half to two weeks prior to
legalization.
The team took the view that there's not a chance that post
legalization reality is going to live up to all this hype. What
they did was they went way under on the large caps and they also
started to allocate to some of the tertiary businesses like the
Scott's Miracle Grow.
In that two-month period, we added about close to 20% Alpha
versus the passive index. The active approach has really worked
well for us in that fund. As we started to focus on that fund, we
started to recognize the opportunity that exists in the US cannabis
space. Looked at stats like Planet 13, which is a big dispensary
business in the US, had more revenue than Kronos, but had one 20th
the market cap of Kronos.
The US companies were way undervalued. Part of it was because
there's a lot of legislative things to deal with in the US as it's
not federally legal yet in the US, but we hope that that's going to
change the next couple years.
But then you have States Act, Farm Act, Safe Act, all these things that are kind of coming into play at the moment and went, and US companies cannot also list in the US right now, so they're listing here in Canada.
But the opportunity is massive. We look at the US opportunity to be kind of like the way the Canadian opportunity was like three years ago.
Rob:
You're trying to get ahead of the bump there.
Raj:
What we try to do with our business, is always try and look forward. I try to stay away from, oh this is a sector that has performed the best over the last five years, so let's launch this product. If you don't have the conviction or the strength to believe that it's going to continue for the next five years, then I don't think you should do it.
You should be thinking early stages. Like for example, we launched a Materials and Mining Needs ETF just last month. It's not a popular sector, right? It's been beaten and battered and bruised. But we believe that that's a sector that's going to recover over the course of the next couple of years and we want to be there for that recovery. So, the same type of logic.
On the US side for cannabis, our view is that as legislation
starts to become more friendly towards cannabis companies, you're
going to start to see more value go into those stocks, more
investors moving into them eventually.
They’ll also be listing in the U S which will be a lot easier for
Americans to buy, versus trying to buy a Canadian listed stock. As
you and I both know, the potential of the US market is always 10 or
more to 1 versus Canada.
The big advantage that they've got, like you look at California, which is the interesting one, California …
Rob:
The size of Canada.
Raj:
Right, similar size. But they allowed them to brand the products and market them properly and things like that. We don't unfortunately have that hear in Canada, so the US will most likely displace Canada in many ways in that space. We want to be there early.
Rob:
And these are listed companies in Canada that are in the ETF?
Raj:
That's right.
Rob:
It's a real neat idea. Congrats, and want to talk about one more. It's really interesting to me.
I'm here with Raj Lala, CEO of Evolve ETFs. Let's talk about Hero. The ETF that you guys launched about Canada's first e-gaming ETF. I played a lot of video games and as a kid, I still wish I had more time to play them. What's Hero?
Raj:
I love this fund. It's an interesting story. I would say about nine months ago, multiple people brought the idea to me; have you looked at the gaming industry, because it's really taken off in a big way. I have two 11-year-old daughters that do not really spend much time gaming. I think my mom spends more time gaming because she plays a lot of candy crush cause she's retired. I was looking at that whole space and I was like, I don't see.
And then as I started to really drill down into it, I was like, wow, this is a massive, massive space. There are today 2.2 billion gamers in the world. A gamer would be defined as somebody that spends six hours or more a week gaming.
Okay, so 2.2 billion. That’s a third of the population …
Rob:
That’s a lot of time, a lot of time.
Raj:
That’s a lot of time, and it’s a third of the population. Most of it is on people's smartphones. So originally, I was thinking, okay, but how does this make a lot of sense?
Because when I think of video gaming, I think about, yeah, when
you and I were teenagers, we were playing video games or in today's
world, you've got your teenager up in their room playing video
games or in the basement or what have you, and then realized how
big the market was because it is people like retired people playing
candy crush and word search games, things like that.
It is 40 something year olds. I've got friends that are 40
something years old, working on the trading desks at the banks,
that wake up on a Saturday morning and they hop online and play an
e-sport together with their friends for three, four hours. The
demographics for this are enormous. That's interesting.
Then I started to take a closer look at the business model of
these companies. And that's where I would say I had my aha moment
that we need to launch this type of product. Because in our days
when, we wanted to play video games, we would go to the store, buy
the cartridge or the CD, we'd come home, we'd plug it into the
console, and away we went, right? But that's where the revenue
stopped for the game manufacturer. In today's world, they have an
entire vertical of revenue.
So, Fortnite as an example …
Rob:
It’s unbelievable.
Raj:
It’s a free game, right? But where they make their money is the boosters, the weapons, the players, all that kind of stuff. Right? But companies like Tencent effectively and directly owns Fortnite. But technically it's not just creating the revenue off that game. What these game manufacturers are also doing, like Activision, Blizzard, EA and Tencent is that they're creating the leagues that people compete in.
Rob:
Yes.
Raj:
And then they create the events. The events are very
interesting. Last year, Dota 2 was a big event, actually the
biggest event so far. It was actually in Vancouver. They had over a
hundred million people. League of legends as well, had over a
hundred million people watching it. So not just filling stadiums to
watch people play games, which surprised me, but watching online.
Today, 11% of all YouTube video viewing hours is about gaming.
Twitch, which is owned by Amazon, is all about gaming. These
companies have created an entire vertical of revenue for the game.
Then it leads to media rights, cause now ESPN is broadcasting, TSN
is broadcasting. Then at leads to sponsorship rights.
You can see how the business model has morphed, evolved and improved significantly for these game manufacturers, which I find super interesting. I never thought in my lifetime that people would go and fill stadiums to watch other people play games. But they have.
And so, when I look at this and I look at how it's just starting
now, you've got 5G coming. When 5G comes, it means that graphics
are going to improve in games, it's going to be faster to play
online. 5G is going to change a lot of things of course, but gaming
is definitely one of them.
You're seeing it, and Fortnite is a great example. You know the
average revenue generated per user is getting close to $100. It's
$96 right now per user. Give you something to equate that to the
average revenue per user on Facebook, Google, Twitch is about $25.
Fortnite is generating four times more revenue per user than some
of these others because they've built a great business model off of
this.
I mean, how many times do you here this story, that my teenager needs to take my credit card. That's why they use PayPal now because they want to buy boosters and weapons and things like that. I look at all of that and I think this is a real business. A lot of people have their eyes on this sector. And I thought, okay, so I get the business model, I get the investment case; let's create a passive index. It's passive market cap weighted.
We just launched it last month. So, it's very new. Probably my favorite ticker that we have as well. The ticker for it is here. So far so good.
Rob:
Nice. Okay, good. Hey, you guys also have some income stuff as well as some actively managed. Real briefly want to touch on some of the covered call strategies that you guys use. Generally, why would someone want to do that?
Raj:
Yeah, covered call strategies are interesting because what they could do is, they could subsidize income and they can help potentially moot some of the downside risk. Effectively, the way a covered call would work is you are going to end up giving up a little bit of your upside potential, but you're not going to have as much downside risk as well.
And in return for that, you're going to generate some yields. There're premiums generated based on the covered calls. We have one fund, the ticker's life that's global healthcare. It's a passive index of the 20 largest global healthcare companies. And then our team does an active covered call overlay on up to a third of the portfolio. They take a passive, and they put a covered call overlay onto it. We also have done the exact same thing for big US banks.
And as I mentioned before, we just launched one on materials and
mining. Right now, depending on the fund, those are our three
covered calls strategies. Right now, between 7 and 8%, a yield
that's being generated between the dividends on the stocks, plus
the premiums from the calls. And then the other one that has, as I
mentioned at the beginning, emerged as our flagship, is our
preferred share fund.
I think it's starting to get a lot more attention now, perhaps have
been beaten up over the last six to nine months. It's not been easy
for them, but where can you get a 5.5 to 6% tax advantage yield in
today's world, pretty tough to find.
It's pretty tough to find …
Rob:
Doesn’t exist really. I mean there's a real estate space that can give you something comparable, but it's a different risk profile for sure. Different volatility profile tool.
Raj:
Absolutely. I think that fund is going to start resonating again as people start to recognize that the pref space, because the pref space is one of the only sectors or asset classes that hasn't recovered yet, unlike the equity markets. We think that over the next little while that fund's going to perform well.
Rob:
All right folks, you heard it here, the preferred market’s going to come back. Fantastic, great to have you here. Appreciate the time. Always good to talk about ETFs, huge part of, I think any portfolio managers toolbox, especially the niche stuff that you guys are doing really, really interesting. We're thankful for your time. Thanks for being here.
Raj:
Thanks.