iShares Insights on New Investment Frontiers

Welcome, everyone, on this week’s podcast. Really excited to have Jay Jacobs. He’s the head of thematic ETF’s at Blackrock, also a CFA, one of the brightest minds in our industry. So we’re going to go in detail about several very timely topics. But first of all, just as an introduction to Jay, welcome to the podcast.

 

Pleasure to be here.

 

Well, I thank you for still doing this podcast. I made a rude joke over email when were scheduling about the. Jay is from the Bay Area. I made a joke about the Chiefs and the 49 ers. But are you recovering okay after the Super Bowl?

 

Jay? We’ve given it a little time. I’m recovering, but it’s going to take a little while to fully heal these wounds.

 

Well, one of your main jobs is obviously, like, looking at the market and what the best investment opportunities are, some of the ETF’s that you’ve helped develop at Blackrock there. So I’ve got to ask, first of all, what are your outlooks for next year’s NFL season? Are you still thinking 49 ers have a good shot at it, or what’s your thoughts?

 

I don’t know. I had a friend make a joke. We’re on a fantasy league together. He said the whole league just did a redraft, that somehow every single important player just switched teams in the last few days. So I don’t even know who’s good and who’s bad anymore. I think we need to figure it out. Outlooks for the markets than for the NFL?

 

Well, I had a conspiracy theory that Taylor Swift, like they were going to miss hundreds of millions if she wasn’t at the Super bowl, but that doesn’t hold true once she was there. I don’t think there’s anything. I think it was a fair game, but either way, the 49 ers are still loaded, so best of luck next year.

 

Thank you.

 

Okay, let’s get right into it. So, Jay, I think one of the biggest questions we get from clients and just we hear out there is what’s going to happen with interest rates. Now, we’ve. We’ve researched there’s lots of fed rate cuts in sight, but what are your thoughts on this. And what should investors be looking at, how to navigate this moving forward?

 

Well, structurally, our view is that interest rates are going to stay higher for longer. That doesn’t mean they’re going to stay at these levels forever. I think we will see some cuts towards the back half of this year, but there’s a lot of inflationary pressure just in the economy right now. That means that the years of really low interest rates might not be coming back anytime soon. You can look at aging populations around the world. People are getting older. That’s shrinking the workforce. That’s an inflationary pressure on people who are in the workforce can demand higher salaries. There’s more geopolitical risk in the world. We’re seeing disrupted supply chains, and that’s putting more inflationary risk. If you look recently, the cost of shipping around the world has increased substantially, with some increased risk in eastern Europe and in the Middle east.

 

And so you do have these inflationary pressures that are structural in nature in keeping rates high. Even just in the last few months, you saw the market was pricing in about five rate cuts from the Fed. Now the market thinks it’s more like two and a half or maybe three. So the market is starting to realize that rates will probably come down this year, but just not as much or as fast as people were expecting. Now, what this means for investors is if you can hold cash or short term bonds and get a pretty good yield for a while, that really creates a high hurdle in why are you going to step out of cash and make an investment in something, go from a low risk exposure to a high risk exposure?

 

You really need a high bar from an investment thesis to be able to make that change. And so when we put together our thematic outlook this year, were really looking at what are the long term structural trends that have high growth opportunities associated with them over the long term. But specifically, what are the catalysts that are going to happen in 2024 that will set off this growth, set off this chain reaction of very rapid revenue and earnings growth across these different segments? Because, again, with high interest rates, you need a really compelling investment thesis, either very high growth or really attractive valuations, to step out of that cash and into the markets.

 

Yeah, everywhere you see, earn 5%. Right on Fidelity.com or all these money markets. So what are your thoughts, I guess, for someone that is not willing to make that hurdle rate. But as far as the risks, as far as I was looking on American Express’s website recently, and they’re offering CDs over five for one year, two years are good, but then you go out to five years and I believe it’s in 1.5% range. So that tells me that the big institutions that have direct contact with the Fed, they’re thinking at least within five years, rates will not be as high as they are. And obviously this is purely speculation, but any thoughts on how someone, obviously cash is cash is king. But someone that is still looking to be really long term, that framework for that decision making, then you’ve got to.

 

Get more granular and nuanced in how you’re investing in the markets. But it is important to be invested as much as 5%. Cash sounds great, and we haven’t seen that in a long time. The reality is the S and P 500 was up over 20% last year, so there was still an opportunity cost to holding cash to the two to 15 plus percent. That doesn’t mean everyone should just immediately jump into the S and P 500. What it does mean is that over the long term, you do want to compound returns. You want to compound it, especially in tax advantaged investments like stocks, where you can defer paying capital gains on it. And that’s important if you’re growing your portfolio. So it’s not enough to just hold cash, especially for people with long time horizons that are looking to really build their wealth.

 

Awesome. Well, you mentioned. So the next question I have for you specifically, 2024 market outlook moving forward. And we’ll go specifically. Obviously, AI is kind of the buzzword right now. Before we get to AI, what are the key themes as you see them? You mentioned a couple in the first question around fed cuts, such as the aging population, et cetera. But what would you see as the most important themes in 2024 and beyond right now?

 

Yeah. So through a thematic lens, again, we’re looking really kind of long term at what are these structural trends and what are the catalysts that are happening in 2024 to accelerate them? And so we really look at three buckets. The first is AI and digital disruption. Seems like it’s been a long time ago. It was really only 16 months ago that chat GPT came out and really completely changed the trajectory of AI adoption. The second theme, and more related to aging populations, is healthcare innovation. We think we’re on the precipice of several major innovations in the healthcare space. And then finally the third area that we’re looking at is really rewiring supply chains. And we know we’re heading into an election year, not just in the United States, but around the world.

 

About 50% of the population is going to be voting for new leadership, and there’s still supply chains are getting rewired, and countries are looking at kind of partnering with new countries and making new policy changes to really rewire what supply chains look like going forward.

 

So as a follow up to the first thing with AI and the digital. So I know one of the recent moves that we’ve made at EWA is to just go to not try to guess which company, but to go right into an ETF that you guys have created called socks. Socks is the semiconductor, and AI doesn’t exist without these very advanced chips. I wanted to hear what are your thoughts about that? And then what other ways can someone, I want to say safely but very logically, go into that first play around the AI and digital space?

 

So far in the markets, there’s been so much talk about AI, but the reality is only a handful of stocks separately benefited from the AI movement thus far, and they’re referred to in financial media as the magnificent seven. These are some of the largest, most powerful tech companies in the world, from hardware manufacturers that are making really powerful chips, to platform developers that are creating or supporting the chad GPTs, the Claude’s, the Geminis of the world that are these AI platforms that are getting a lot of attention. Last year, on average, those mag seven stocks were up over 80%, I think close to 100%. But we have a basket of AI stocks, over 100 around the world, and excluding those seven major companies, the average return was about 13%.

 

So a huge difference between those top seven and the rest of the AI space, which to us means if you’re really bullish on AI and really see it as an incredible transformation to the global economy, which we do, there should be a lot more breadth and companies that are benefiting from that. It is not just going to be those seven that win. And so one lens that we look at it from is what we call the AI tech stack. And it’s really thinking about almost like a layer cake, these different levels of these different companies that are involved in AI and touch it in different ways.

 

And so you reference SoC semiconductors that sits kind of at the bottom, at the foundation of our tech stack around AI, which is, it doesn’t matter what platform you’re building, it doesn’t matter how you’re using AI, who’s using AI? Any AI that’s going to be developed has to use semiconductors, because ultimately it is a number crunching game. It requires really powerful semiconductors to crunch numbers, to process AI, and that should really benefit really an entire basket of semiconductor stocks around the world you have, and just to break it down a little bit more, you have GPU’s, graphics processing units, which are really the ferraris of semiconductors. They are incredibly expensive, but incredibly powerful.

 

These are the state of the art chips today that are being used to train a lot of these AI platforms, to teach them how to create images, to speak almost like a human. But then you also have CPU manufacturers, central processing units. These are much simpler chips and they’re really good at just processing single streams of information. Very quickly, as AI gets more trained up, you won’t actually necessarily need as many gpu’s anymore. You might need more cpu’s. This is the difference of like if you’re learning math, if you’re learning how to do math versus doing math problems, by the 20th problem, it gets a lot easier. It’s the same thing with semiconductors. Training AI is hard. Once AI is trained, you can use simpler semiconductors to do so.

 

So when we look at the opportunity within semiconductors as that layer of the AI tech stack, we want both, we want the GPU manufacturers, we want the CPU manufacturers. We really want exposure to that entire basket, because more and more AI adoption, one of the critical choke points is just building more semiconductors to power that. Now, on top of that, though, there’s other aspects of this AI tech stack. So all of those semiconductors have to be housed somewhere. There literally has to be digital infrastructure that provides power to those semiconductors, that cools those semiconductors, that provide security. So these places can be attacked or hacked in some way. And so there’s a whole digital infrastructure layer, literally the physical real estate that supports those semiconductors.

 

So far, those companies have been somewhat ignored by this AI fascination, which I find to be kind of a missed opportunity by the markets. There’s absolutely going to be more demand for this infrastructure. In fact, probably we need about twice as much infrastructure over the next ten years to be able to satisfy all of this AI growth. And then you have the platform developers. So this goes back to some of those magnificent seven stocks, the people that are developing these really revolutionary AI technologies. These companies have a lot of software engineers, have a lot of money, have a lot of data, and all of that is very valuable for training up AI. And then finally, on top of all of that, you have the applications that are going to be built using AI or enhanced with AI. For example, think about travel services.

 

Right now you’re booking a trip, going to California, you got to go to a travel website, you’re putting in your dates, you’re playing around with different preferences around nonstop or price or where you want to sit on the plane. And then you got to start booking reservations and you can spend hours building an itinerary for a trip. This is actually pretty easily doable by AI. And if it knew your preferences or if you input. I’m here for three days, I want to focus on being outdoors and getting sun. And here’s my budget. Go build me an itinerary. AI could do that very easily. And this is a huge product enhancement for travel websites because if it’s easier for you to book travel, you’re going to do it more often and probably spend more money.

 

So to us, the applications that are going to incorporate AI, like those travel websites, like healthcare providers that maybe can do more with your data, like legal providers, legal service providers that can give faster turnaround on legal documents, you name it, there’s all these different use cases. Those products are really going to be enhanced by AI. What I like to relate this back to is one of the most revolutionary and almost underrated technologies of the last ten years was the leap from 3G connectivity on your phone, the 4g connectivity on your phone. Now, 3G feels like so long ago that we forget, but basically the first iPhone was 3G only and you could basically text on it. If you tried to load a website, it took a really long time.

 

You could really never watch videos on it if you’re trying to download that from cellular connection. But when 4G came out, you had faster connectivity, you had lower latency, and all of a sudden you could shop on your phone, you could do social media on your phone, you could watch YouTube on your phone, you could do all these things through 4g technology because it was this incredible platform that enabled all these other applications to be built on top of it. We see AI the same way. The AI product is not necessarily chat GPT, it’s the other businesses and products that will be using chat GPT to power them to become more powerful. Could be that travel website could be something we’ve never thought of yet.

 

But the fact that this technology exists is going to create really a renaissance of new technologies that really sits at the top of this AI stack of almost this question mark of what are the big industries that will be built because AI now exists.

 

That’s very insightful. I appreciate you sharing, Jay, just to make sure I heard you correctly, at the bottom, it’s a food pyramid. You have to have the semiconductors for any of this to exist. And secondly, because this exists, we’re going to have problems where to store this stuff. There’s going to be bad actors out there that are going to use this to steal your information. So we need their cybersecurity infrastructure, cybersecurity ramifications. So that’s going to exist no matter what. And then the third or the top of it is not a speculation, but just more of a, you have to wait and see. And we know what companies have started to adopt the AI, but there’s going to be things that people think of every day, of how to make more effective travel, healthcare, legal, streamline our lives and save time.

 

You have developed ETF’s that directly go into each three of those layers, and I believe some that pull all three of those together. Is that correct?

 

Exactly. So you mentioned Sox before. Soxx, that’s really, it’s a us semiconductor fund investing in semiconductor, you know, basket of different semiconductor companies. We have a digital infrastructure ETF IDGT, which is really looking at digital real estate that’s supporting all that processing power. And then cutting across the entire AI stack is our ETF, Irbo Erbo, which is really investing in kind of all the companies in the value chain of AI, from the semiconductors to the digital infrastructure to the application developers.

 

Awesome. Well, the second one I relate to a lot because when I was first as a financial advisor, I remember meeting a mentor and he was like, who’s your network? At that point, I was meeting with young residents and still work with lots of physicians and grateful that we do, but he said, Matt, you know, we’re, to build a business, you have to manage money, and to manage money you have to meet with people that have money. And then he shared a statistic, this was ten years ago, but he said, people over the age of 65, the only people I’ll work with because they own 85% of the net worth in America. So not only, in my opinion, do we ever, we have this aging population.

 

You shared when were getting coffee a couple weeks ago, you shared that this is like the first time in history there’s more people this age than people. And it was like, it was mind blowing to me. But do you know, is that statistics, we hear that there’s going to be trillions of dollars transitioning over the next 20 years, but that’s still, we’re the very start of that, kind of like, we’re the very start of AI. Do you know, broad based, like, if you were to guess how much wealth is still owned by the older population.

 

Oh, it’s trillions. I mean, it seems like every year the number gets bigger. And what this generational transition of wealth will look like, I’ve seen estimates from 20 trillion, 30 trillion, 40 trillion. The numbers are staggering. It makes sense. Older populations have had the most time to save, to compound and to build their net worth, whereas millennials have to spend a lot of money on childcare and are still early in their careers and trying to buy houses and all that good stuff, the stat you were referencing. So in 2024, there will be more people over the age of 65 in the United States than under the age of 15 for the first time. And if you go back 100 years ago, there was about five times more people under the age of 15 than over the age of 65.

 

So demographics happen slowly, but are powerful. It’s like a glacier moving through the economy. And we’re really starting to reach a tipping point of we’re an older society now. People are having less kids, people are living longer because of great medical advancements. But from a thematic lens and from an investing lens is you have to think about who benefits from this. This is really going to disproportionately impact. Where do seniors spend money? And you just mentioned it, seniors have a lot of money compared to other generations. So where they spend it is going to be really important and could be a really long, you know, really good driver of stock returns going forward. So, you know, we’ve looked at it in the context of really, what are the medical innovations that are happening today that predominantly impact senior populations?

 

So just in the last year or so, you know, we’ve seen a huge rise of GLP, one drugs, which a lot of people view as weight loss drugs, and it is being used in that context, but really it’s designed to treat diabetes, which predominantly impacts seniors. We’ve seen phase two trials for things like skin care, for skin cancer vaccines. We have seen the first breakthrough in Alzheimer’s in about 20 years with Lekembi being approved by the FDA and some other fast follows there. So there’s some really incredible medical advancements that just happened a few months ago and are starting to commercialize, may be about to happen in the coming months that really treat some of the diseases that predominantly impact senior citizens. So you have the aging population tailwind, you have the AI tailwind.

 

Right now, major drugs cost about $2 billion to develop and take ten years from idea to approval from the FDA. We believe that AI could potentially cut that by 25% to 50%, both the time and the cost, because there’s a lot of number crunching that has to be done. You can look at genetic data, you can look at different drug compounds, you can model them with computers and really save a lot of time and cost by leveraging AI effectively. There’s other areas within the medical system where AI could be doing a better job, resourcing hospitals, making sure people are in the right place at the right time, ordering the right amount of devices and supplies. So this is one sector that, in particular, we think AI can really enhance, either through accelerating revolutionary drugs, as well as to, you know, reducing unnecessary costs.

 

So healthcare is the main theme I heard, and obviously, that hits home from the heart emotionally. I’ve had relatives, I’ve had Alzheimer’s, and I can just imagine, if that solution does strongly come to the table, that an unlimited people would be willing to unload an unlimited amount of their resources to address that problem.

 

There’s a lot of hope in neuroscience in particular, and I was actually just this past week at south by Southwest, not for the music and tv shows, unfortunately, but for the kind of tech and innovation part of Southby. And one panel I was listening to was called demystifying aging. And really, what are some of the advancements in dementia treatment? Their view was that the last 30 years was incredible advancements in cancer. That cancer previously really was a death sentence, and now it’s still very dangerous. But there’s a lot of treatment, there’s been a lot of advancements in certain cancers to make it some. Something that we can treat and live with and manage. The optimism now is that a lot of that, the next generation is going to be advancements in neuroscience, that we are just starting to understand the brain.

 

We’re just understanding aging and dementia and Alzheimer’s and Parkinson’s. And maybe we won’t necessarily completely solve these ailments in the next 30 years, but we can start to treat them and reduce their impacts. And even that, given the aging populations we have, could have a massive impact on society. So, by the age of 65, one in three people already have dementia. If you live to be 80, sorry, you have a one in nine chance by 65. If you live to be 80, it’s a one in three chance. So you could just imagine the size of the baby boomer generation and how long, amazingly, baby boomers are living. Just how much of a bigger part, dementia treatment is going to be a part of healthcare going forward.

 

Interesting. So, off the cuff here, before we get to the third thing, when you mentioned that half the world’s going to be out to vote this year. Fast forward ten or 20 years, and with the healthcare innovations, people may live longer and the wealth transfer may be a lot longer than we think. But let’s assume that does start that trickle down effect of that there’s a big inheritance come they come to families that don’t necessarily have kids, as you mentioned. How do you see that 1020 year out? When that wealth transfer does go to the younger generation? How do you see that affecting the economy, if at all?

 

It could have massive implications. Let’s look at it from the consumer angle again. Where do people spend money? Millennials and Gen Z will be the big inheritors of this wealth transfer. And these are two generations that are digital native. We grew up with the Internet, we grew up with computers, we grew up with being able to have on demand music and tv and all kinds of content in our pocket at any second. And so you can look at some kind of consumer surveys about how baby boomers spend money versus millennials in Gen Z. And there’s really big differences. Like millennials in Gen Z prefer digital experiences and lifestyle experiences, whereas these are generalizations. But baby boomers tend to prefer kind of more physical goods.

 

Think about the massive house tends to be the baby boomer, whereas the luxurious vacation and taking a bunch of photos on it and posting it to Instagram tends to be the millennial. And I know these are kind of stereotypes, but there are surveys that kind of back this up in terms of preferences. So if you think about it from that consumer lens, it is important to see how these trillions of dollars will ultimately be spent. I think the other aspect, and there’s probably bigger conversation on this, which is how do millennials and Gen Z like to invest? We see that younger generations are much more likely to use ETF’s.

 

We see younger generations are much more likely to be invested in digital assets, and that could have big implications for the market, as well as those trillions of dollars find their way into the investing world.

 

Interesting, and I know there’s a statistic. We’re going to talk about crypto the blockchain in a little bit, and obviously that’s going to be a big part for most millennials. Before we get there, though, you did mention half the world, we have an election coming up this year in the US, and then globally, 49%, I think you told me again, over coffees, which rounded up, 50% of the population is going to be out to vote. So lots of political turmoil, lots of political turnover potential is going to happen. So how do you see that affecting investors in 2024 and beyond.

 

I mean, we like to kind of paint with the longer term brushstrokes of what’s happening structurally with supply chains and geopolitics. And I think one of the things that just, it’s been set in motion since the financial crisis, frankly, is rewiring of supply chains. That there’s a bit of a focus on. How can the United States become more resilient in things like manufacturing? Who does the United States partner with in their supply chains? You can think about near shoring and producing more near the United States in places like Mexico. You can think about french shoring and the United States developing relationships with places like India, which has a really large, youthful, tech savvy population unto itself. So there’s a big effort underway to really think through what does supply chains look like in the beyond?

 

I think this is a big implication of just what’s happening geopolitically around the world today. So we mentioned a few of them. But one of the big winners here is Mexico. You have USMCA, so you have free trade with Mexico. Cost of manufacturing in Mexico is about one 10th of the cost of the United States, incredibly close with proximity. And then you have a couple of public policy pieces that have passed in the last few years, like the Inflation Reduction act to really promote domestic manufacturing, or north american manufacturing of things like electric vehicles. And so you’ve already seen a big ramp up in production through Mexico. It is now the biggest trade partner of the United States. And so we expect that trend to continue.

 

Mexico also has a very young population, which makes it a great destination for training and for leveraging that workforce. India has been a big recipient of these rewiring supply chains as well. Again, large, youthful, tech savvy population, starting to see tariffs being rolled back between the United States and India as well, and then more domestic policy. So the Infrastructure act from 2019, the Chips and Science act, to build more semiconductors in the United States. There’s been a lot of political will and spend across the aisle to build more in the United States and become more self sufficient, especially in really critical industries, the growth industries of the future. So you’re starting to see really a lot of build out of manufacturing in the United States again for the first time in several decades.

 

Interesting. One of the conversations we have really recently, when we implemented the portfolios is excluding in emerging markets, excluding China. So obviously an ETF that excludes China. And still in emerging markets, there’s going to be heavier weights to some of these countries that you just mentioned, like Mexico and India, et cetera. So one of the statistics I’ve heard is the 2008 housing crisis in the US. If you look at where the levered, the leverage was there, and you look back compared to China right now, China is three times where were in 2008. So I believe that’s one of the reasons coming up with that recommendation to exclude China. And that goes directly into who’s going to benefit from that, which you just mentioned. But do you have any other thoughts on the landscape where the US is currently with China overall?

 

Yeah, I mean, part of this is just how capital markets have evolved. If you go back to the 1980s, Japan became such a massive part of the investing world that investors started breaking apart Japan from the Asia Pacific region. So you saw all these funds popping up a pack ex Japan funds. So you could be very intentional about how do you allocate to Japan? Do you want to just get benchmark exposure? Do you want an active manager? Do you want to underweight, overweight Japan? We see a similar phenomenon happening with China now, where it represents about 30% of the emerging markets. Increasingly, it’s so large that people want to express an opinion on China. Overweight, underweight, different ways to slice and dice it. When you look at the rewiring supply chains, we absolutely see places like India and Mexico benefiting.

 

And you can upweight those exposures through something like that EMXC product. I think India is the top exposure within emerging markets, excluding China. So it’s really a way about getting more granular in the emerging market space. You have a lot of idiosyncrasies across emerging markets, different countries, different geographies, different populations. So it’s a way to kind of get more focus on certain countries.

 

Awesome, awesome. Okay, well, going back 1 second about the millennia, so eventually there’s this wealth transfer. So let’s talk about bitcoin. And recently, BlackRock released this extremely economical solution to someone that doesn’t want to go in and have cold storage, hot storage and all these. A lot of people I don’t think have gone into bitcoin, especially the older generation, just because how complicated it would be to do it properly. I guess the first discussion we can have, do you have any statistics to share on adoption rates, millennials moving forward? And then let’s specifically talk about why was this bitcoin launched and what are the pros and cons to it?

 

Yeah, so in a big picture, we’ve seen digital assets being adopted at a rate that actually exceeds other revolutionary technologies, things like the Internet and mobile phones, and there’s different use cases for it. But I think a lot of it has to do with demographics, with a digitalizing economy, where if you’re a digital native, millennial Gen Z, you tend to have kind of a predisposition towards digital assets and digital currencies. So there’s a lot of tailwinds towards the adoption of bitcoin itself. From an ETF lens, the challenge has really been about accessing bitcoin. Previously, people had to go open an account with a crypto exchange, buy the crypto, which can often be very expensive to purchase on an exchange. It’s kind of like going to an airport and getting a currency exchange. You don’t really know if you’re getting a great rate or not.

 

And then often it’s getting stored in hot wallets, meaning it’s being stored in a way that’s connected to the Internet. Now, what’s really kind of state of the art, the best way to do this for a lot of investors is to do cold storage to keep bitcoin offline in secure vaults. And so the ETF itself is really focused on, can we provide better access to bitcoin? Can you buy it through your brokerage or advisory account to sit alongside your stocks and bonds? You don’t have to go to an exchange. Is there more convenience here? Can you get tighter trading, lower costs with that, trading, more efficiency with taxes? And then ultimately, can you get institutional grade quality, really being able to store it in cold storage in a way that’s really kind of the state of the art.

 

And the ETF really wraps all those things together. So in a lot of ways, this is just solving for one of the pain points of investors is how do you get convenient, efficient, high quality access to bitcoin, which is something that people wanted for years and now finally can get through an ETF like ibit?

 

Okay, so ibit, let’s just dig into details like, I’m an investor, you know, considering this. So if I buy ibit, do I actually, do I own the bitcoin? Does Blackrock own the bitcoin on my behalf, or how does that work?

 

So when you go out and buy ibit, you are buying a share, and we’ll get a little bit into technical. So what’s called a Grantor trust, and the Grantor trust owns bitcoin. So you are getting really precise access to bitcoin through that structure. This is the same structure that’s been in place for over 20 years for gold ETF’s gold. ETF’s allow you to buy a share of ETF, which is giving you a share in a grant or trust which has a vault which owns gold in that vault. It’s really a very similar construct with this, of course, being around digital assets.

 

So you hold the actual bitcoin and do you hold that? Not you blackrock from a cold or hot perspective.

 

So Coinbase is our custodian for this product and owns the bitcoin and holds it in cold storage. So every night, whenever we have, if money is coming into the fund, we go out and buy bitcoin. And every night that new bitcoin is going to be swept into cold storage. So that is capped offline and secure.

 

Okay, and how do we ensure, as you read horror stories, someone loses their. Their keys in the cold storage? And then I’ve read somewhere someone lost like $100 million this way because they were early investors. Then you lose these keys or whatever and you can’t recover it. That’s the whole purpose of what makes it so secure, can also come back as the greatest weakness of it. So how does Blackrock as a whole, with this being billions already in the fund and growing, keep track of all this?

 

Yeah. So this is why you want to work with the best partners in the space and build the best processes. With Coinbase’s custody platform to store the bitcoin, it’s the most institutional grade process for storing bitcoin. We’ve put them through very rigorous due diligence to ensure those processes. And on top of that, it’s really about leveraging the architecture and infrastructure that we’ve built for all of our ETF’s. So we have a technology platform that runs 1400 ETF’s around the world. World investing in stocks, investing in bonds, now investing in bitcoin. And really it’s about the ability to see and to manage all of that bitcoin exposure as efficiently and with as much transparency as possible.

 

And this is really part of the benefit of being at a place like Blackrock, which has the scale that we have, is that we’ve built so much of these technological systems to manage our ETF’s around the world that it can be kind of easily extended to the bitcoin asset as well.

 

Are there any doubt? If I was a bitcoin expert and I had the processes down, I felt comfortable. It’s cold. So I’m not worried about a cybercriminal. The only thing I’m worried about is if literally a physical criminal comes in and finds my pass keys wherever I have them, if that’s on a flash drive or written down on a piece of paper, what would be the downsides for me, if any, for me to sell that? Obviously taxes would be one downside and then repurchase and simplify my life. Let’s say I have my accounts or fidelity and just go purchase the ETF. Am I really going to get the same results? What are the pros and cons, I guess, or any downsides that you see?

 

Yeah, we’ve seen a lot of people do that who were owning bitcoin on their own, but would prefer the ETF. Easier to trade. You get that institutional grade storage. There is a tax implication. If you own bitcoin and you sell it for a realized game, you could have a tax liability because of that to buy the ETF. The other aspect is an ETF has a management fee associated with it. While it might have lower trading spreads, right now our ETF is trading around three, four basis points, really minuscule trading spreads. There is an ongoing management fee associated with it, and that management fee is in part to pay for the institutional grade custody solution. So some people may choose to own bitcoin themselves. That’s okay. What we see is the lion share.

 

If people don’t feel comfortable doing that, don’t feel comfortable that they’re going to have the appropriate security and safeguards in place, and would rather pay a small management fee for an ETF to do that for them.

 

I read in prepping for this call, once you reach a certain level of assets that the fee will cap at 25 basis points of 0.25%. So obviously that’s a very low cost. My question is, how are you guys doing that for 25 basis points? When you look at other companies that were charging one and a half to 2% to do the same thing, were they just grossly overcharging? Are you expecting you’re going to have the scale? Why is there such a huge price difference between some other competitors on the market?

 

Yeah, I can comment on other competitors pricing, but we feel the 25 basis points is a very competitive fee and we can achieve that because of the scale of the business. We’ve seen tremendous asset growth so far. We expect continued growth as we see more people really starting to get educated on bitcoin, learning about it as an asset, and determining for themselves if it makes sense in their portfolio. But because of that scale, we can be very competitive on fees.

 

Awesome for some novice investors and newbies. As far as the fraud that you’ve seen happen, whether that’s FTX, or I think it was the TD Ameritrade company that literally went under. I had some friends that had literally some lost money, took it out just in time. But for outside looking in, how would you explain what’s gone on in the bitcoin industry, and then how some of those problems are currently being solved and how this ETF would potentially eliminate those risks for someone just getting into it?

 

Yeah. So in a lot of ways, this kind of comes, again towards the hot wallets versus cold storage, again, which is you want to minimize risks here. Cold storage is really the most institutional grade, kind of highest level of security you can achieve with bitcoin. And if you use kind of the appropriate infrastructure, which has evolved a lot over the last few years, you use the appropriate custodians that can be safe kept on behalf of clients. There’s been challenges in the industry. You’ve seen bad actors, you’ve seen people, you know, misuse funds. But again, if you are using appropriate cold storage and processes, that’s really mitigated.

 

Gotcha. Okay, excellent. So I think we’ve addressed a lot of the questions around, but any other closing remarks around bitcoin or the crypto space overall that you think would be useful for investors?

 

Yeah, I think it’s important for people to go through their own educational process on this asset. Bitcoin is the largest and longest lived digital asset out there, but it’s still only 15 years old. It can be volatile. It can behave very differently from stocks and bonds. I think it’s important for people to take their time and get education on these assets. Then think about, does it make sense in my portfolio? It’s not going to make sense for everyone. If you’re a retiree and you’re focused on income and minimizing risk, it may not make sense in your portfolio. It might make more sense for someone with a higher risk tolerance than a long time horizon. But really, it’s up to the individual. It’s up to you, Matt, and how you’re helping your clients navigate this landscape.

 

But it’s a unique asset, and I think the educational aspect is going to be key.

 

Yeah, absolutely. So our general, we have some clients that have done it, not through us. Is that blockchain, the technology kind of going back to the semiconductors of what boost AI, the blockchain Fortune 500 companies have adopted that has increased their efficiency, their securities, their processes, etcetera. And as far as the use case for decentralized currency, obviously I see it there. As far as adoption rates go. Do you see a time in the next year, ten years, 20 years, that it’s normalized? I know people do pay with bitcoin. I don’t know what percentage of transaction it is compared to a credit card or cash. I’m sure it’s very low. When, if ever, do you see this becoming a norm?

 

I mean, so there’s different aspects. I mean, the world of digital assets is such a broad world and there’s so many different aspects to it. I think what we’re seeing with bitcoin is predominantly the use of this store value right now, as people look at it as potential geopolitical or monetary hedge, or a way to store value in the face of inflation. But more broadly, if you look at blockchain technology, there was a lot of excitement around it. There was a lot of companies starting to do research on how to incorporate it into their businesses. And then there’s a bit of a comeback, a little bit of a comeback to reality of is this really a technology that’s ready, scalable?

 

And now I think we’re starting to see in the long adoption of technology which can have fits and starts, we’re starting to see that adoption ramp up again. There’s some use cases and things like supply chains, where if you know exactly where a specific product has come from, different people, it stuched how different payments have been made along the way. It’s much easier for things like safety to reduce theft recalls, all these different aspects that long supply chains, all these risks that long supply chains introduce. So I think the underlying technology, we can continue to see a lot of adoption in the coming years as we start to see these use cases, like things like supply chain, we see more adoption.

 

Yeah, absolutely. As far as risks go for those that are investing in it just for the sake of investing and not for use case. But just like you said, the geopolitical risk, diversification, whatever it might be, when I look at it, I say, well, people are attracted to this as decentralized. It removes the middlemen, it removes the lack of transparency made for banks and fees and spreads. But then when you really look at it and you look at the US, one thing they never mess around with, it’s like the opposite of the justice system is you’re guilty until you’re proven innocent, is taxes. And so, you know, the government, in my opinion, is not going to mess around with not getting their tax money. People aren’t reporting it, they’re not reporting gains.

 

And then it seems to me that it’s kind of self defeating the purpose of it being private, of it being decentralized, if there is, you know, 100% transparency, I think the government’s going to require. So how would you not saying if you’re for or against it, but how would you address those concerns? Concerns or the kind of that competition between, you know, what makes it so attractive, but also, you know, what may end up making it, I don’t want to say less valuable may self defeat some of the purposes it serves.

 

I think both things can exist. It can be decentralized, it can have different use cases as a geopolitical monetary hedge, as a store of value, as a bet on further adoption option of blockchain, and you can still pay taxes on it. I don’t think those things are in conflict. One of the great use cases of the ETF is it does simplify the taxes. So tax code around digital assets, it’s a little nuanced. The reporting is a little nuanced. If you own digital assets directly, if you own a bitcoin ETF and a brokerage account, you get a 1099 at the end of the year like any other asset. And so that just simplifies it for investors and I think to a lot of investors, kind of a relief that it is a simple reporting process.

 

So just another kind of use case for the ETF versus owning digital assets directly. Is that tax simplification.

 

Awesome. Well, Jay, can’t thank you enough for coming on. Super insightful, incredible wisdom. I want to ask anything we missed or any other themes, what, if any, underrated themes are out there other than the main three that you hit.

 

On today, man, we covered a lot of ground today. What’s underrated? We still see a big story in us infrastructure as well. And this is kind of somewhat tied to the supply chain story, but a lot of money being spent to upgrade roads, airports, digital infrastructure. As we manufacture more in the United States, as we do more near shoring with Mexico. All of that infrastructure build out should be really positive for economic growth in the United States, but also create some very specific winners of companies that build and manage infrastructure. So that’s something else that’s on our mind as we think through next 510 years.

 

Awesome. Well, Jay, can’t thank you enough for joining. Very insightful, one of the brightest minds in the industry and very innovative in some of these ETF’s that you’ve help co create at Blackrock. So can’t thank you enough for your time and joining the podcast.

 

Yeah, pleasure to be here. Thanks for having me, Matt, thanks for.

 

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