A Revolution In Thematic Tech Indexing (Podcast Transcript)

Summary

• Starting out with a focus on indexing Israeli equities, BlueStar Indexes gained a deep understanding of key sectors driving the global tech revolution.
• BlueStar's Steven Schoenfeld applied his patented indexing approach, involving painstaking company-level research, combined with a global view of corporate revenue sources to more than 20 thematic tech indexes.
• Steven rejoins Let's Talk ETFs to offer an under-the-hood look at three ETFs that track proprietary BlueStar indexes: FIVG (5G Technology), QTUM (Quantum Computing) and DIET (Food Sustainability).
• This article includes a full transcript of the podcast that was posted last week.

Editors' Note: This is the transcript version of the podcast we published last week. We hope you find it useful.

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Jonathan Liss [JL]: For reference purposes, this podcast is being recorded on the morning of Tuesday, February 4, 2020. My guest today is Steven Schoenfeld. Steven is the Founder and Chief Investment Officer of BlueStar Indexes, which is a research-driven provider of indexes and data. He is a 31-year veteran of the investment management industry, and the author of Active Index Investing published by Wiley Finance.

Many of you will remember Stephen from episode nine of this show, Indexing Israel, to Investors have enough of the Startup Nation in their portfolio. I recommend listeners go back to that episode after finishing this one as it touches on an entirely different side of what BlueStar does. Anyway, welcome back to the show, Steven.

Steven Schoenfeld [SS]: Great to be with you, Yoni.

JL: Yeah, I'm thrilled you were able to rejoin me so quickly. So, last time we spoke back in August, we covered Israeli equity markets, I think really pretty extensively from top to bottom. We tried to stress test some of your ideas there. I think your thesis came out pretty intact on the whole. The performance of Israeli markets has certainly continued to support that. And that's obviously a big part of what BlueStar Indexes does, the whole Israel side of your business.

But there's another side of your business that focuses on Thematic Equity indexes, largely, though not exclusively in the tech space. And it's there I would like to pick up the conversation because, like with your Israel funds, BlueStar has an incredibly unique approach to building thematic equity and nexus.

So, just before we even get in, I'm just going to go through the breath of your existing thematic indexes, so listeners can get an idea of really just the full range of what BlueStar is offering in the index space. You have a Robotics Index, Artificial Intelligence, 5G Communications, and of course, many of these indexes have exchange-traded funds that are connected to them. There are five in total trading in the U.S., and many more that are available in Israel.

You have an Autonomous Driving Index, Blockchain Technology, Quantum Computing, Next Gen Video Gaming, Internet of Things, et cetera, et cetera. You also have some things which are not necessarily high tech or don't appear to be per se, although I have this sense that as we get into the discussion, you're going to demonstrate ways that they really are. So, things like food, and agriculture, sustainability or future utilities don't necessarily seem like high tech right off the bat. But I suspect that your approach will end up being something that leans towards tech. So, I have to ask why to focus on tech specifically in all of your thematic indexes.

SS: So, you referenced how BlueStar got its start developing what we think is the best and the broadest set of indexes for Israeli equities. Our most popular and the most widely accepted index on the Israeli side is our BlueStar Israel Global Technology Index or BIGITech, which has three vehicles, tracking it, two listed in Israel, one in the (ITEQ), Israel Technology ETF in the U.S.

And by launching that index back in 2013, and really trying to cover the full breadth of Israeli tech innovation, not just software and hardware, but cyber security, big data, defense tech, clean and renewable energy, biotech, advanced medical devices, sustainable agriculture, solar and renewable energy, we became very well versed in Israel's public companies that are at the cutting edge of innovation, but you can become knowledgeable of the tech space of Israeli companies without also understanding the innovation happening in early stage and mezzanine stage private companies.

And so, as we developed our expertise in what we saw very early as being disruptive tech areas, we realized that this is obviously as much as Israel Companies are leaders and punching above their weight, there are global companies that are equally innovative. At the same time, as we built our business in Israel, which, of course, started with Israeli equity indexes which we licensed to Israel's rather large ETF and indexing ecosystem, a number of our clients said, well, Steven, we love what you're doing for Israel, we love BIGITech, can you build us a Robotics Index that fits the needs of Israeli investors better that is better than what's out there?

Can you build us something that is focused on Internet of Things, and from those conversations, we started developing what has now become a very broad family, more than 20 thematic, mostly tech-focused indexes for global equities. And the initial commercialization was for Israeli clients, such as basically the leaders in the industry in Israel, like Migdal, like Kesem Excellence, Psagot, et cetera. But now, we're very pleased to also be working with one of the most innovative ETF issuers, Defined CTF. And to date, all three of their thematic tech indexes are based on our benchmarks.

Obviously, I can dig in deeper into all the different themes and more on our clients. But that's how we got into it. We became familiar with Israeli innovation. And we realized this is a global phenomenon. And now, we've built a family of thematic tech indexes that we're very proud of.

JL: That's really kind of an interesting route to get to starting with a very specific focused market, which happens to be really a leader in tech globally, and then expanding to cover all of these different themes on a global scale as a result of that. So, in terms of how your approach to building thematic indexes sets you apart from peers and I'm specifically thinking about firms like GlobalX, VanEck. First Trust, Amplify, these are firms that all have very specific approaches to niche thematic indexes, particularly in the tech space, how would you say broadly speaking, your approach differentiates you as an indexer?

SS: So, those companies and some of the others that have thematic tech ETFs…

JL: Sure, yeah, that was a partial listing anecdotally.

SS: Yeah, and we don't consider those companies our - they're not our competitors, they're in fact our clients and our prospects. So, VanEck is a - licenses our broad Israel Index from us for the Israel ETF, and we are in conversations with some of the other issuers, aside from Defiance about our capabilities.

I think our philosophy isn't dramatically different than for example, VanEck and their eSports Index, there's a lot of similarities in how we approach categorization. So, we're a global, we look at companies regardless of where they're listed. But I think what really distinguishes us is that we our background, even though we're an index provider, the background of everyone in the firm and our approach, as you said in the intro, it's research-driven, and we think like investors, and we research the industries. And we map out how we think the companies that are involved in any one of these themes will actually benefit.

So, we don't just do a keyword search and see if someone has robotics or see if someone has Blockchain in their annual report, we actually look at where the revenue is derived, and we look forward looking the way a research analyst would, or an asset manager would and think, okay, 5G maybe an early-stage trend, but how will its growth impact the companies operating in the spaces.

So, when we get into discussing our Food and Agricultural Sustainability Index, which is tracked by Diet, or our 5G Communication Index, which is tracked by the 5G ETF, I could give you some very specific examples, but I think the overarching theme of our approach to thematics is that we look at it as long-term investors and which companies will benefit, which companies are truly involved in the space, and where we'll make a material difference.

We're also very cognizant of the fact that investors, when they invest in a thematic ETF, they want as much purity as possible. Now, it's inevitable that you're going to get some very large tech companies in lots of different themes or lots of different thematic ETFs. But we don't want those same tech companies whether it's Nvidia (NVDA) or Google (GOOGL) (GOOG) or Intel (INTC) to dominate because investors are getting plenty of those companies in their large cap tech ETFs, for example.

And so, we have a weighting approach, which buckets and segments the different drivers in a particular theme so that the indexes are not dominated by very, very large global tech companies.

JL: Yeah, sure. That makes a lot of sense. And then, I guess this is going to be a broad indexing methodology question. But, for example, you have a Blockchain Index. So, let's just say for the sake of arguments, Facebook (FB) is kind of a big player in the Blockchain space, but when it comes down to it, only 5% of their revenue, I'm making up numbers here, but just for this point, only 5% of their revenue is directly related to that technology.

So, in terms of total revenue, in the Blockchain space, globally, there may be companies who when you put them in the index, you're not really getting that exposure or that data because they're likely to go up or down based on things that are totally unrelated to the theme that the investor's looking for, even though they are a major player in this space. So, how do you kind of handle those massive tech conglomerates, those fame stocks that may have very big exposure to specific themes, but on the other hand, it really doesn't represent a very big percent of their overall business.

SS: So, we're extremely cognizant of that. One way that we handle it is many of our thematic indexes to begin with are not only not cap weighting, but will use tiers, and we’ll allocate a percentage of the index to one or more of the drivers powering the theme. For the very large companies, some of it depends on our clients, they may want full inclusion of the big companies because investors may expect to see it, but we will cap their weight. So, they'll be capped because of the overall weighting scheme if it's modified, equal weighting or even, but they'll also be caps on the largest single stock.

It's the last thing we would want to do in a thematic index is to have, again, one of these giant global tech heavyweights, which is already so prevalent in so many people's portfolios in ways that they know and that they don't know, to dominate a thematic index. I mean it's not just the Facebook, Alibaba (BABA) and Tencent (OTCPK:TCEHY) are in a lot of global tech indexes. And they're also dominant stocks in the broad emerging market indexes there, that big.

So, if investors look under their hood for where they have Facebook and where they have Alibaba and Tencent, they'll find it in all sorts of places. We wouldn't want to make those big companies as great as they could be dominant in a relatively narrow thematic index that is targeting a broader trend.

JL: Sure, yeah. Investors end up tripling and quadrupling up on names like that without even realizing it because of those -- because of that difference. And so, yeah, I think, the kind of the takeaway point here for me is that what you're doing in terms of not having free floats in your thematic indexes is something which is really necessary when you're trying to get the betas of a very specific niche theme. And of course, if you're looking at a broad global index, like an S&P 500 or EAFE Index, you're going to want a free float there because you're really just looking at market cap or different kinds of factor exposures.

But in the case of a theme, you really need to put safeguards in place to make sure that it doesn't become an index, dominated by a couple of names kind of, like the way that maybe 10 or 12 years ago, those chip stock indexes, semiconductor indexes were like 70% or 80%. And just a couple names like Intel and AMD (AMD) and the idea of having a diversified ETF kind of disappeared, the second you dug into the weightings of those holdings there. So, yeah you know that makes a lot of sense.

Okay, so, in terms of Defiance, specifically before we get into some of your the specific indexes, that are tied to U.S. listed ETFs here, and I want to dig into each of them because I think all each of the three funds that have been launched around your indexes to-date, each has its own very interesting story, and I want to get into it. Why Defiance, specifically, what is it about your relationship with them that has allowed you to roll out so many products with them?

SS: We're fans of what Defiance is doing. They like us are a small entrepreneurial firm. They're focused on being an ETF issuer, and they've developed some very sophisticated, and we believe successful marketing and sales approaches. Their entire message and their raison d'être is to be an ETF provider for the Next Generation. So, they're targeting younger investors, people who understand the transformative nature of quantum computing, the investors who care about how their food is produced, and what its impact on the environment is. And so, we have a philosophical meeting of the minds.

We knew the Founder of Defiance, Matt Bielski from his previous roles. And so, some of it as is always the case in the very dynamic ETF industry, it's personal relationships, and we have a great relationship with all the members of his team and our team works hard with them to both help envisage their ideas and bring them ideas. And so, we're thrilled to be partnered with them and they're very commercially minded. They recognize that they want distinct products and based on the success of their initial product set, we think we've chosen well and they've chosen well.

JL: Yeah, definitely the assets gathered by at least two of these funds and the third one is very new, only launched in November, so, obviously, the jury's still out on it. But so getting into the specific funds here you have, in addition to the two Israel focused ETFs, the VanEck Vectors Israel ETF, ticker symbol ISRA, and the BlueStar Israel Technology ETF, ticker symbol ITEQ, both of those have gathered assets at a nice clip. I know ITEQ just went over the hundred million mark. So, congratulations.

SS: Thank you.

JL: You have NYSEARCA:FIVG, F-I-V-G, which is the Defiance Next Gen Connectivity ETF and its underlying BlueStar FIVG Communications Index and that is a $220 million fund which is really incredible. considering it has not even been on the market and available to investors for a full year yet at this point. So, that one's just a total home run out of the gate obviously.

And then, you have Quantum ETF, the Defiance Quantum ETF, ticker symbol NYSEARCA:QTUM, which is about $20 million in assets under management and then the newest of the bunch, the next Defiance Next Gen, Food and Agriculture ETF, ticker symbol NYSEARCA:DIET, great ticker symbols by the way on all of these funds. I don't know if you have anything to do with that or not. But so, that's the kind of the final piece of the puzzle in terms of BlueStar indexes that are publicly available to U.S. investors right now.

So, let's just go straight to the top of the list here with Defiance, Next Gen connectivity ETF again ticker symbol, FIVG. How is this index constructed exactly, and what sorts of companies are included? And I guess most importantly, why do you think the fund has had such a resonance with investors straight out of the gate?

SS: So, the BlueStar 5G Communications Index, which is tracked by the 5G ETF, it focuses on the companies that will benefit from the rollout of 5G, and so, its communications infrastructure and the core mobile network equipment and services. So, think cell phone tower REITs, 5G antennas, signal converter chips, but we also include a good dose of exposure to other segments, such as the well-known mobile network operators who have live 5G networks and are advertising with full page or two page ads in the major newspapers and or with the bus stops and sides of subways as well.

JL: Not to mention a pretty prominent spot during the Super Bowl.

SS: Super Bowl, yes, exactly. So, everyone expects Verizon (VZ) to be there and Sprint (S) and T-Mobile (TMUS). But it's not the only piece of it, but also carrier grade cloud computing. This is what powers the 5G and also fiber optic solutions. And our research team took many months to research and map out 5G network architecture. And to understand that in this first phase of 5G rollout, that the infrastructure presented some of the best investment opportunities and certainly will last for 10 years or more.

And so, it's important, and we do think this distinguishes the 5G's benchmark that we're looking at all the pieces that are going to benefit and what matters to investors, revenue and benefit from 5G. And so, this ETF, in many ways is selling itself, being the first mover matters, having a great ticker, matters, but also and obviously, we're biased, we built the index, but many neutral ETF analysts, including the team at Bloomberg, as soon as this ETF was launched, they noticed and recognized that it really provided excellent exposure to the trend.

Also, one of the interesting things is that because you have some of the infrastructure and tower REITs, you actually have a relatively high dividend yield compared to other tech-centric index. So, you don't think of thematic tech as a place to go for dividends. But because some of the beneficiaries of this trend are essentially REITs, you're going to have some yield that you don't normally get in a thematic tech ETF.

JL: Sure. And just out of out of curiosity, before we dig in deeper here, any of the companies that actually make the handsets and any of them in the index, because I would imagine that companies like Apple (AAPL) and Samsung (OTCPK:SSNLF) will see an increased demand in their products as they have phones that are -- as they have handsets that are 5G enabled available to consumers.

SS: Yes. So, they're not top weights, because again, they would dominate. But there is exposure to the more consumer product-oriented companies that are also in this space. You can't ignore the fact that they're going to benefit without going into too many companies. It is notable that as dominant as Apple is, in so many other spaces, it is actually not a first mover in 5G.

JL: True. Yeah, definitely. Okay, cool. So, in terms of the breakdown here, what is this I mean, I'm looking at, is it about 10% real estate exposure, REIT exposure or is it actually higher than that?

SS: It varies because some of these stocks are volatile, but it is around that level, it's been a little higher real estate has been hit by some of the interest rate moves. But yeah, I'd say yeah, 10 to 12.

JL: Sure. And then, globally, how diversified is this index. I imagine that this is a trend that will play out predominantly in developed markets in the near future, maybe with China being the exception there, and we'll get into some China weightings broadly speaking a bit later. But so is this the kind of index that you can expect to evolve over time as this kind of becomes an old story in certain markets but still a new and emerging play in less developed markets.

SS: So, we will definitely have the latitude to evolve the index and its constituents over time as new players come in. But because the issuer wanted this to be a very hep, we added a very attractive expense ratio, which you'll be able to share with your listeners, we built this index with just U.S. listed companies. So, it doesn't mean it's U.S. only companies. So, Nokia (NOK), which is Finnish, is actually in the top tier of companies as is Ericsson (ERIC) of Sweden. But it is a U.S.-listed constituent. And so, the U.S. domiciled companies are around 70%, with Netherlands, Finland, Sweden and all being around 5% to 6%.

JL: Sure, and that's how you're able to keep the expense ratio at 30 basis points, I assume, which is really very low for thematic, niche thematic indexes, it's very common to see expense ratios of 50 and 60 and even 75 basis points.

SS: Correct. And that's part of Defiance’s strategy to make their ETFs a very good value proposition as well as being thematically pure and very innovative.

JL: Sure, this is not just some sort of one year exemption just…

SS: Absolutely not.

JL: Right. Okay, because I've spoken to some other issuers who they'll come out of the gate with very low expense ratio, 25 or 30 basis points, but that's really just to gather assets and build liquidity. And then, suddenly, there's a bit of a bait and switch going on where suddenly at year end everybody is paying 50 basis points, not 25. And my guess is they're probably not very publicly announcing that switch to a new expense ratio. People just kind of have to stumble on that at some point...

SS: Look, it's in the prospectus, this is the expense ratio.

JL: Okay, great.

Next up is the Defiance Quantum ETF and its underlying BlueStar Quantum Computing and Machine Learning Index. And I'm just curious if it really is possible to build a pure play index for Quantum Computing at this stage. Are there enough players in this space with enough exposure on their earnings reports, let's say, in terms of where their money is coming from, or is this index essentially just companies that are doing a lot of R&D in this space but aren't necessarily profiting from it just yet.

SS: Yoni, it's an excellent question. And this certainly is not a pure play on Quantum for exactly the reason that, the premise of your question, that it doesn't exist yet even though many, many companies are in the space, including Alphabet and IBM (IBM) and Intel and more. So, this index focuses on machine learning, which is integral component of artificial intelligence. And Quantum Computing is an emerging technology that could be transformative to machine learning.

And so, if you read the name of our index, it's the BlueStar Quantum Computing and Machine Learning Index. And it is the combination of increasingly powerful computing power with the AI of machine learning, which is what is going to transform the impact on industry. And there are lots of other buzzwords thrown around by the big consultants like the fourth industrial revolution. That was a theme at Davos this year. This index provides exposure to the companies that are right smack in the center of this trend.

And similar to 5G, our research team took the time to map out the machine learning process, and we found that big data analytics, database management system, certain semiconductor companies, and of course, those companies that are innovating in quantum computing, present the best way to gain exposure to the economic benefits that innovations in machine learning will derive.

And so, the index is a mix of companies that many people have heard of, they think of in semiconductors, right, but also again, Apple's in here because you can't ignore Apple, but it's pretty diverse and it's more global than 5G. For example, the U.S. is only around 55% of the index.

JL: Right. And so, I mean, I see Apple is definitely not in the top 10 holdings here. What's the weighting schematic, like are you waiting based on exposures or how is that?

SS: So, this index based on a lot of iterative work with Defiance is essentially equal weighted, because we've picked the categories and then in order that the giants don't dominate, we're taking an equal weighted approach. It's not rebalanced daily, so, of course, you're going to have some stocks higher than others, but it's about 80-85 stocks. And you'll see the weights are between 1.2% and 1.7% of the top 10 holdings.

JL: Yeah, sure. And then, is it a quarterly?

SS: Most BlueStar Indexes are twice a year, rebalanced.

JL: Okay, cool. So, yeah, the things have room to run and then all your winners and buy more of the things that haven't done as well.

SS: Yeah, and not to be not to be too much of a grammatical nerd, that means it's semiannual not biannual.

JL: Actually, I looked into that, and if you look up the dictionary definition of like bi-weekly or biannual, it actually could be used in either way every two years or twice a year. It might be one of these British-American divides.

SS: Well, while we're at it, I know you talk about this with every podcast, but just for your broad listener base, the proper American usage is indexes and not indices.

JL: Indices, yeah.

SS: Which is a British usage.

JL: Yeah, definitely. That's good. Okay, and so, I guess in terms of long-term dynamics here in the Quantum Computing and Machine Learning space, it seems like to some extent, this is a -- it's a byproduct kind of a means to an end. So, companies use machine learning to achieve a variety of different outcomes. And it seems like we're probably fast approaching a point where I mean, I'm looking at this index is 85% tech companies, but in reality, I mean, won't every company in the world be using machine learning and very -- I mean would Walmart (WMT) be using it as much as Amazon (AMZN) is in very short order?

SS: Yes, but Walmart's results will still be based on sales of goods and not as much the -- I mean but there's no doubt, part of this is a bet that every company large and small will be adopting more and more machine learning in their production process, in their sales process. My wife is in charge of e-commerce for a large global luxury brand and the things they're doing on their website and on the e-commerce site and the app would never have been possible five years ago. And her company's website is now their biggest store. And so, -- and we see how it works in e-commerce and now, it works in physical stores, and it's going to work in manufacturing. And you can see from the performance of this index and ETF that tracks it that investors are certainly noticing the potential.

JL: Certainly, yeah, it has definitely handily the S&P 500, all measured periods that I'm looking at here. So, their…

SS: And this ETF, just the volume has grown significantly in the last few months and we're seeing more creations and so, we think the AUM is going to continue to grow in this ETF.

JL: As the liquidity ramps up et cetera. Yeah, that's great. Okay, and then let's move over to the Defiance Next Gen Food and Agriculture ETF ticker symbol DIET and the accompanying BlueStar Food and Agriculture Sustainability Index.

So, to me, this is maybe the most interesting group here, really unique index and fun concept, which is essentially a play on a demographic concern around feeding a still rapidly growing global population, particularly in the midst of challenges posed by climate change and challenges to food sources as a result of that.

So, first of all, I'm just curious, where -- are you just kind of brainstorming these, are these ideas coming to you in the shower, or are you being asked by particular firms to create these indexes because I just think there's a certain level of brilliance that underlies a lot of these concepts here in the idea of wow, this is clearly something that's happening, but let's actually productize it and turn it into something that somebody could invest in and profit off of in some way.

SS: So, I do want to give a lot of credit to our partners, whether in this case, it's Defiance or in Israel companies, like Migdal and Kesem Excellence I have got, but…

JL: Sure, and for those that are unaware, those are the largest investing funds in Israel. So, they're the equivalence of like…

SS: Vanguard and iShares and SPDR and Fidelity. And I know we covered it in the last podcast, but most of your listeners are probably not aware that Israel, depending on how one measures is the 10th or 11th largest ETF and indexing ecosystem. So, it's as big as Australia or France in the world of indexing. And so, the issuers there, they look at trends around the world, they look at stock stories, everyone saw what happened with Beyond Meat (BYND), for example. And they look at what's being issued by other ETF issuers in Europe and the United States. And we go back and forth with ideas.

So, a lot of the best products that are, and we'll get to this in a bit that we've launched in Israel came from us pitching the issuer and saying, guys, defense has changed, and it's more than just tanks and bombs. And that from Israel, we'll get to some of those indexes in the middle in a minute.

But in the case of the BlueStar Food and Agriculture Sustainability Index, the term sustainability, I mean, if you look at the web searches, Google searches on it is, it's off the charts. Sustainability was one of the core themes of the World Economic Forum that just finished in Davos. I was just at Inside ETFs in Florida last week and ESG sustainability, socially conscious investing was top of mind, all four days of the conference. And so at the very core of sustainability is, what we eat, how we eat, and most importantly, how its produced and what's the impact on the environment.

Everyone understands that to produce a hamburger, or to produce a chicken cutlet, it's not just -- it's the production of the food that goes into the animal before it becomes the food, it's energy, it's transportation, it's all the pieces that utilize resources to bring food to our tables into our mouth. And so, one of the biggest challenges in the world is both from a societal standpoint, and an economic standpoint is how do we feed a growing population in a healthy and sustainable manner.

And so, in doing so, we're looking at innovative companies in all aspects of food in all aspects of people's diet, which is, I agree a great ticker symbol. So, we have companies that develop food flavors, nutrients from natural ingredients, and we got to know that space a lot from an Israeli company called Frutarom, which was recently acquired.

We also look at providers of fish and poultry, meat, and dairy, but we only include the companies that are using sustainable farming practices. We also include agricultural services, and smart irrigation. Again, we learned about this space from pioneering Israeli companies, like Netafim, which was also recently acquired, in fact by a Mexican company. But that was the pioneer of drip irrigation.

So, just like our other thematic indexes, we got a lot of familiarity with Agro Tech and Food tech, from the innovations that have come out of Israel. Also connected is livestock, health, livestock pharmaceuticals.

JL: I just going to see, I see you have Zoetis (ZTS) in there, which is that Pfizer (PFE) spin off of a couple years ago, so, yeah.

SS: Exactly. And so, it's a very diverse group. We were not experts before we built this index in Nordic countries, competitive advantage and sustainable fish farming, but we've learned a lot about that. And Norway is almost 9% of the index, and we think it's a fantastic theme. We are very excited to be taking this index to other potential issuers around the world. We've had interest from it, and even though it's relatively new ETF, and it's just getting going our partner Defiance is extremely excited about it and is going to be emphasizing the sustainable theme that is embedded in DIET.

JL: I was going to say this one, really, I think it captures the zeitgeist in a very significant way. And it's definitely something I'm going to add to my watch list and research further here. I'm curious some of the potential holdings here. So, you're only holding companies that are producing sustainable agriculture, exclusively, like for example, lot of, let's say, green energy indexes, there's always the question of some of the largest producers of green energy are also the largest producers of traditional fossil fuel burning energy. So, companies like Exxon Mobil (XOM) will have very large global footprint in green energy and innovation as they look to their future, but also be a big part of the problem simultaneously. And I wonder if there are companies like Monsanto, let's say it, I know they were purchased recently, but companies of that sort that maybe are kind of playing both sides of this issue and what the approaches they are in terms of companies.

SS: So, our objective is to be as pure as possible, to be 100% pure on any of these is not possible. You look at some of the ESG indexes and you have, you still have energy companies because they include only the least bad energy companies. We do not approach this from a least bad. We are looking for producers that do use sustainable farming practices, and not as a byproduct. This will continue to evolve and we will have challenges in the future when the bigger companies get into this space. Is there going to be a cut off?

One of the things, and it wasn't a question of yours, but I want to highlight this for your listeners is, from the day we were founded in 2011, BlueStar has had an index Advisory Committee. As we've gotten deeper and deeper into thematic indexes, about a year ago, we just we realized that we decided that we need a thematic index sub advisory subcommittee, which we've established. And we include people with tech knowledge, both public companies and private companies, as well as deep index knowledge and investing knowledge.

This is a dynamic conversation, and we recognize that not only our definitions will evolve, but in the investing communities, preferences and requirements will evolve. So, we accept that, when the biggest poultry producers claim that they're sustainable, we're going to have a challenge and say, well, how sustainable are you and do you meet the same standards of ours?

But if that happens, if and when that happens, that's a great thing. The index, which currently has 65-70 stocks, maybe will have to be 150 or more. And we'll have to establish a more rigorous purity test.

JL: Sure. And I mean, this is one of the reasons I love BlueStar as an indexer, because you're actually thinking through these issues in a very cutting edge way. So, I think for the bulk of the history of thematic indexes, what most of the issuers were doing was they were essentially just looking at GICS or some equivalent, and they were saying, all right, let's see a list of which companies they have in this subgroup here. And they were essentially just creating a cap weighted index in that way.

And there was very little deep dive going on in terms of understanding what the theme really was, how pure play many of the names that were being included in the index, were they were relying on somebody else's slice and dice of markets on thematic and industry levels, which I don't think was done for this purpose, exactly. It was essentially done for other purposes. And so, I think it's great that you guys are thinking about this deeply. And I think the result is indexes that are much more intelligently constructed as a result.

SS: I thank you for your compliment. And we definitely do view it that way. I mean, I know all the people who are involved in the development of GICS and it's still a an incredibly important part of the financial infrastructure, but when it gets comes to thematic, one can be guided by GICS. And in fact, it's been a long effort, but we hope to roll that out later this year. But we've developed our own thematic classification system. It's super-complicated, we think it's quite sophisticated. We're excited to share it with the industry because with thematic indexes, it's critically important to understand how companies get in.

It's also important to understand, overlap across thematic, because you're going to get overlap and something, it's not an elegant term, but we use it internally, under-lap, what is still missing? And where are those companies. So that, eventually, we want investors who -- for whom thematic investing resonates to understand that they can build a portfolio of thematic ETFs. But they still have to understand how that interacts with the rest of their allocation, which may be sector-based or size based or country based. We think this is going to be one of the elements of investing in the future.

JL: Sure, yeah now that's great. I can't wait to see that. And I imagine that it will have applications beyond just the fund management space. So, I could see that kind of a classification system being the kind of thing that could be very interesting to a site like Seeking Alpha, which is really just a research platform and uses more traditional thematic slices to allow our users to research different themes. And if there was a better way to provide that data and package it, I think it would be very beneficial.

SS: Well, we see it as so. I mean, we think active managers could potentially use it, individual investors researching their portfolios and researching ETF. So, we look forward to sharing it with you, Yoni.

JL: Yeah, definitely. Great. So, the other region of the world you seem focused on and I think this is still relatively small part of what you do but curious if you're going to be growing in this direction, is China and Asia tech. Why the focus there? Are you applying similar indexing techniques to what you've done with your Israel global indexes, including companies not domiciled in China or Asia, but do the majority of their business in these locales.

SS: So, we do have a China Internet and Software Index and an Asia Technology Index that are live, and there are funds tracking them in Israel. We have other regional indexes that are either under development or not live yet. But the reason we started with Asia and China is twofold. One, our clients were interested and they saw the success in the United States of some of these China-themed ETFs and they wanted something that works for them in Israel. We absolutely apply what is now the BlueStar standard global approach to defining companies.

So until very recently, almost all the Chinese tech companies were listed outside of China. Now, that's beginning to change. Hong Kong is somewhere in between, but you had a lot of Chinese tech listed in the United States, and so critical.

In Asia, it's a broader definition. It's even there are debates, for example, we've had debates with clients and prospective clients. You're going to do Asia, you're going to include India or not. I mean, obviously, India is in the continent of Asia, but not every investor thinks about it. And so, we do include India because there are some incredible cutting edge tech companies in India. But a lot of the smaller countries in Asia both developed and emerging, their tech companies get lost in the shadow of the giants from particularly China, but also even Japan and Korea.

And so, highlighting the tech companies that are in India, in Singapore, in Thailand is something that investors want. But what I do want to emphasize is as much as we're currently have live indexes for China and Asia, we're developing indexes for Canada, for the UK. We're looking at Brazil and Latin America. So, our ambition and our plan is to be a global index provider that adds value by really understanding the country dynamics, and the company dynamics and the industries.

And I know, you and I have talked offline on this. One of our next big steps into this space is an Emerging Market Index that has an alternatively weighted approach. And for this, we're mobilizing, not just my early history in the early days of emerging markets, but if any of your listeners go on our website, you'll see the people who are on our index committee collectively, including myself, we have over 150 years of emerging market experience.

And we're applying that to build a better index for emerging markets, not to compete directly with MSCI or FTSE or S&P Global because they're established. But if you look at the standard emerging market indexes for any of those three providers, you had a wade in China as of the beginning of this year of well over a third. And clearly, we're not -- we like China and we’re supportive of the growth of China. But that is not, in my opinion, the right way to build a diversified emerging market benchmark to have so much concentration in one country. So, we're doing a lot of research in that space, and we're very excited to introduce this index in the coming months as well.

JL: Looking forward to that. And in terms of A shares being added into MSCI and others, I think those weightings are going to go up even more for China, are they not?

SS: Absolutely, and so I wrote an article in financial advisor magazine in August, kind of highlighting these weights and the fact that many investors are going to open up their statements in January and see it year-end December. How much more China exposure they were going to get? Neither I nor anyone else who was concerned about, this was anticipating the coronavirus and the economic impact of.

My concern was really an investment risk issue and the fact that since China is still an emerging market, and in a crisis, just as we've seen in Russia, just as we've seen in Malaysia, and just as we've seen in Venezuela and Argentina, it is very possible that the government would impose some kind of investment restrictions or even capital controls. And lo and behold, we saw that already this week. And it helped support the market.

But we've seen how Chinese authorities have intervened in the past in 2015, and 2016 and so for the weight of Chinese locally listed shares to continually go up in the emerging markets. It does make sense from a capital market perspective because you're including more of the market, but investors also need to be aware of the risks and recognize that locally listed A shares in China are not necessarily going to give investors the same transparency or liquidity that they're going to get in locally listed shares in a more advanced emerging market, Mexico or Poland.

JL: Poland or Korea. Yeah, sure.

SS: And so, we think it's important that investors are aware of that. And, maybe we'll do a third podcast later this year where we could talk in more detail about that.

JL: That sounds great. Yeah, no, I'd love to dig in there. I had a great conversation with Perth Tolle over at Freedom Indexes. And she, of course, excludes China entirely, which is really kind of a value-based play because I don't think there's really any investing case to leave China out of -- not have any exposure to China whatsoever. But so, I'm very curious to see what your approach ends up being what the right amount of exposure ends up being in the emerging indexes that you built.

SS: So, I personally applaud her effort and I hope that the ETF that tracks it is a huge success. Our approach is a little bit more institutional, given that that's a lot of the background of the members of our index committee. And we want to introduce a benchmark that would be very broad, very complete, but attenuate not just the country weight risk, but also sector risks and single stock exposure risks, while not excluding a broad economic sectors, because we think investors ultimately are going want to have exposure to all the major growth potential of emerging markets, but might want to attenuate some of the risks.

JL: Yeah, sure. Now makes total sense. Okay, so in terms of other indexes you have out there right now or that you're developing, which are a couple that you're particularly excited about right now that you want to kind of put in front of our listeners for a bit.

SS: Sure. So, these indexes are, are live and they're either going to be launched as an ETF or an index fund relatively soon, or they already have, but U.S. investors may not have heard of them because they may be launched somewhere else. So, one concept that we are extremely excited about is it has been launched as a fund in Israel, as an index that we call our total security index.

If you think about defense, in the past, it was soldiers and bombs and tanks and planes and boats, and hardware, and traditional armies are going to remain a key part of defense. But as we've seen in the Middle East and Israel's example, of course, is foremost in our mind because we've seen it. A big part of defense is cyber security, another part is perimeter security. Israel’s borders are kept secure by not walls, but sensors and fences and balloons and technology that detects tunnels. And it's the whole idea of perimeter security, which can be used to defend countries but is also used to secure Olympics and other major sporting events such as the Super Bowl.

And so, it includes actionable intelligence, video surveillance, ability to process the data, that video surveillance gathers. It was an Israeli technology that helped capture the bombers from the Boston Marathon. And then adding to that the whole cyber front. So, cyber defense, cyber offense. And we consider this a total security concept, and we think that is the future of domestic security, national security. And so, we built an index that captures that theme.

Our client, IBI in Israel has launched index fund on that, and we were hopeful that we're going to find issuers, whether in North America or Europe or Asia for this index. It sounds ironic to talk about global tourism as a thematic index. But we've launched tourism index which an issuer in Israel is now going through the regulatory process. Global tourism stocks were hit hard, based on the coronavirus, but it's still a very strong demographic trend as the world grows and the world gets wealthier people want to travel. And so, we think this is a -- you asked about tech and non-tech. This is a more non-tech ETF, it's just a very robust theme that we think can be adopted.

JL: Sure, I was going to say yeah, I'm looking at different kinds of gaming stocks here some airline stocks, hotels. So, yeah, definitely heavy coverage of that theme and decidedly non-tech.

SS: Right. But also you have all the e-commerce companies that are selling tourism.

JL: You're saying like the Expedias (EXPE), those types of sites also. Yeah.

SS: Exactly. And so, this is an area we're excited about. The other thing that we are working on is that is non-tech is looking at the world and individual country economies, and really segmenting, where economies get their growth from, is it domestic exposure or global exposure, we already have a family of indexes that does this for the Israeli economy, and we're now rolling this out for other economies.

And we think as the world both becomes more integrated, but then, you have some backsliding as we've seen with U.S. and China's trade war, or Brexit, investors will increasingly look at their domestic economy and foreign investing in a new segmentation and so, we're doing work around that as well.

JL: Nice, that's great, and in terms of things that are I'm sure you can't actually disclose this, but are there indexes of yours right now that are likely to be launched in U.S. listed ETF wrapper in the coming months or not quite at that stage to do that.

SS: So, we're hopeful. We're in discussions, and but I can't do. When we work with the issuers, we really are partners in their product development process. And so, we almost act as an extension of their team, so they wouldn't want us to be talking about it. But everything I've spoken about and every in all the indexes that are on our website, those are there and if they're not yet attached to a U.S. listed ETF, obviously, we're interested in finding folks who find the theme attractive, and we would be happy to commercialize them.

JL: Sure, yeah, and so for those that are interested, what's the best place to learn more about your indexes and your approach to indexing.

Steven Schoenfeld So, the our website is BlueStarindexes.com, spelt the American way. So, B-L-U-E-S-T-A-R-I-N-D-E-X-E-S dotcom and on Twitter BlueStar is BlueStar Indexes. And personally, I'm on Twitter as well, SASchoenfeld. So, S-A-S-C-H-O-E-N-F-E-L-D. And we're at the industry conferences, and we're reachable by phone and email. That's information is on our website as well.

JL: Sure. Anyway, Steven, this has been great, really wide ranging conversation. I hope we can do it again sometime soon.

SS: So, sounds great. Look forward to it. And thanks for the opportunity.

JL: For disclosures, Steven Schoenfeld is long ISRA, ITEQ, FIVG, DIET and QTUM. I don't have positions in any of the stocks or funds discussed in today's show. If you've been enjoying Let's Talk ETFs, you can subscribe on Apple podcasts, Google podcasts, Spotify, or whichever podcast platform you prefer. And if you find this podcast useful, please consider leaving a review on one of those platforms so that other investors can discover it. You can also find this podcast on seekingalpha.com by typing Let's Talk ETFs into the search bar at the top of the site.

Analyst’s Disclosure: I am/we are long ISRA, ITEQ, FIVG, DIET, QTUM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Steven Schoenfeld is long ISRA, ITEQ, FIVG, DIET and QTUM. Jonathan Liss doesn't have positions in any of the stocks or funds discussed in today’s show.

Comments

[AppreciativeReader]

thank you for the informative transcript of the podcast