Financial Products for Hedging with Vest Co-Founder Jeff Chang

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But in this limited series podcast, we uncover the darker truth behind his global empire of faith and fear. From Exactly Right and Adonde Media, this is Two-Faced, John of God. Listen on the iHeartRadio app, Apple Podcasts, or wherever you get your podcasts. Bloomberg Audio Studios, podcasts, radio, news. This is Masters in Business with Barry Ritholtz on Bloomberg Radio. On the latest Masters in Business podcast, I sit down with Jeff Chang. He's co-founder and president of Vest. They are a firm that specializes in defined outcome investing, buffered ETFs. They try and remove the uncertainty of outcomes of your investing by using options and derivatives to come up with very, very specific products. I thought our conversation was fascinating, and I think you will also. With no further ado, my podcast with Jeff Chang. Jeff Chang, welcome to Bloomberg. Great to be here and thanks for having me. Well, thank you so much for coming. I'm kind of always fascinated by people who have unusual or diverse backgrounds. You in particular, U.S. Naval Academy and then an MBA from Georgetown. Is that right? What was the original career plan? So I grew up in Annapolis. The original career plan was to be, you know, be part of the Navy. And unfortunately, I got medically discharged for asthma and then decided to pursue more of a business path. And that's what kind of led me to Georgetown. And then after Georgetown, I actually – right after, I actually always wanted to start my own company, right? In fact, this is kind of a funny thing. Most people don't know this. I've never actually said this. When I first started, I actually started a flat screen TV company in 2012. OEMing them from China. And do you remember back in the day, like, flat screen TVs used to be like $25,000, $30,000? Oh, yeah. When they first came out, they were crazy. Yeah. So I was in D.C. selling those. In fact, I remember selling TVs to Reagan National Airport. So when you, like, look at what terminal you are back in the early 2000s, those were Jeff Chang TVs that were there. No kidding. I think another client was Six Flags, like when you – The weight? How long the weight is? Yeah, yeah, exactly. Exactly. Exactly. But then, you know, as TVs became further and further down, I was like, hey, that's not the business I want to be in. All commoditized. Why do you want to be there? Yeah, all commoditized. So it taught me a lot about starting a business on, you know, that and about life is that I realized that I needed actual hard skills that created a value add. And also, the other component was I also realized that doing like accounting books, I didn't pay too much attention in accounting. So I actually, for six months, went and studied for the CPA exam and took the CPA exam to be accounting, which was actually a twofold kind of reason. I think one of my mentors once told me is that like, hey, there is, for the better word, there's F you money and F you skills, right? You don't have that money. So make sure you build skills in which you're not always beholden to other people. And if you thought about it, that, you know, the two guaranteed things in life is death and taxes. And so in my head was I didn't want to be an undertaker, but I could take the CPA exam. and assure that. Participate in taxes. Exactly. Exactly. A growth industry. So that was the reason why I took the CPA exam was that like, hey, I know I would never starve because, you know, after the failure of my first firm, I was like, hey, there's you always have to have at least a safety net. And that also informed me that when I started a new company, accounting is actually extremely important when you're starting a firm or even a startup for that matter. And it actually came to pass that that has been a very, very important part of my career path as well. So it's certainly a useful set of skills. But I'm going to assume the first business didn't fail because of bad accounting. It's just a hyper competitive market with razor thin margins. And as stuff, as economies of scale came out, the market just dies for that. Yeah. And that really informed me is that you have to have an edge. I think over the 13 years of founding this company, I noticed that there were actually key features that I noticed even going through Y Combinator, my classmates and people that built very successful companies, they had very common characteristics for their success. Right. In fact, I had Asian parents. They optimized for intelligence, which was very, you know, you get straight A's, you play the violin or the piano and you kind of go through that. They're optimizing for Ivy League admission is what you're implying. Exactly, exactly. And or be a doctor for that matter. It's so different from Jewish parents. Exactly. And so it was, and then as kind of over the years, I realized that the optimization, like if, you know, when I have kids, because, you know, I don't have kids, at least none that I know of. But if I did, I would optimize for actually number one is grit. Like that in that grit is the not giving up. Like, you know, your company fails. What's the next thing? Like, you know, you pick up yourself from your bootstraps and you get up and go. So it's almost like the thing is like, as an example, my parents didn't let me play video games, right? But I realized video games, actually, if you introduce grit, like, you know, if you play Call of Duty, like I was the guy that when I play Call of Duty in my 20s, I would buy the headphones that would let me hear whether or not someone's behind me. Because whatever it takes to win, like that type of, you ever see that kid that does not want to lose, that like fails, but then gets up and figures out a way to win? That is grit. That resilience is more important than anything else. And then the second is I realize that nothing in this world can be done alone. That success requires you to have partnerships, friendships, and know people that can help build great things. Great things don't come by yourself. And that's what I think second is influence. Your ability to let people see your dream and believe in your dream. Think about this. It's like if you're starting a company, not just selling your product requires influence. Convincing your first investors, your first employees to quit their jobs, their high-paying jobs, to make almost nothing and take equity. That's – talk about like selling a dream. That's influence. Think about some of the greatest entrepreneurs out there. You probably heard like Steve Jobs is a reality distortion field. You know what that is? That's influence, right? That is one of the key things, I think, when you're looking at business. Influence is such a key thing of something that required to have success because, like I said, nothing in the world is done alone. This third, which comes back to my point, is creativity. The ability to spot things that other people don't see, right? To basically be – to see opportunity, to see things, to combine things together and have that opportunity. And then the last, if you combine it, is intelligence. If you do all four, and I can give you examples of people who are immensely successful just with grit. And by the way, it's in that order. Grit, influence, creativity, and last is intelligence. So I want to stop you there for a sec because I want to spend time going over Y Combinator. I want to talk about this. But before we get there, I mentioned the Naval Academy. You have such an unusual background. Talk a little bit about what your experiences were like at places like Freddie Mac, the World Bank, FBR, and ProShares. That's such a diverse set of experiences. What did you take away from that life experience and how did that ultimately lead you to launching your own firm? Yeah. So I could tell you one of the best things about what the military teaches you is not just teamwork and looking after the people next to you and really making a commitment. But there's also another thing is work ethic. Like I could tell you that I'm a morning person. I didn't grow up a morning person, but it's like 5 a.m. I'm up. And the funny thing is my girlfriend's a night person. She's like, how are you like sprightly at 530? And I was like, that is actually learned behavior. Right. So that was like kind of the first thing of learning grit and, you know, tackling the day early on, making your bed. Things, those small things in life, I think had been really, I'd say, important and, you know, kind of keystone in that process. The second is actually when I first started my first job at the World Bank after trying to start my company, I had to translate energy companies in China. And I had two problems. Number one was I didn't – my Chinese wasn't good enough. And secondly, my accounting wasn't good enough, hence the CPA came in. I was like, at least I got to learn one. And then I cut over to Freddie Mac. And if you remember, during the 2002, 2003 timeframe is when Freddie Mac went into restatement. So as a certified public accountant, I was extremely sought after at that time. So I worked at Freddie Mac, and I realized that I really wanted to – I read Liar's Poker by Michael Lewis. And I realized that, hey, I really wanted to trade mortgages. So I started to – Which, by the way, he said he is horrified because he thought this was a portionary tale. Yeah. And all it did was encourage more people to go to Wall Street. Totally. Totally. Reading that book really made me want to be, you know, what he said in the book, big swinging d**k, right? Like everybody, it was just such a fun story. It almost painted Wall Street in a specific way. But it was just the interesting part. And by the way, it also got me into reading Fabozzi about fixed income, about the mortgage market. And then I wanted to be a trader. So, you know, I studied for the CFA exam. I got my CFA charter. I didn't know that would lead me to over a decade of teaching CFA. But that was really fun to do that and kind of give back. but so trading mortgages uh freddy and then fpr i got to trade during 2008 i got to have a front row seat to uh seeing um the you know bear stearns uh lehman uh you know i remember trading uh repo during uh the 08 september 08 it's the the month i lost all my chest hair in in one month uh but it was fascinating i mean that's what i thought finance was like uh so then you know later on i cut over to convertible bonds and options. Then the flash crash hit in 2010, which was, by the way, I'd never seen an entire trading desk stand up within one minute of everybody's like, what's going on? So yeah, I got to see a lot of Wall Street in my 20s and 30s. It was definitely a formative time of understanding, you know, kind of what made capital markets tick and understanding And also understanding the pitfalls, the hubris of finance that – Well, that has to be the big takeaway from 08-09 is that markets go up and down. And if you're leveraged, it's a problem. And if you're highly leveraged, it's usually pretty fatal. Yeah, exactly. And disasters are always clear in hindsight, right? And you look back and you're looking at 20, 30 percent default rates. You're like, why? That would have been so clear in your mind when you started to look at some of the data. And so that was really formative. And the other component is kind of like what Warren Buffett says. You always know who's not wearing pants when the water goes out. Yeah, when the tide goes out. Yeah, exactly. And so I always, I'd say, think about, hey, if the tide goes out, make sure the money we manage for our clients that we got pants on. So risk management turns out to be more than just a phrase. It's really important if you're running other people's mind. Exactly. And it's something that you live and breathe. And what I actually, you know, a lot of our investment products is to try to get our clients to understand that and utilize kind of a lot of the tools that we build are basically pants. Like, you know, when the water goes out, make sure that you have something there because of uncertainty. That's to say the very least. So let's talk a little bit about that. You come out of this experience on a desk through the financial crisis. You launched Vest in 2012. What was the motivator? What led you to say, hey, I think we could do this better? Yeah, so I had a very short stint at ProShares where I met my co-founder, Karan Sud. He worked on the structuring desk at Barclays. And we talked about, you know, like, hey, let's start our own firm. And then our first idea was going to be buffers, like downside protection, that we saw in the structured note market. And by the way, this actually segued into the mortgage crisis because in 2008, the largest issuer of structured notes was Lehman Brothers. You have a 100% protected note, and now you're standing in bankruptcy court. So that was a big change in the industry. I think the structured note industry went from $120 billion to $30 billion in that time frame from after the 2008 crisis. I'll tell you a funny story. I was a market strategist at a brokerage firm in 2002, 2003, and we got pitched a downside-protected SMA. And I was just sitting in a conference room hearing this pitch. What are the – any questions? And I didn't ask the obvious question that I thought, which was, well, great, the NASDAQ's down 81%. Where were you five years ago? Who needs this now? But the question I asked and got called into the corporate counsel's office for was, hey, what about counterparty risk? How do we know that you guys are going to be there to make the trade good? sir lehman brothers has been here for 189 years it'll be here long after you're gone i'm like okay okay no it's an actual risk that no one was even discussing it's just assumed uh so it turned out that um you know counterparty risk is a real it's a real thing oh yeah it's a very real thing so we're going to talk a little more about vest and buffer funds in a moment but i just want to get the timing right and talk a little bit about your experiences at Y Combinator. You launched Vest with your co-founder in 2012. You joined Y Combinator in 2015. What led you to saying, hey, let's see if we can hook up with the guys over at Y Combinator? Yeah. So that's the thing in finance is there's not too much innovation, right? Because it's a lot of regulation and so on and so forth. And so even at our company, we always, even our identity today is still, you know, Silicon Valley meets Wall Street, right? I always think that like in my mind, if, you know, someone in Silicon Valley were to come into our business, they could end up in jail, right? Or if Wall Street ends up in Silicon Valley, you know, you might be, you know, just end up in a ditch because, you know, you're in over for sure. Yeah, exactly. Because the end of the day is, you know, we went four years with no income. Wow. Right. Like lived off our Wall Street bonuses. Me and my co-founder, Karan Su, like we didn't get paid for, you know, four plus years to found this company. Like that's how much you have to the grit and the belief in something. And in that culture, really, really, I think, comes out of kind of startup, kind of the Silicon Valley area. Y Combinator at the time. Run by Paul Graham, is it? Paul Graham, that was the first year Paul Graham stepped down and Sam Altman, when I showed up, was president of Y Combinator. 2015? Yeah, 2015. Sam was president of Y Combinator. For the folks out there that don know so YC similar to a college application you fill out an online college application You actually don need a company They help you form the firm And the companies that have come out of that program Airbnb Reddit Coinbase Storedash OpenAI was funded by YC Research. So all of that, all of those firms came out of YC. So in fact, I think I read a book called The Launchpad, which talks about YC, the companies that they're, I mean, the first class of YC included Sam Altman, Justin Kahn, who founded Twitch, and Alexis Ohanan, who founded Reddit. And I think there was like, correct me, maybe nine companies. I mean, that's an all-star cast, if you ask me for a class. And so it was definitely someplace that we wanted to be around. There weren't a lot of finance firms. In fact, Vest is the largest asset manager to emerge out of YC. So it was definitely something to try something different and really get into the Silicon Valley and really push the innovation within finance. I don't know if this is still the case, but a couple of years ago, the standard deal was something like half a million dollars for 7% of the company plus a three-month program of building, iterating, pitching, et cetera. Does that more or less sound right? That's right. That's the deal today. our deal was probably close to one fifth of that. Oh, really? Well, 10 years ago, a lot has changed over the last decade. And they have done a great job. I think they have maintained their, I think the stat was since 2012, 20% of the super unicorns were funded by Y Combinator. Wow, that's amazing. And then like second place is like 3% plus or something like that. And this is like a full-on boot camp where it's three months and they are really taking you through the process. Here's how you build a startup. Here's how you iterate. When you first joined YC, did you have any idea what the final product of Vest was going to be? Or did that experience clarify where you wanted to go? There were certain – we went in with the idea of buffers and downside protection. There were certain pivots as far as like, hey, what's the best delivery vehicle to start with? Meaning an ETF as opposed to an SMA? Yeah, exactly. Exactly. But that was the foundational. If you even look at our application, our pitch, it was exactly talking about the need for downside protection, the need to fix liquidity and credit risk and other types of instruments. Those were kind of the foundational problems because YC always says that, like, make something that people want. And then don't just come up with the ideas. Start with the problem. You're solving for a specific problem. And the problem needs to be painful enough. And so anybody out there that's ever thinking about starting a startup, always start with the problem first. And make sure the problem is painful enough for your customer that that becomes, you know, how you solve it can change a little bit. But the problem always existed, and we thought that that was a noble problem and a painful enough problem to seek. That's a very customer-focused approach to building a business. I don't know if Wall Street necessarily thinks in those terms. There tends to be an attitude of this is how it's been. It's been successful. Why do you think you're smarter than everybody else, smarter than the market? Like that's the sort of pushback you've gotten and that you tend to get when you roll out a different approach. How has the experience been marrying the Wall Street ethos where failure is abhorrent and the Silicon Valley mindset, which is, hey, failure just gets you to the solution. It's just one more step. And that's where kind of the ethos of our Silicon Valley meets Wall Street is that we live in both worlds. Like our background, me and Karan's our Wall Street backgrounds, that there is no move fast and break things mentality on our Wall Street ethos. It is measure four times, cut once. This is people's livelihoods, their wealth. So that part we did not adopt. not like break things type mentality. That is not. It's hard to do that when you're a highly regulated industry. Exactly, exactly. Second is that we also realized you can't do this alone. It's not like we're starting an Airbnb where we can just kind of do X, Y, and Z. We needed partnerships. We needed, like coming back to the point of influence, like we needed people that really could help us with innovation. Hence, we actually only have two investors. One is Siebel Global Markets, Chicago Board Option Exchange, the largest option exchange in the world. And First Trust, one of the largest ETF providers here in the United States, that has been intricate in the ability to shape and mold the industry, just like even with the exchange. Wait, let me roll you back. You said you only had two investors. Now, today. Now, today. All right. So before we get there, let's talk about the post Y Combinator experience. So they give you barely six figures for a small chunk of the company. they take you through a boot camp that teaches you all these different things from focus on problem solving to iteration to pitching investors. Who were the early investors in Vest? So we had our lead coming out of Y Combinator was First Round Capital. People aren't familiar, that's the company. It's a great name if you're doing venture investing. Exactly. They were one of the first investors in a small company called Uber. So that worked out okay. Yeah, they got a lot of big wins there. And after that, we had kind of a party round of a lot of different angels and other smaller VCs. But after that, that's when Civo came in and wanted a bigger stake in the firm. But the whole YC experience was very much like the show Silicon Valley. Which I just loved. So great. And to the point where, like when we got to YC, we rented a hacker house. By the way, the house that we rented was called Hacker House. And it was a one-story building with like three bedrooms, not enough bedrooms for all of us that were working there. I think Karan had to sleep on the floor on a mattress for three months. And by the way, this is coming from being over a decade on Wall Street. Like we're now sleeping on the floor. Hey, there's nothing to do but get this done. Exactly. And this is why I say like sometimes like if a former trader on Wall Street ends up in Silicon Valley, they may end up in a dish because like you have to go four years, no pay, sleep on the floor. It's not fun where you're used to like wearing, you know, suits and loafers on Park Avenue. It's a big shock to the system. But that's the thing is like, you know, at the same time, it's OK sleeping on the floor. It's better than sleeping on the ground when you're in the military. But that that's the grit that you kind of go through. Right. Coming up, we continue our conversation with Jeff Chang, co-founder and president of Vest, talking about his experiences at Y Combinator. I'm Barry Ritholtz. You're listening to Masters Business on Bloomberg Radio. in London with the hosts of the Bloomberg Daybreak Europe podcast. We're up early every weekday keeping an eye on what's happening across Europe and around the world. We do it early so the news is fresh, not recycled, and so you know what actually matters as the day gets going. From Brussels, I'm following the politics, policy and the people shaping the European Union right now. And from London, I'm looking at what all that means for markets, money and the wider economy. We've got reporters across Europe and around the globe feeding in as stories break So whether it's geopolitics, energy, tech or markets, you're hearing it while it happens It's smart, calm and to the point And it fits into your morning You can find new episodes of the Bloomberg Daybreak Europe podcast by 7am in Dublin or 8am in Brussels, Berlin and Paris On Apple, Spotify, YouTube or wherever you get your podcasts I'm Barry Ritholtz. You're listening to Masters in Business on Bloomberg Radio. My extra special guest this week is Jeff Chang. He is the co-founder and president of Vest. The firm manages $50 billion in ETFs that are described as outcome-oriented investing. Some people call them buffer funds. So you have this experience with Y Combinator. Any of that graduating class with you you're still in touch with who else were so uh i'm not sure folks out there know git lab oh of course sid was our our group um my no relationship to github which predates that by a long time but yeah but git lab was our i think they ipo'd on the nasdaq uh i think over five billion or something like that um they're doing really well uh there's the Equipment share was also our batch. A lot of big winners in our batch. And by the way, you've probably been to college where you go into a lecture hall, right? And you have your first day of class. The first day of YC, you know what they tell you? They're like, you know, 4% of you guys in this room will be billionaires. Right. No intimidation factor at all. By the way, that's the math, right? On average, it's a 4%. I think right now it's like 5% to 6% unicorn rate. But how many classes can you go through that? Like, you're like, hey, 4% to 5% of you guys are going to have extremely successful companies coming out of this class. And by the way, you look around, you're like, oh, man, is that really possible? And then you blink 13 years later. You're like, wow, it really did happen. Like, there's incredibly successful firms and incredibly successful people. And you look back. And, like, even now, I look at my group partners. I look back, my group partners were incredible. I had Gary Tan, who founded Initialize, and also is now the present COY Combinator. Alexis Ohanen, founder of Reddit. Justin Kahn founded Twitch. Kat Melinek, who was like an all-star in marketing and PR. Like, I had an all-star group. Yeah, no, it definitely sounds like it. We're talking about winners, but Silicon Valley wears losers like a badge of pride. Like it's, hey, this is what's expected, which is very different than the way the East Coast tends to approach things. Tell us about that not being afraid to fail, not being afraid to try things, iterate and take this doesn't work. Let's go with that. How different is that experience on the West Coast than what you experienced on Wall Street? Yeah, I mean, definitely in Silicon Valley, failure is okay. They have a saying, if you're going to fail, fail fast, right? Whereas I feel like on Wall Street, it's like you don't want to fail fast. Like that's called a blow up, right? So there are some parts, given the industry that we're in, we have to ignore some of the aspects of it. I think everything that we did, I wouldn't say was ultimate failure, maybe not the success that we wanted, because we wanted to make sure everything we built were strong and foundation, right? It would like last, stand the test of time, no matter what happened. Maybe not wildly successful, but then that that's how you pivot. So it's not necessarily failure per se, but not the success you're looking for, then pivot and try to find other ways to deliver and how to solve the problem better. But I still think that the idea of not being afraid of failure and that grit and the ability to, you know, pick yourself up, it's that attitude that like, you know, this is not the end. Failure is just the mother of success. And you just have to keep learning from those mistakes because everything is a learning process. I can't tell you one person that I know that's successful that has not failed. No, that makes perfect sense. You know, you don't know what's going to work and you don't know what's not going to work until you try. And if, you know, there's a story about, hey, if you're not failing occasionally, then you're just not taking enough risk to say the very least. All right. So let's talk a little bit about how this developed. You come out of Y Combinator sometime in 2015. When did you first start taking client assets, client money? Well, in YC, we were taking client assets. I think we launched our first mutual fund in 2016. It was the first buffer fund of its kind. And then – So wait, let's stay with mutual funds, which have their own complications with capital gains tax. Sure. Given what you do primarily with derivatives and options in order to create that buffer, how does that play out in a mutual fund wrapper? Yeah, there are obviously challenges that may not be as, well, let's say the same as like an ETF that, you know, in 2019, they introduced the in-kind. This is also another example of the partnership with Cibo. It's been around for real estate for forever, it seems. That's right. And it just took Wall Street a while to catch up to that. Explain what in-kind creation and redemption looks like and what it means to you. So in mutual funds, there's a challenge in some cases that if there's a redemption, you would sell your securities, which could have the potential to realize gains. And ETFs, not just unique to these ETFs or all ETFs, they have the ability to, let's say, in-kind security. So when someone wants their money back, instead of giving the market maker selling securities and giving them cash, in some cases, you can give them securities, thereby not potentially realizing the gain for the shareholder. So it has the potential for tax efficiency by having in-kind. Now, prior to 2019, October of 2019, that was not – we weren't able to do that with options. That was introduced in October of 2019, so we launched our first buffer ETFs in November of 2019 in partnership with our partners at First Trust. And so that has been one of the fastest-growing areas, not just for our firm but as the ETF industry as a whole. So let's talk a little bit about what a buffer fund does. What are the advantages? What are you giving up in order to obtain those advantages? What's the largest ETF now at Vest? So the largest buffer fund and the one at Vest is BUFR. And it's built on the foundation that the kind of fundamentals of the strategy is the buffer strategy, which is let's say you get S&P exposure for one year. The first 10% is protected. So as an example strategy, if S&P is down 10, you're flat for the year. And then you get upside up to, let's say, a predetermined cap. So let's say S&P is up 15, you're up 15. But the most you can make is 15. So if S&P is up 16, you're up 15, right? So you're capped out at that 15%. So years like 23 and 24 are kind of unusual. You don't usually see 25% two years in a row. But if you were in the fund in 22, down 22% means you're only down 12%. That's right. Right? That's right. So that's the trade-off. Yeah. Yeah, and here's the thing is that most people don't realize these strategies have the potential to outperform the market, even if you're talking about high double-digit equity returns. Because think about this. In 2022, because of inflation, when interest rates went up, stocks and bonds both went down at the same time. You could have mixed your stocks and bonds any way you wanted in 2022. 60-40 was negative in 2022. And unless you were managing money 40 years ago, you had not experienced inflation. And you couldn't hide anywhere. I mean, you were like Tom Brady choosing between alimony and child support while taking your kids to jujitsu practice. Like the thing is, there was nowhere to hide. Right. Whereas if you were hedging and the great thing about hedging is if you buy S&P and you buy an S&P put, that put is perfectly negatively correlated. Right. It's an inverse. It's the opposite. Right. And so imagine if you had a strategy that did not participate in the majority of the drawdowns in 2022. That means you had more to invest to take advantage of the gains in 2023, 2024, and 2025. This is the compounding effect of winning without losing, right? It's the compounding effect of playing offense and defense at the same time. Because the end of the day is a lot of times, you know, these types of strategies are not the get-rich game. If you're 20 years old, probably not the strategy for you. But in our industry, a lot of the people that have wealth, they're in the stay rich game. These types of strategies are in the stay rich game because if you have wealth, you just don't want to be poor, right? So that's why – that's the kind of crux of protecting your equity exposure. And the idea is the issue with hedging has always been that to hedge with options and so on and so forth. One of the biggest, and they had surveys on why investors and financial advisors don't hedge with options. And everybody said the same two things, compliance and scalability. The compliance burden associated with trading options and scalability. Because when you buy a fund, you buy a stock, you can put in your portfolio, fall asleep for 30 years. Maybe you rebalance once a quarter. You buy an option every 30 days 60 days from now you have to trade it By having it inside a fund we can trade that for you And so now you can asset allocate rebalance once a quarter It solves a lot of those issues And this is the thing that I find very interesting is two things. Number one is these strategies have been around for over 30 years. The buffer structure note has been around for years. Buffer annuities, I think, were introduced in 2010. All we did was cut the bank and insurance company out. way. Instead of having the bank or insurance company hedge themselves with options and then issue you a policy or issue you a no, we just said, why not just put the hedge in a fund and now you own it? We cut the middleman out of the middle. The other component is to think about in business that I always look back. So Richard Thaler, the professor at the University of Chicago, won the Nobel Prize for behavioral finance, right? Essentially created the field. Yeah, the nudge. And I believe one of the studies by Cornell University had this study of, I think they had kids in the lunch line. They gave them free apples. Like, you get the end of that, you get a free apple, right? By the way, the consumption was like less than like, I don't know, 20%. Like, it was a very low consumption rate. No one took the apple. Then they cut the apples up and they put them in little bags. By the way, the consumption went through the roof. Why? This was the nudge. This was the idea that you make it simple, people will use it. Think about options as apples. And then that we had bagged those apples to make it easier for the user to consume them without the compliance and scalability burden to them. Because theoretically, any broker or any financial advisor out there can actually trade those themselves. But that's like the same thing. Like every child could sit there and cut their own slice their own apples, but they don't want to do that. So let me ask you, because you've brought this up a few times and I want to hone in on this. Is your target consumer mom and pop Main Street investors or are you focused more on the advisor channel or brokerage channel or all three, some combination? We are not that focused in the retail space. Mostly, and by the way, I would say 100% of our focus is in financial professionals. Really? Because those are our partners. Those are the people that we stand side by side with. We build products. Those are the people we're solving problems for them, which they're solving problems for their clients. We stand side by side with the financial professionals that manage, you know, the wealth. And once you bring them up to speed, it's incumbent on them to find the clients that think are the right fit for this and they get to explain that. Exactly. Because every single client is different and unique. We make products across and every client is different and how that gets utilized. We help the financial advisor even how to best build and achieve their client's investment objectives. But as far as the end client, that's typically not our customer. So I mentioned 60-40 earlier. Does a buffered fund act as a substitute for a 60-40? In other words, if you own, whether it's 60-40, 70-30, you own bonds for income, of which there hasn't been a lot over the past 15, 20 years, but also as a non-correlated asset with equity, other than 81 and 2022, does this – and it offsets the volatility and drawdowns in equities. Do buffered funds behave similarly to a 60-40? Is that the thinking? I wouldn't say similarly. Let me give you kind of how we think about it. So if you look at, let's say, a strategy of a 10% buffer on S&P, in fact, there are indexes out there that track these. And if you compare that to, let's say, like a BlackRock 60-40 portfolio, you actually notice the standard deviation is almost identical. The volatility is very similar, right, over the long term. But the source of the risk management is different, right? You're actually hedging. You're not hoping that the correlation between stocks and bonds, the negative correlation is there that, you know, when my stocks go down, I hope my bonds go up kind of situation, right? Well, historically, they do most of the time. They didn't in 2022. They didn't in 1981. Exactly. So it's every 40 years or so we seem to get this headache. Or with inflation at 3%, what happens if inflation rears its head again? The next rising – Exactly. You'll end up with the same issue the next time we see a serious set of rate hikes. Exactly. And this is why we say, why not diversify your risk management and hedge? So if I have a $100 portfolio, and let's say I have $60 in equity, $40 in fixed income, and let's just say I take $10 out. I take $6 from equity, $4 from fixed income, and I put it into, let's say, a 10% buffer strategy in S&P. Perhaps the standard deviation of the portfolio could be very, very similar. But notice the source of your risk management has changed. You've introduced hedging as the source of your risk management. Without the compliance, without the trading scalability issues of options, you've introduced hedging as the source of risk management if inflation were to rear its head. Because the thing is, this is what everybody needs to ask themselves. If inflation were to come back, right, which is a very – it's not a – there's a – It's a non-zero possibility and way above that. Yeah, exactly. What in your portfolio is going to save you if 2022 repeats itself? That's the question everybody needs to ask. I always get the answer, commodities. Great. Commodities, it's a timing trade. Right. You can get in, it'll work. But when it's not inflationary, what happens to that trade? I mean, I'm not smart enough. And let me point out that gold didn't do great in 21 or 22. It's only in the past few years where it's really exploded higher. That's right. That's right. So I'm not smart enough to time that trade. And that's the great thing about these types of solutions is you don't have to time the trade, right? Like you're diversifying your risk management through just hedging. And like I said, repeated again, this is the stay rich game, right? How do we protect wealth? Not like make exorbitant amounts of it, but protect wealth and get a decent return from people's wealth. So, Buffer is 10% hedged on the S&P 500. Tell us about some of the other ETFs you guys run. So, one of the kind of overall themes that we've seen in the market is, you know, two things that really people are looking for is downside protection. But the other one is income generation. As the boomers are in retirement, the need for yield has really shown how high it is. I mean, if you look at the derivative income space, I think in 2018, Morningstar was ranked 58th. Last year, it was ranked ninth in flows, right? People are looking for income. And as volatility goes up, just like strategies, like writing cover calls, are extremely, it's another way to derive yield by monetizing volatility in different asset classes. You can do it in gold. You can do it in Bitcoin. You can do it in equities. You can do it in fixed income. And that's the thing is people were always thinking one dimensionally, That like the innovation is always about thinking three-dimensionally when everybody else is thinking in two-dimension, right? This is why we have, you know, built strategies to derive income from, you know, not just equities but fixed income. But from gold, from Bitcoin, from any asset class. So give us a few ETFs that are primarily income-focused. Yeah, so one of our biggest ones is KNG, which tracks the dividend aristocrats, RDVI, which tracks the dividend achievers. These all provide attractive level of yield, I think. So dividend aristocrats tend to be high dividend, low price. They tend not to be high PE companies, so they're fairly stable. Yeah, so the companies that have grown their dividend – this was created by S&P back in 2005. Companies that have grown their dividend for 25 consecutive years. Wow. And these are dividend growers. They're not dividend payers. So they typically, I believe, yield less than 2%. But they've grown their dividend for 25 consecutive years. So for a company to grow their dividend for 25 consecutive years – That's a stable business. Yes. And it has to cash flow. It's not a P.E. play, right, for all intents and purposes. It is companies that have to have strong moats. And the other thing that people miss is good corporate governance because who makes dividend policy? The board. For a board to never cut a dividend for 25 years, it actually was a filter for good corporate governance. Now – And that stock symbol is – that ETF symbol is? KNG. KNG. Yeah. And you guys generate additional income on that with covered call writing. That's right. So if it's a 2% yield, what do you actually pull apart general? So our distribution yields probably in the past year, over 8%. Really? That's a big number. And we're on average, I believe, covering around 20% of every single name. So if I have 100 shares in Walmart, I'm writing an at-the-money call on, let's say, 20 of those shares as an example to achieve that target income. So one of the things that core beliefs that we have when writing cover calls is like one of the biggest drivers is stock selection. You pick good stocks, you get good results, right? While, you know, the aristocrats, they don't have the high-flying MAG-7 names. But definitely as you look forward into the windshield, these are really going to be the names as the market bronze out, right? I really do think in the next year you're really looking at kind of a barbell approach where you have the NVIDIAs and the hyperscalers in your portfolio. But you really need to have the strong staples that cash flow. What are some of the names in KNG? Well, you got like Chevron, Walmart, like your really blue chip names that are there. I mean, look at Chevron. They have the potential to be one of the beneficiaries of oil in Venezuela, right? Like they were there before. And these are the cash flow companies that, like I said, grown their dividend for 25 consecutive years. These are strong names that are out there. Do you do anything with fixed income on the yield side as well? Yeah, so we have cover calls on high yield. Tracking HYG gives you also, I believe, a double-digit distribution yield, only covering about 20% to 25% of the portfolio. So you're still getting over on a weekly basis. And what's that ETF symbol? H-Y-T-I, Heidi. And what about – do you do anything on the commodity side? So we have gold, IGLD. So, you know, because not all gold has been a hunk of metal since your portfolio doesn't do anything. Now you can monetize the volatility and have, you know, potentially. Same process, covered call writing. Exactly. So this is why CBO is a partner with you guys. How does that relationship help you manage all of this option writing, all this call activity? That's a great question. So let's take iGold as an example, right? Right. Prior to that fund, GLD options stopped trading at 4 o'clock. By the way, this is one of the reasons why SIBO partnered with us is how do we solve certain issues in the option market for the construction of funds, right? If options stop trading at 4 o'clock and I need to know the close, I can't create an ETF on that, right? S&P options, SPY options, they trade – they close at 4.15. Today, GLD options stopped trading at 415. By the way, that's a really cool statement to say, that the entire street trades GLD options that extra 15 minutes because we wanted that. That's great. Because you have to take the closing price at 4 and then use it for an end-of-day hedge. We need that option market to be open that extra 15 minutes. And by the way, those products by First Trust Invest are the reason why we have an extra 15 minutes to trade GLD options. So if you're late and you're trading at 405, that's us. And option trading is so much more complicated, so much more difficult. Like you, I started on an equity desk but have always been a little bit of an option junkie because it's so fascinating. And most people don't use options correctly. They're just making like a lottery ticket bet, which tends not to be smart. You guys are using options for a very specific purpose to achieve what you describe as a defined outcome result. Solving a problem. Solving a problem. Really interesting. Yeah. Coming up, we continue our conversation with Jeff Chang, co-founder and president of Vest. I'm Barry Ritholtz. You're listening to Masters in Business on Bloomberg Radio. The news doesn't stop on the weekends. Context changes constantly. And now Bloomberg is the place to stay on top of it all. Hi, I'm David Gurra. 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Make us part of your weekend routine on Bloomberg Television, radio, and wherever you get your podcasts. I'm Barry Ritholtz. You're listening to Masters in Business on Bloomberg Radio. My extra special guest this week is Jeff Chang. He's president and co-founder of Vest. The firm specializes in outcome-oriented investing via primarily ETFs. They run over $50 billion in assets. Before I get to my favorite questions, I want to ask any – so we've covered stocks, bonds, commodities. You mentioned crypto. What are you doing in terms of crypto and generating additional defined outcome results using derivatives? Yeah, so we have a strategy, also target income, almost I believe about an 18-19% yield and you're still only covering about 20%. So that strategy tracks Bitcoin. So you can get on a weekly basis, let's say, you know, 70, 80 percent of the upside in Bitcoin and then, you know, really high, almost 20 percent yield by monetizing the volatility. It's the same thing because like just like gold, some of the knock is is that it just sits in my portfolio, doesn't do anything. And the value. Well, no one can say that about Bitcoin. It's always doing something, going up or going down. Yeah, exactly. And what's the ETF symbol for that? Ibit. Uh-huh. I'm sorry, I'm sorry, not Ibit. That's BlackRock. Yeah, yeah, yeah. DeFi. D-F-I-I. That's right. D-F-I-I. And so that's options. How much of the upside? How much of the downside do you get and give up or is it just geared? We're just writing cover calls to target a specific yield. Like I said, I think anywhere from we're covering every week about 20% to 25% at the money. How often do those roll? Every week. Every week? Every Friday, yeah. The reason why we like weeklies is that when you sell a call, you want the premium to go to zero. Right, that's right. And that decay accelerates in that last week if you're selling a monthly option. So if you do it four times a month, you have the potential to generate more yield because you're always capturing that extra decay. It's like football tickets, right? Like you ever go on StubHub, like game time's at one o'clock and you go on StubHub at 12, the ticket starts to drop like a rock. Imagine if you kept tracking that and you made money off that drop, right? And everything kind of follows that. In fact, there's actually only one thing that doesn't follow that. You know what that is? Go on. Giants tickets. They decay before the season starts. Well, as a guy who used to be in New Jersey, for sure. Or Jets tickets. Actually, both of those are an anomaly. So really, so in other words, bad assets don't generate good option returns. That's pretty reasonable. How often do things get called away? That's obviously the risk when you're writing calls. How do you manage around that? How frequently is that built into your models? I mean, that can happen pretty frequently. But here's the deal. Think about this. And this is just a concept of – let's say I collect a $2 premium and the stock goes up $1. You're good. Yeah. I made a dollar, but it still got called away. But I still made a dollar. I just buy the stock back or however way I deal with the assignment depending on the strategy. So the idea is as long as the stock doesn't go above the premium if I'm writing out the money or what I've actually – It gives you a buffer to repurchase the stock, not at a loss. Exactly. And this comes into what we call about the implied versus realized premium meaning options If I look historically of a particular asset whether it be a stock or a commodity or whatever and it historically moves X I not going to sell the premium at that number Right. It's got to be X plus. Plus, right? Just like when you sell car insurance, like if my expected loss is $1,000, I'm not going to sell the premium for $1,000. I'm going to sell it for $1,200 to make $200, right? That extra little bit. So in options, they have what's called the implied versus realized premium. And so that's really kind of where you're trying to capture is the implied volatility versus what the realized volatility. And you're hoping that the implied will be greater than the realized. I mean, that's the hope and options, especially when you're selling them. All right. I think there's a stat that like, you know, 60 percent or 70 percent of the time, the person selling the option wins the trade. Right. Right. Most, you know, old option traders don't die. They just expire worthless. is the old desk joke. But, you know, if you're a writer of options, you're making a very specific bet. And if you're a purchase of options, you're making a very different bet. Yeah, yeah. I mean, you see this, you know, in some cases of buying options, like you said, it can, you know, even Warren Buffett said there could be weapons of mass destruction. I mean, you can see these zero-day options that people are buying. Yeah, that's become crazy. I mean, those are like scratch-off lottery tickets. Right, right. Who's buying them? I don't know. The kid in his mom's basement, the Poppinist pimples eating mayonnaise sandwiches. I don't know. At one point in time, I imagine that there were market makers that had a hedge, that for reasons that were complicated, they were stuck with overnight positions. Like I almost understand that. But the day traders playing with these, this is fan duels and draft king, pure speculative nonsense. Yeah, exactly. So that's why we don't have anything in that space. But it is something to look at from afar. Really, really fascinating stuff. Last question before I jump to my favorite questions. So you're constantly thinking about how do we hedge this position? How do we create a buffer? How do we define a specific outcome for clients? What do you think the average investor isn't thinking about relative to that approach, but perhaps should be? What do you think most people are kind of missing or not paying enough attention to? And it could be a geography. It could be a policy, whatever. But you're obviously thinking about a lot of things differently than the typical index purchaser. What are we missing? Yeah, I think while we've had a tremendous amount of growth in kind of the options space of downside protection and the income generation part, I think a lot of the market is still, I think, thinking two-dimensionally in stocks and bonds, right? Like, instead of just diversifying across, think about – you can still diversify, but think about other ways to shape your return, right? Or thinking about income generation out of the equity portfolio. Think about income generation or boosting yield in your fixed income part of it. And then also thinking about risk management beyond diversification. While there is a lot of good part of the financial professional space that is picking up on this, I still don't think like we're just tip of the iceberg at this point, right? That's on one standpoint. I think people are still missing. The second I think is the – I think one of the biggest drivers in the market today, and no one would disagree, is AI, right? Sure. However, that's not the part that people are missing. that, you know, having been through the 2000s, I really feel like this is like 1999, 2000. Like think about the stocks that were big then, right? Like you had- Juniper Networks, Metromedia Fiber, right? Like, you guys remember Priceline? Global Crossing. Yeah. You know, a lot of these companies have been either absorbed into other companies and still Priceline, Expedia, there's a through line there. How is Pets.com not chewy today? So some of them were just a little early. Exactly. So let me ask you, who won that trade? Facebook, Google, Netflix. Amazon. Amazon. Apple, Microsoft. A lot of those companies were private or startups then. Google. Right? Think about that. And I think that's the same. History doesn't repeat itself. It rhymes. I actually think a lot of the hugely successful companies from AI are in startup mode. They're at Y Combinary. 90% of the – almost 80% to 90% of the companies at YC are AI-driven. They have – I've seen an article recently. Their month-over-month average for the batch is double digits, meaning their revenue is growing over 10% month-to-month. Or in some cases, week-over-week. That's unbelievable. I said to someone the other day, someone said, who's going to dethrone NVIDIA? And I said, the founder of that company hasn't graduated high school yet, but he's coming or she's coming. He's not. It's not impossible. All right. Let's jump to our favorite questions that we ask all of our guests, starting with who are your mentors who helped shape your career? Oh, that's a great question. um i would actually uh have to say my brother really yes um and uh in what way my i have an older brother he's four years older than me um he's the overachiever i'm the underachiever of the family uh so uh my brother i remember growing up he was like the uh he was good at math and science i would literally show up to class and they'd be like oh you're bill change brother you must be smart by the way you know what that does to you it's like a lot of pressure yeah a lot of pressure um so he went on uh he worked at apple and then uh was at tesla um i think he was chief architect of the dojo um um dojo project if folks that aren't uh familiar with dojo it's the ai system at tesla that coded the self-driving right um he uh recently and in fact bloomberg wrote an article about uh his firm density ai that uh i think they are one of the the first companies to really uh kind of take on um because the dojo i think system is one of the one of the more efficient ways that can take on nvidia for the chip so that's why it's funny that you said like hey the person that's going to dethrone nvidia may may not may still be in high school i was like yeah he might just be four years older than me right um or he could be uh deep into the process already yeah so um uh they recently um uh like i said like bloomberg just wrote an article about them on density ai and he he has been extremely like a lot of times people ask like hey did you work that hard because your parents were you know like tiger parents no actually i was just chasing my brother the whole time it was definitely a different dynamic um and uh yeah i couldn't be more proud of him. And a lot of times people are like, hey, what tea are the Chang's drinking? Because we're, but we get along great while we're competitive. We support each other, but he's been- You're in different fields, so the competition stops at a certain point. Yes, exactly. He's in engineering. I'm in- Financial engineering. Yeah, yeah, exactly. So similar background. Let's talk about books. What are some of your favorites? What are you reading right now? Yeah, well, I said Liar's Poker was a very influential one. Classic. Yeah. Just had its 30th anniversary, I think, last year. I thought it was really good for me was the book Influence by Robert Cialdani. Fantastic. It was a great book. Along with that, How to Win Friends and Influence People, I think those are great. I actually, in finance, one of my first ones was The Intelligent Investor by Ben Graham. Those are kind of cornerstones. Yeah, that's a great list. I know you are on a lot when you're not reading what what are you streaming what's keeping you entertained on these long cross-country flights either podcasts or netflix or whatever i do listen to uh uh podcasts a master's in business however um there's a new thing that i i i've been doing actually it's not a book all right and it'll probably be hit everybody differently on on what i'm doing here Okay. And I could tell you I got this from a good friend of mine, and he's going to kill me for saying this. So a friend of mine, his name is Matt Bellamy. He's the lead singer to Muse. Okay. And he actually taught me this, so I can't take credit for this. We go into ChatGPT, and he actually sent me the prompt. And we prompt ChatGPT, tell me in the last two weeks what you have learned that is beyond human comprehension. Something along those lines. How fascinating. And by the way, it spits out all this stuff. Because if you think about it, humans, like we as a human, you could get a PhD in biology. You get a PhD in astrophysicists. You get a PhD in chemistry. But like you're the expert in their field. But think about this, that like ChatGPT passed the bar exam in like, I don't know, like a couple weeks right so it's becoming experts in everything and then it's combining all of those things together so how many like PhDs in chemistry astrophysicists do you have that like have like the expert in everything and then what comes out like you tend to learn so many things that like by the way it turns into this rabbit hole and I noticed that my prompt actually because I always tell it to me like explain it to me like I'm 16 so I've been driving into this other thing of, it's been teaching me about quantum entanglement. Are you familiar with this? Of course. Who isn't familiar with spooky action at a distance? I mean, they teach that in middle school. Yeah, exactly. So the quantum entanglement of that you have two protons that, you know, if you do want to X, Y will do the same. It's just like having two dice. If dice on earth, by the way, they've proven this. Like if you roll the dice on earth, it rolls a six, It'll definitely roll six. And it's not bound by space and time. So basically it could be light years away. You roll that dice. It rolls an eight. This one in earth is going to roll an eight. And so then they sort of combine that with, is that part of human consciousness? That is your consciousness quantum entangled is what makes you, you, by the way, this type of like thinking. There's a related topic and I haven't run this through chat GBT, but I should, which is the concept of emergence intelligence emergence as the natural outcome of the universe why does the universe exist if not to create a conscience intelligence although the flip side of that is um life is fairly common throughout the universe hydrogen carbon oxygen nitrogen but advanced technological life so far at least appears to be exceedingly rare so that's the counterbalance of emergence. Totally. And then the other thing that I found recently that people can dig into, I think this is fascinating, is that your head experiences time different than your feet from the proximity of gravity's... Well, certainly we have to adjust GPS for the relativity, which Einstein turned out to be right about that. Exactly. But the difference between your head and feet is so tiny unless you're falling into a black hole and then spaghettification is the problem. Yeah. So then you take quantum entanglement and you then say, okay, if I have a proton here and a proton elsewhere and the light in the, how that proton experiences time through entanglement versus how time bends with gravity. By the way, all of this just keeps going deeper and deeper and deeper. And then, and then the thing is, is that I keep telling it to explain it to me like I'm 16. Now my entire prompt explains everything. I will explain it to you as if you're 16 years old. So the, the issue I occasionally run into with perplexity or, or chat GPT is it tends to conform its output to you. And sometimes I'll ask a question and it's like no i don't want a list of 10 podcast questions i just tell me about jeff chang and what led to vest don't give me a podcast i i have my own questions that's why i use multiple grok everything else that way i get a a whole plethora and then what ends up happening is you get all this new stuff and then you dig deep into whatever topic and i found that so fascinating because uh i just it's curiosity it's like if you're interested in these sorts of things exactly and But you have to be on guard for the occasional hallucination. Oh, 100%. And every now and then I find myself leaving AI to go to just traditional search and say, hey, show me a source for this. I don't think before AI, I don't think people were skeptical enough about the sources of what they consumed. With AI, you really have to know what is real and what is fake. That's right. People miss that. All right. Our final two questions. What sort of advice would you give to a recent college grad interested in a career in asset management or ETFs specifically? Yeah, I think a recent college grad, I think similar to kind of bringing it full circle, same thing. Like develop the skills that you're not beholden to anybody, right? whatever that is whether you're in college or out of college develop those skills that you can actually that they're portable one or the other and then not be afraid of failure take chances now this is not for everybody I would say meaning not everybody is going to be a founder not everybody is going to be an entrepreneur which by the way I find as two different people founder has the creativity an entrepreneur has the grit and influence uh a founder has to have the creativity because you're you're actually introducing a whole new industry or a whole new thing that somebody else has not seen yet right um but that's the thing and then also keep your eye out for painful problems that you have the skill set to solve so obtain those skill sets and then have your eyes out eyes peeled throughout life write them down look for pain points Look for pain points. Look for problems. And then the last thing is just a personal thing is don't take yourself too seriously, right? Have fun with life. And I think that that is because otherwise all this stuff can create massive amounts of burnout. And our final question, what do you know about the world of buffered funds investing ETFs today might have been helpful 15, 20 years ago when you were first getting started? how hard it would have been right like literally would that have discouraged you from launching yes I think that was actually the superpower right like when you climb a mountain and you don't know how high it is and there's a cloud base if you saw it and a clear view it probably wouldn't be if you told me to quit my job and I wouldn't get paid for four plus years I probably wouldn't have done that but then it's like always success is always around the corner at least you dream of it, right? Everybody sees what you are now. They don't see the pain where you're constantly just waiting for that cloud to clear on the next part of the mountain. Because I could tell you this, that like if you saw how big the mountain is, it would be, nobody would do it. Really, really interesting. Thank you, Jeff, for being so generous with your time. We have been speaking with Jeff Chang, co-founder and president of Vest. If you enjoy this conversation, well, Check out any of the 600 we've done over the past 12 years. You can find those at iTunes, Spotify, YouTube, Bloomberg, wherever you get your favorite podcasts. I would be remiss if I didn't thank the crack staff that helps put these conversations together each week. Alexis Noriega is my video producer. Sean Russo is my researcher. Anna Luke is my podcast producer. I'm Barry Ritholtz. You've been listening to Masters in Business on Bloomberg Radio. all as it is happening in real time. And we've got complete coverage of the U.S. market close. 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