Market Insights

How bond ETFs are shaping the trading landscape

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Meridy Cleary: Hi, you're listening to Market Matters, our market series here on JP Morgan's Making Sense podcast. I'm your host, Meridy Cleary from the FICC Market Structure team. And in today's episode, we're going to break down the credit ETF landscape, looking at what is driving demand and how these products are making fixed-income markets more resilient and accessible to a broader investment base. Here with me today, I'm joined by Matt Legg, Global Head of Delta One and ETF Sales, and Julie Abbott, Head of North America ETF Sales. Hey, guys, thanks for joining me today.

Matt Legg: It's a pleasure. Thank you.

Julie Abbott: Thanks, Meridy. Great to be here.

Meridy Cleary: Yeah, it's great to have you guys. So Matt, let's start with you. A topic we've been monitoring in the market structure team is the evolution of the credit market, particularly around how credit instruments like corporate bonds and credit derivatives are evolving. Over the last decade or so, we've seen ETFs enter the fixed-income market, and since 2020, credit ETFs have hit really major milestones. Matt, how is the growing adoption shaping how these products are being traded from your perspective?

Matt Legg: Absolutely. So Bond ETFs have been growing for a number of years now. In fact, we'd have to say accelerating for a number of years and it's a global story. The strong asset growth in each region, U.S., Europe, and starting to accumulate in Asia. To give some numbers and some context, there's now around $2.5 trillion of assets in bond ETFs, and that's out of the $14 or so trillion of total AUM and ETFs. It's a really meaningful portion. And the milestones you mentioned, Meridy, are pretty recent as well. I remember when the industry, only five years ago, celebrated the milestone of AUM and fixed-income ETFs going through $1 trillion. Now we're at two and a half.

Meridy Cleary: Oh, wow.

Matt Legg: And they're not simply investment assets. They're being used as trading assets as well. In the U.S., fixed-income ETFs make up 15% of total ETF traded volume. And in Europe, even more so at 25% of total volume. That adds up to a really significant run rate. Currently, we're on track to execute $6 trillion of notional in fixed-income ETFs, meaning it's a really important asset class for all market participants.

Meridy Cleary: Wow. That's really interesting. And I'm curious in times of market volatility, if we think back to March 2020, or the SVB selloff, or even recent times of geopolitical events, what role can ETFs play during those periods?

Matt Legg: Well I think in those periods of time, investors are really looking for access to bond beta. That's what ETFs can provide. That's a really strong pull factor into the asset class. Increasingly, in periods of stress, we've actually seen ETFs pull liquidity and act as a price discovery instrument when underlying bond markets starting to dry up. And those events have actually acted as a proof of concept for ETFs as that liquidity instrument and as that price discovery instrument. And since then, we've seen accelerating usage with more investors relying on them to provide beta in those times of stress. It's been really common to see hedge funds, multi-asset investors, and a range of other investors manage their portfolio beta through ETFs, the same as they previously might have done with index TRS or with CDS products.

Meridy Cleary: Thanks, Matt. That's really interesting. And Julie, I'd love to hear your thoughts as well. If we contextualize the credit ETF landscape with the broader ETF ecosystem, in your view, what is the current structure of the market, and what are some of the differences between U.S. and European ETF markets?

Julie Abbott: Thanks, Meridy. Of course. So the U.S .ETF market is the largest in size globally and has grown to over 10 trillion U.S. dollars in assets across all asset classes. Specifically, fixed-income ETFs have grown to over 1.6 trillion. U.S. ETF volumes as a percentage of total volumes on average have made up a large amount of daily volume, 25 to 30% of the daily ADV compared to European ETF markets, which stand at approximately 16%. You also mentioned market volatility earlier. What we've observed is that in times of market stress, ETFs percentage of volumes tend to increase. In the U.S., for example, this number reached as high as 38% on August 5th of 2024.

Meridy Cleary: Interesting. And how are ETFs traded? If we think about the U.S. and Europe, how are they traded differently in those two jurisdictions?

Julie Abbott: Yes, it's a bit of a different story in Europe. The market structure is currently much more fragmented, partly because there is currently no consolidated tape. And therefore, we observe a much smaller percent of on-exchange ETF trading. The introduction of the EU consolidated tape is set to provide investors with a bit of a clearer picture of ETF trading and liquidity in the EU.

Meridy Cleary: Interesting thanks and let's get into some of the execution trends that you're seeing, Julie. How are market participants executing and how has this changed in recent years?

Julie Abbott: Yeah in the U.S., we observed three main execution types for ETFs. It's really block trading, request for quote, and on-exchange trading. Alongside larger ETF volumes, we're also seeing more and more instances of oversized block trades as a key trend. A block trade, as a reminder, is an off-exchange protocol that allows investors to trade a larger amount of shares and notional dollars in a single trade with more discretion. In fact, it now represents approximately 30% of all J.P .Morgan fixed-income ETF market volumes in the U.S.. This off-exchange activity is due to the comparatively fragmented European ETF market, as every ETF in Europe is able to be listed and traded across multiple exchanges across the continent.

Meridy Cleary: That's really interesting, thank you. And I'm curious how the investor base has evolved. We know that retail participation in ETF has picked up quite a bit since COVID. What about the institutional space?

Julie Abbott: In the U.S., ETFs have and continue to be the wrapper of choice for asset allocation decisions within the managed wealth space. ETFs are an attractive investment products because of their relatively low share price, which provides flexibility, intraday trading, and tax efficiency. The growth of the model portfolio market in the managed wealth space is also fueling the growth of ETFs. What we are observing is growing adoption of ETFs in the institutional space as well. A subsection of ETFs, especially fixed-income ETFs, have grown and are utilized like macro products alongside futures and swaps as part of the Delta One toolkit. The rise of portfolio trading due to the growth of ETFs has driven more demand in the institutional investor base as well.

Meridy Cleary: Innovation in the credit space has been pretty exciting to watch. The rise of credit portfolio trading, Julie, that you mentioned, has been a key trend in market structure. This is where a basket of credit instruments can be executed in a single trade. Matt, how is the rise of portfolio trading linked to the growth in credit ETFs?

Matt Legg: Well I mean, I think the portfolio trading in credit really has only become possible since or because of the growth of ETFs, or it's certainly, they're heavily codependent. So ETFs help portfolio trading in the sense that they provide a real-time level on a basket of bonds, and that basket of bonds essentially looks and feels like a portfolio trade. And because of this, ETFs are really commonly used as a central component of the pricing of that portfolio of bonds or of a portfolio of bonds. And when you're pricing up a portfolio of bonds, ETFs or the ETF levels are going to be one of the first inputs or components that's going to be used to help determine that level. Further to this, ETFs make up nearly 12% of the IG bond market, nearly a quarter, maybe even a quarter of the high-yield market. And so another way to think about this is that as well as providing pricing inputs and pricing transparency, the ETFs are also providing liquidity to a less liquid component of the market and are also providing liquidity to less liquid portions of the market and transparency to more opaque parts of the market. So certainly, a key component of the growth of portfolio trading.

Meridy Cleary: Interesting, and what you're saying is that this increased liquidity translates to the underlying bond market as well.

Matt Legg: Yeah, absolutely. We can look back to recent history, 2019 to 2023, credit ETF volumes nearly doubled. So really significant increases in the amount of activity in that wrapper, and that has fed through to liquidity to the underlying market. It's led to a large universe of bonds being traded in total and more volume being traded in those bonds. We can look back to a few data points since 2020, for example, the percentage of high-grade bonds that don't show a trace print over one week has dropped 2% from over 7% before. And similarly, if we think about the share of high-grade bonds that trade less than a million dollars a week, that's continued to decline, dropping from 30% in 2020 to under 17% today.

Meridy Cleary: Oh, wow.

Matt Legg: The additional liquidity that the ETF market provides is really allowing for larger-size portfolio transactions.

Meridy Cleary: Thanks, Matt. And Julie, a trend that I find quite interesting is that the majority of new ETF launches in 2024 have been actively managed. Could you explain this shift from passive to active? What types of investors are attracted to the active strategies?

Julie Abbott: Yeah, absolutely. It's actually a very interesting development. Actively managed strategies now represent over 60% of the new launches in each of the past four years and have taken in over 25% of all U.S. ETF inflows in the past year, which is really impressive. Their current assets under management in the U.S. has grown to over 800 billion year-to-date. And we really believe there are some major recent developments that have contributed to the growth of active ETFs. Number one, the introduction of the ETF for all, which really gives the expansion of the same regulation as for passive that allows active ETFs to use custom creation redemption baskets, which permit them to be more efficient in portfolio rebalancing and therefore more tax efficient. Also, the approval of the non-transparent and semi-transparent ETF structures, which really opened the door for active strategies. And those managers take a closer look at the ETF wrapper and feel more comfortable with the structure. Although they ultimately did not really adopt this one, they did go ahead and adopt the active transparent. Also, along the same time, the popularity of thematic strategies, especially disruptive innovation, as well as options-based ETFs have been a big driver. And then also the ease and ability to convert existing portfolios, such as mutual funds and separately managed accounts to the ETF wrapper have grown growth as well.

Meridy Cleary: Thanks, Julie. And something you mentioned there, ETF options certainly making headlines. Matt, can you tell us a bit more about how ETF options emerged and what benefits do they provide for investors?

Matt Legg: So the options market and the ETF markets have really started to intersect and they've intersected in two different areas. One is actually options on ETFs. So providing nonlinear returns on the ETF wrapper itself. And the other is the use of options within ETFs. So giving the ETF the ability to pass on a nonlinear return within the fund itself. So if we're thinking about the first, which I think was the direction of the question, there's been a very, very significant growth in options on ETF volumes traded. So looking at the U.S. and most of that growth as we'll come onto has been in the U.S., but looking at the U.S., there's been very significant volume growth. And there's a big, big range of possibilities of what you can trade options on within the ETF markets. 45% of the ETF market has a listed option on it. That makes up around 1,600 funds. So you've really got a broad range of possibilities to trade. That said, a lot of that volume is concentrated in quite a narrow set. So even though we're seeing big increases in volume, it's really coming principally in SPY, in Qs, in IWM, and actually those three ETFs represent around 95% of total options volume. So it's a good story in that there's lots and lots of volume in those, but it's a little bit narrow still. There's a wide range of possibilities, but it's still concentrated in the volume. The volume is still concentrated in a narrow set of funds. Going outside of the U.S., the picture is not quite as good. So it hasn't really been adopted in other markets in the same way it's been adopted in the U.S. There are some options available, but the liquidity and the volume is really not there yet. However, as with most things in the ETF market, we've tended to see the proof of concept and the growth occur in the U.S. and then that translates over to other markets. I do expect that to change going forward.

Meridy Cleary: That must bring about a lot of benefits, right?

Matt Legg: Absolutely. Obviously, having the ability to trade options changes the possible set of returns that the investor can access through ETFs and we look at the usage of options on ETFs and we can determine how investors are using them. Principally for ETFs, interestingly, they're using them for downside protection. And when we look at the put-call ratio of options trades, it's around 1.7 puts per call traded in ETFs. So as you can see, heavily skewing towards downside protection. If we compare that to single stock markets, it's more balanced. It's actually maybe slightly more calls to puts. Either a balanced use of upside versus downside or slightly more use for accessing upside. It's a different use case to single stocks, but clearly, investors are utilizing that options market to provide downside beta protection, which is obviously a great benefit to allowing them to protect their portfolios.

Meridy Cleary: And you also mentioned the use of options within ETFs. Can you tell us a little bit more about that?

Matt Legg:  So yeah, actually that's been growing pretty quickly as well. There's a range of funds which have been utilizing options to give investors access to nonlinear return streams, which as we know is one of the principal use cases of ETFs to give access to investors to a range of returns that would be otherwise challenging for them to access directly. The example here, the AUM in these funds has actually grown now to almost $115 billion. That's across 350 different funds. Over the past three years, that's a six-fold increase. Really rapid rise in the uptake and utilization of those type of funds by investors. And if we look into that and what investors are buying, call-put writing funds are the largest segment. They make up around 60% of the assets in options-based ETFs. And then second is buffer ETFs, which are put spread collar or collar overlay type strategies. That makes up around 36% of the AUM. As mentioned before, the value proposition of that is simply that investors get access to a return stream which would be challenging for them to hold otherwise.

Meridy Cleary: Okay, great. That's really interesting. And earlier we mentioned the consolidated tapes in Europe, as some of our listeners may know, the consolidated tapes have been decades in the making. Matt, how impactful do you think, in the context of the ETF market, could these tapes be for European markets?

Matt Legg: I think it could be very impactful. I think Julie already mentioned the lack of on-exchange liquidity in Europe relative to the U.S., and that's a commonly known and appreciated problem, and lots of people have been working to try to address that for a period of time. The fact that there's not a lot of on-screen liquidity doesn't mean that the ETFs are not actually liquid. It's most dealers, or it's very common to access liquidity for the ETFs by accessing either the liquidity of the underliers or by accessing proxy assets like futures or index swaps or various other ways of getting access to the underlying returns of the ETF, and thereby providing liquidity in the ETF itself. The ETFs can be very liquid, it just doesn't display that on-screen, and the consolidated tape has been one of the solutions that's been put forward to help address that issue. We took a big step towards that after MiFID II, there was a requirement for all ETF trades to print, and therefore all of these OTC trades which were occurring, and there were lots of OTC, lots of liquidity in OTC markets on these ETFs, they all needed to print. And so at least, there was an ability to pull together all of the traded volume and actually see that, but to do that, you have to access it from all the different venues. The idea behind the consolidated tape is simply that it will pull it together and make it more obvious and more accessible for everyday investors to see, and therefore remove some of the questions around the illiquidity of ETFs in Europe, which is not representative of the true liquidity accessible in the product.

Meridy Cleary: We've covered a lot today, so thank you so much Matt and Julie for your insights.

Matt Legg: Thanks, Meridy.

Julie Abbott: Thanks, Meridy.

Meridy Cleary: And to our listeners, please stay tuned for more FICC market structure and liquidity strategy content here on JP Morgan's Making Sense podcast. If you're a JP Morgan client and have any questions or would like any further information on the topics we discussed today, please reach out to your JP Morgan sales representative. I hope you have a great day.

Voiceover: Thanks for listening to “Market Matters?” If you’ve enjoyed this conversation, we hope you’ll review, rate, and subscribe to J.P. Morgan’s “Making Sense” to stay on top of the latest industry news and trends – available on Apple Podcasts, Spotify, and YouTube. The views expressed in this podcast may not necessarily reflect the views of JPMorgan Chase & Co, and its affiliates, together J.P. Morgan, and do not constitute research or recommendation advice or an offer or a solicitation to buy or sell any security or financial instrument. They are not issued by J.P. Morgan’s research department, but are a solicitation under CFTC Rule 1.71. Referenced products and services in this podcast may not be suitable for you and may not be available in all jurisdictions. J.P. Morgan may make markets and trade as principal in securities and other asset classes and financial products that may have been discussed. The FICC market structure publications, or to one, newsletters, mentioned in this podcast are available for J.P. Morgan clients. Please contact your J.P. Morgan sales representative should you wish to receive these. For additional disclaimers and regulatory disclosures, please visit www.jpmorgan.com/disclosures

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How high is positioning in U.S. Equities?

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ELOISE GOULDER: Hi, I'm Eloise Goulder, head of the Data Assets and Alpha Group here at J.P. Morgan. And today, I'm really excited to be joined by my colleague John Schlegel, who's head of the Global Positioning Intelligence team here in New York to talk all things positioning post a stellar rally in US equities over the last few weeks and months. So, John, thank you so much for sitting down with us here today.

John Schlegel: It's great to be here.

ELOISE GOULDER: So, US equities have staged an impressive rally over the last couple of months with the S&P 500 now up over 10% since August lows and in fact, up 22% year-to-date. And it's been a very pro-cyclical rally with consumer cyclicals, industrials, financials, materials, and, of course, tech really leading the charge. And my interpretation is this has been a macro-driven rally, given that we've seen consistent upgrades to economic growth assumptions for the US over that period. In fact, our own economists upgraded their Q3 GDP forecasts from 1.5% to 2.5%. And, of course, we've seen very strong data points across the employment and the services sector in the US as well. And this is happening at the same time as the Fed cutting rates. So, this is driving further equity strength. John, do you agree with this narrative.

John Schlegel: Yes, I generally agree. But I would add that positioning-- if you look back to when this recent rally really kicked off in early August, had gotten to a fairly neutral level on a long-term basis. So there was ample room for clients to re-risk. And I think what has been a bit surprising compared to the expectations back then was just how strong the macro data had been even prior to the Fed starting to cut rates. So I think you've had a very strong US story from both an economic standpoint as well as a positioning standpoint. And then you've also had strong performance out of other regions, given some of the measures that are happening in China recently as well as other parts of Asia. So, globally, maybe excluding Europe, which is a bit more mixed, there's been ample room for markets to rally on the back of these drivers.

ELOISE GOULDER: That makes a lot of sense. Thank you, John. And you mentioned that back in July, August positioning was looking much more neutral in US markets. So who have been the main buyers of US equities since then?

John Schlegel: So I think if you go back to what drove the sell-off in late July to early August, a lot of that came more from hedges that were added or futures that were reduced, so think sort of broad-based instruments trying to reduce risk into the concerns around the potential economic growth slowdown. And if you think about what's driven positioning higher since then, a lot of that is the same things that were sold. So a lot of futures that are being bought back-- if you look at options in terms of the call-to-put ratios, those had turn more bearish into early August, have turned more bullish more recently. And then in the last few weeks, we've seen hedge funds even start to tick up their flows to be more positive. And this is after they had been selling from most of second half of July through middle to late September. So, in aggregate, there's a number of factors that are driving it, but I would say really macro products were the biggest drivers of the rally as we see it.

ELOISE GOULDER: And so where does that leave positioning today?

John Schlegel: So, in the US, we see positioning as fairly elevated, very similar to what we saw in early July. Our aggregate measure of US positioning is just over the 90th percentile. And over the last four weeks we've seen positioning turn positive. But we're not quite at those peak levels that we saw in July. So there's definitely some room for a bit more upside at this stage but not a whole lot from a positioning standpoint.

ELOISE GOULDER: That's really helpful. So positioning has risen quite a lot and is now looking relatively elevated, as you say. But, on the other hand, the macro data, the micro data, and, of course, the global data, including from Asia, is looking more positive. So where does this leave overall risk-reward for markets at this stage?

John Schlegel: I think at this stage, the economic data and the fundamental data arguably could trump positioning. By this, I mean, if you think about seasonality into year end tends to be very strong. For US election years, it's typically strongest after the election-- so November, December. And given positioning is pretty high, I'm a bit more concerned about what markets could do over the next few weeks because there can be some choppiness. Even if you look at the last three US elections, there's been a little bit of downside in the three weeks leading into the election. And just given where markets are at all-time highs and positioning having risen a bit in the last month, I think there is room for that to come off a little bit. But, overall, I think into year end, there's seasonality, strong economic growth, Fed cutting rates, China trying to stimulate their economy-- all of this suggests that we could continue to rally into year end.

ELOISE GOULDER: Yep. So there's a lot of positives on the macro front. If we turn to thematics, arguably, we've seen some quite hawkish data points recently. We've seen higher payrolls data, we've seen a slightly higher CPI versus expectations. And so there's this risk that bond yields really widen from here. John, do you see that as a risk for market levels and in particular for certain pockets and themes within the markets?

John Schlegel: Yeah, so I think certain pockets and themes could be at risk. I think for the wider market, our view would be there is room for rates to rise from a position standpoint simply because by the mid-September period, as markets were expecting the Fed to cut but debating 25 versus 50 basis points, we had seen positioning in bonds get more long. So CTA net risk and a bunch of the different tenors were at the most net long we'd seen in a few years. And there's room for this to come down-- that net length towards the long end to be reduced a bit. So US rates could rise a bit further. But if you look at how the S&P 500 as a whole has acted, it usually hasn't taken on a more negative stance unless rates rise significantly. And if you look at the past couple of times when equities have sold off, it's been when rates have risen above about 4.3% in the US 10-year. And so I think there is a little bit more room before we get there given where rates are today. But I think, more specifically on the rotational side, there are some areas that could be under pressure. I think some of the defensives-- especially rate-sensitive ones like utilities, which rallied a lot-- could come under pressure because of their sensitivity to rates also because positioning has gotten a lot higher for a sector like that in the third quarter. So I'd be a little bit more specific around which sectors could be hurt due to higher rates. But I think more generically, the market could be OK as long as we don't really keep accelerating higher in US rates from these levels.

ELOISE GOULDER: And, of course, we have seen a very pro-cyclical skew to market strength over the last month or so with our cyclicals baskets outperforming our defensive baskets.

John Schlegel: that's correct.

ELOISE GOULDER: Thank you so much, John. So the fundamental and the macro drivers of the market are looking very robust. But, as you say, positioning in the aggregate has got that much more elevated. So are there pockets where you see more upside risk perhaps because the fundamentals are so strong or perhaps because positioning is lighter in those pockets?

John Schlegel: So I think there are three areas I point out that all are on the more cyclical end of the spectrum that could do better if the macro backdrop remains robust. But positioning in these areas are still somewhat light from our view. So the three I would call out would be, one, energy, partly because of what we see for oil positioning as well as what's happening in China. If the economy continues to re-accelerate globally, energy could be a beneficiary. I think financials in the US are another beneficiary. As long as rates don't rise too rapidly, rates stabilizing at high or levels than they were a few years back generally could be a positive for the sector and positioning overall has been reduced quite a bit. One of the key areas that we think positioning could arise is in ETFs. So ETF flows were the most negative financials in September versus other sectors and that could return more positively. And then the last one would be semis in the US. Now, this might be a little more controversial in terms of whether or not positioning is actually light. But as we see it in the aggregate, we think a lot of positioning did come out in the second half of July into early September period when semis and broader tech stocks generally underperformed the market. And we don't think it's come back that strongly yet. I think one of the most interesting data points to us is that hedge funds, which were starting to sell into the semis peak in June, have actually been buying over the last few weeks. So it suggests that more fundamental investors who saw, sort of, the top toppiness of the market back in the second quarter are now a little bit more confident in adding some risk in that sector.

ELOISE GOULDER: Fascinating. Thank you. So three sectors there to be watching the energy, the financials, and the semis-- all of them more pro-cyclical beneficiaries, presumably, of stronger macro data as we're seeing at the moment but also, as you're arguing, all with lighter positioning, at least versus their own histories.

John Schlegel: That's correct. Yeah.

ELOISE GOULDER: And then, finally, if we can turn to the other regions, you mentioned at the outset that pockets of Asia have been stronger recently, perhaps less so in Europe. Can you contextualize what you're seeing from a fundamental and a positioning angle in the other regions?

John Schlegel: So I think China is probably the most interesting and most topical at this point. We've seen, obviously, the markets there rally quite strongly over the past few weeks given the stimulus measures that have been announced and the expectation for more to come. In terms of positioning changes, at this stage, we think a lot has changed from a few weeks ago. So whether it's the flows that we see in our prime brokerage book across hedge funds, we've seen a lot of buying of local China shares. If we think about what we're seeing in futures, there's been quite a bit of directionality added and even CTAs in the Hang Seng index are now the most net long they've been since early 2021, so a 3 and 1/2 year high. I think the overall skew from a positioning lens has shifted much, much more positive in China. And there will be a lot more emphasis needed on the continuation of the stimulus measures to keep this rally going. But, clearly, if the government continues to come out with strong measures, there's a lot of potential for the retail investor in China, as I see it in particular to continue to be supportive of that market. If I think about Europe, it's a lot more mixed is the way I view it. There's not been a whole lot of performance in the absolute sense in the past few months. It's also been an underperformer versus the US. But from a positioning standpoint, we've seen it right around the two-year average and so, therefore, not really striking me as something that is either wildly underpositioned or overpositioned and in line-- with a market that's been middling for the last few months.

ELOISE GOULDER: That makes sense. And I guess we're going to have to watch macro data from here in Europe because it's certainly not been strong in the way that it has in the US recently.  

John Schlegel: Yes. And I think there's a tug of war between some of the stimulus measures in China and what that could mean for certain sectors in Europe versus the more domestic economy and some of the slowdown that we're seeing there. And so it's a bit trickier market than maybe others.

ELOISE GOULDER: So to summarize, then, John, you remain relatively optimistic that US equities can rally further into year end, albeit they may be somewhat constrained in the near term by more elevated positioning levels. So which events and data points will you be watching from here to confirm or to refute your views? We, obviously, have US elections in a few weeks, but beyond that, what will you be watching?

John Schlegel: So I think the key things will continue to be the macro data. What do we see for payrolls? What do we see for inflation? Does that continue to move in a more Goldilocks fashion and allow the Fed to continue to lower rates at a modest pace? I think, also, earnings, which are kicking off right now in the US, will be key. If earnings continue to beat and expectations can rise from here, I think that will support the market. And then arguably, from a global standpoint, do we continue to see some of the measures out of China remain positive for that market and help to drive a broader global growth story into year end.

Eloise Goulder: Brilliant. Well, those are very clear views, John, so thank you so much. We really appreciate all of your time and your thoughts today.

John Schlegel: It's been great having this conversation with you.

ELOISE GOULDER: Thank you also to our listeners for tuning in to this bi-weekly podcast series from our group. If you have feedback or if you'd like to get in touch, then please do go to our website at jpmorgan.com/market data intelligence where you can send us a message via the Contact Us form. And with that, we'll close. Thank you.

Voiceover: Thanks for listening to “Market Matters?” If you’ve enjoyed this conversation, we hope you’ll review, rate, and subscribe to J.P. Morgan’s “Making Sense” to stay on top of the latest industry news and trends – available on Apple Podcasts, Spotify, and YouTube. The views expressed in this podcast may not necessarily reflect the views of J.P. Morgan Chase & Co and its affiliates (together “J.P. Morgan”), they are not the product of J.P. Morgan’s Research Department and do not constitute a recommendation, advice, or an offer or a solicitation to buy or sell any security or financial instrument.  This podcast is intended for institutional and professional investors only and is not intended for retail investor use, it is provided for information purposes only. Referenced products and services in this podcast may not be suitable for you and may not be available in all jurisdictions.  J.P. Morgan may make markets and trade as principal in securities and other asset classes and financial products that may have been discussed.  For additional disclaimers and regulatory disclosures, please visit: www.jpmorgan.com/disclosures/salesandtradingdisclaimer. For the avoidance of doubt, opinions expressed by any external speakers are the personal views of those speakers and do not represent the views of J.P. Morgan.

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Lee Price: Hi there, you're listening to Market Matters, our market series here on J.P. Morgan's Making Sense podcast channel. I'm Lee Price from the FICC Market Structure and Liquidity Strategy Team. In this episode, we're going to focus on a very topical area in capital markets: Private credit. Private credit has become extremely popular with investors in recent years, causing the size of the market to rise rapidly. Today, we'll start out by exploring some of the circumstances behind that growth, and then examine the evolving competitive dynamics and market structure going forward. To discuss these elements, I'm joined by Jake Pollack, Global Head of Credit Financing and Direct Lending at J.P. Morgan. Jake, thanks for being on today.

Jake Pollack: My pleasure. Thanks for having me.

Lee Price: All right, let's kick things off here. In the Market Structure team, we evaluate policy developments and execution trends that impact access to liquidity and if we think about the last 15 years or so, bank regulatory reforms have fundamentally altered the corporate lending landscape. The familiar narrative is that in the years following the global financial crisis, stricter regulatory policies and capital constraints have made bank lending more conservative by necessity. And as a consequence of that, there has been this window of opportunity for alternative investment firms and non-bank lenders, who operated outside the public markets. Jake, we've seen an increasing number of borrowers opt for the private credit delivery mechanism in recent years and while private credit is not a new concept or activity, it has experienced spectacular growth with recent estimates totaling $1.7 trillion in assets under management. From your perspective, what are some of the key factors that have contributed to the exponential growth in private credit?

Jake Pollack: Yeah, so it's a good question. I mean, I think, the larger point I would note is that credit as an asset class has grown tremendously over the last 20, 25 years, and that's both public and private credit. So, if you zoom in on just sub-investment grade corporate credit outstanding, and we go back to, say, 2000, that number was sub a $1 trillion, and the vast majority of that was in high-yield bonds. So, there was really only a $100-or-so million of loans outstanding, and a negligible portion of that was direct lending. Fast-forward to today. There's about $5.3 trillion of sub-investment grade credit outstanding. Whether it's public or private, it's $5.3 trillion of credit. So, as you point out, private credit makes up roughly $1.7 trillion of that number, and it's clearly the largest growth segment. But the first point we have to make is that there's been, like, a five to six-fold increase of sub-investment grade corporate credit outstanding over the past 25 years. The second factor I would highlight is the middle market. So, if we rewind back, again, to the early 2000s, the vast majority of middle market lending was really in the form of bank lending, term loan A's, pro rata deals, to middle market companies that were corporate, and even sometimes family owned. Since then, and particularly over the last decade, PE has made a big push into the middle market, and now it counts for a pretty sizable and growing portion of the ownership of businesses in this space. And so, the PE move deserves a lot of credit as well into the space, because they've created a lot of enterprise value by streamlining operations, rolling up smaller companies, et cetera. And that's effectively created the demand for debt capital that has fueled the direct lending trend that you're noting. So look, yes, regulatory has been a factor. Banks pulling back. That's sort of well-documented. But I think if you zoom out and you look at the growth of credit at large, you see that the middle market PE is what really laid the groundwork, as well as the vast amount of capital that's been raised by the private credit folks who have gained so much scale.

Lee Price: That's right. And if we think about the origins of private credit, starting in small bilateral loans, you mentioned this push into the middle market. And that expansion has really continued with loans being made to larger companies that, today, would have access to the public markets. As a result, private credit is now roughly equivalent to the size of the high-yield market. So, we have an extraordinary amount of capital that has been raised. Obviously, that represents a significant business opportunity. So, it's no surprise that private credit has become a major strategic priority for J.P. Morgan. Jake, you and your team have been building out J.P. Morgan's direct lending program. How's that going so far?

Jake Pollack: The first thing I would say is, at J.P. Morgan, we've been making loans directly to businesses for hundreds of years so it isn't a new concept for us. Private credit came first. Public markets developed after. What is new, and I referenced this a second ago, is the extraordinary amount of capital that's been raised by direct lenders has changed the game in a number of ways. These firms, by the way, are also some of our largest asset manager clients. And so, what's happened is these firms have gotten so big that they are also able to do large transactions directly with borrowers themselves on a bilateral basis, or sometimes with one or two other direct lenders. So in 2021, we set up our direct lending business, and we set it up as a partnership between our markets and our banking businesses, leveraging our best-in-class capabilities of each to enable us to offer borrowers really the best of all worlds. So, we're future proofing our business, right? We're enabling borrowers to decide. If they want to raise money in the public credit markets, they can. If they want to raise money in the private credit market, they can. And so, we earmarked an initial $10 billion of our own balance sheet for direct lending. We've since allocated a good portion of that. And so, we're very much now in the game in direct lending and we aim to allocate substantially more capital going forward, and also to augment that capital with third party co-lenders as well.

Lee Price: Wow, yeah, it sounds very promising. Thanks, Jake. And we've seen this rapid growth, and in both invested capital an in accumulation of dry powder in private credit. A lot of excitement in the space. Sometimes that can foster misconceptions. So, it seems like much of the narrative around private credit has been focused on competition between direct lending firms and banks, but the reality is that many of these firms are also JP Morgan clients. And I think that the market evolution here is extremely compelling. We're in this environment where direct lending activity both competes with and compliments the financing solutions being provided by more traditional debt capital markets and credit trading franchises. From your experience leading the private credit financing business, how does J.P. Morgan strike the right balance between partnering with and competing against direct lenders?

Jake Pollack: Yeah, I mean, it's a great question. I think the first thing we have to recognize is that the competitive landscape today is challenging, and it's certainly more complex than it once was. In particular, the lines between competitor and client have blurred and the reality is that in many cases, some of our best clients in one area are also competitors in others, and that's okay, right? That's sort of the state of the market we're in today. I give the example of Netflix and Comcast. In content, they're fierce competitors. NBC and Peacock, which are owned by Comcast, compete for viewers with Netflix. But in the wifi business, Comcast enables Netflix. There's an example of a complex relationship, but one that actually is also symbiotic. And I think most direct lenders who would compete with J.P. Morgan's newer direct lending business also have public markets businesses, which trade with our credit trading desk. They buy new issues of debt from our debt capital markets and syndication desks. They're clients of our CLO franchise, and they're also large borrowers from us in our private credit financing business. So, the new reality can make client relationship conversations more challenging. But frankly, I think once both sides understand the complexities of the market, the focus becomes on how we can partner in areas where we compliment each other, rather just in areas where we're competing.

Lee Price: Yeah, and that's great context. I mean, this mutual beneficial relationships among competitors is something to watch. You mentioned the Netflix and Comcast example. Just because we're recording a podcast, it reminds me of the way you might be listening to a Spotify podcast on your Apple phone. So, I think it's more complex, extremely interesting from a market structure perspective. We've witnessed the entry of alternative liquidity providers in certain fixed income trading markets; the US Treasuries comes to mind that has influenced the execution landscape. And it feels like there are some parallels here in the sense that we have clients that are also competitors. So these lines blurring, as you mentioned. It's an area where I wonder if you can expand on how you're partnering with certain players in private credit today.

Jake Pollack: Yeah. So we talk a lot about our private credit flywheel. So clients of our financing business, oftentimes it might start out with a subline, right? And then moves to an asset-based facility. And then it can move then to a product we call private credit CLOs, right? Where we're actually providing securitization for a client's portfolio. We also syndicate our financing facilities to clients and the syndication partners are often clients that are interested in very high quality exposure to private credit. So these syndications are sometimes unrated to banks or those that need a rating. But when it's to a client that does need a rating like an insurance company, our facilities can be rated between A and up to AAA if we do it in a CLO format. So our financing effectively becomes investment grade private credit which is very attractive, as I mentioned, to insurance and other clients. Many of these clients are also counter parties of our public markets trading businesses and when we connect in one area, we tend to connect and may areas. So I would say our connectivity with clients across the private credit ecosystem tends to lead to a win/win relationship that will grow business for both our clients and for JP Morgan in a symbiotic relationship. And it's very exciting.

Lee Price: Yeah, no and it makes a lotta sense. As this market segment continues to evolve seems like we're seeing innovation in the ways to participate. So you mentioned securitization but trading of private credit has gotten a lot of attention lately, although it seems a bit nascent. I'm wondering what you're seeing in terms of secondary market development and private credit. Is there much activity there today?

Jake Pollack: It reminds me a little bit of the saying amongst the nuclear scientist that said cold fusion is 30 years away, and always will be. So the question has come up a lot about private credit trading and when we're gonna see more of it. The market is almost $2 trillion and there has been scant secondary liquidity. First, it does depend on how you define private credit. So I think the definition can expand to sort of when we talk about IG private credit like the recent Intel deal that some private credit folks arranged. I could see those kind of transactions trading with great frequency. When we talk about private credit in terms of, again, sub-investment grade, upper middle market, lower to upper middle market, corporate credit, the players in that space have tended to not wanna see a trade. And it is challenging to create secondary liquidity in a market when the players themselves that only assets aren't looking for liquidity. And look, there's a little bit of a joke that it's pitched as a very high, sharp ratio product. There's almost no volatility 'cause it doesn't trade and the returns have been very strong. So the LPs and the GPs have liked it that way. So that's one point. In times of stress ... And I kinda refer back to the 4th quarter of 2022 was when capital was especially scarce. We did see demand from holders of private credit assets looking for liquidity. So I would expect when we see more volatility again. I think the recent bout was probably too short-lived. But in the next bout of stress we have, I do expect to see more demand for liquidity. And look, as the market grows, it will create more opportunity, but this is still an area where the answer is it's on the come.

Lee Price: That's, Jake. That's very helpful. I didn't anticipate that we'd go into cold fusion on a podcast about private credit-

Jake Pollack:  (laughs)

Lee Price: ... but obviously I'm glad that we did.

Jake Pollack: Yeah. (laughs)

Lee Price: And it's interesting  this illiquidity seems like an important characteristic of private credit. You mentioned the performance of private credit in times of stress. And a little earlier we discussed that in some ways, the stricter regulatory environment for banks help create the original pipeline for non-bank lenders to grow so much. And our team in market structure, we've been tracking that non-bank financial leverage and systemic risk are key focus areas for global policy markers and there have been some concerns, including in a recent feds notes, that private credit contributes to a rise in corporate leverage and that increased competition in private credit markets could lead to a deterioration of lending standards and credit quality. And I wonder if you think these concerns are warranted and what rising corporate default rates would mean for private credit.

Jake Pollack: I think we have to start by acknowledging that the default rate for both public and private credit has been low and our base case expectation is it's going to rise. So the historical default rate in credit has been sort of in the four to five percent range. We've been operating in the two percent range depending how you define it. So the default rate is gonna to pick up, and given how long it stayed in this unnaturally low two percent range, it wouldn't' surprise me if we went a bit above five percent in the next year or two. What would surprise me is if the default rate, again, in the sub-investment grade universe, were meaningfully different than that of the public broadly syndicated sort of B3 market and high yield B3 market over a multi-year period. Certain industries may experience greater defaults than others, but private credit as a whole, in my view, will likely experience a very similar default experience to the public markets and a similar loss, given default. So why? Private credit; you called it a delivery mechanism earlier; and I think that's actually an apt way to say it. Private credit is sometimes written about as if it's some brand new thing like a cryptocurrency or something. It's really just companies that have opted for a bilateral borrower/lender relationship as opposed to a public, syndicated loan. So that choice by the business that's borrowing the money shouldn't have much of an impact on whether that business is able to repay their loan.

Lee Price: That's really helpful. Thanks, Jake. And I guess it leads me to wonder about banks specifically participating in the private credit space. So if you can talk about JP Morgan's approach to managing some of these risks.

Jake Pollack: We do as we always do. We've got a very conservative underwriting approach in all our businesses and we take our fortress balance sheet very seriously. So our disciplined approach to underwriting and managing risk is really ingrained in our team's culture. It tends to make us pull back when the market gets frothy and lean in and act as a port in the storm when other lenders are more fearful. So I expect us to continue to operate that way as we increasingly see market volatility.

Lee Price: No, that's helpful and you make an important point about the JP Morgan approach, the focus remaining on high quality loans to strong companies. Do you anticipate further efforts to bring transparency to these markets?

Jake Pollack: It's certainly a popular topic and I do think it'll continue to gain traction. Again, especially if we enter a period of greater volatility to the extent that the default rate in credit broadly picks up meaningfully if that creates liquidity issues for funds. Now look, funds can put up gates typically, right? So they tend to prevent it. But, you know, if you've got a situation where a lot of investors would like to basically liquidate their positions and get cash, that has the potential to create a louder voice, right? So I think that's something that bears watching and could lead to a greater push for more transparency in private credit. So we'll have to see.

Lee Price: Definitely. So the global regulatory focus on systemic risk and non-bank financial intermediation will be an area to monitor for sure. Before we wrap up, let's look back into the crystal ball from a markets perspective. I wonder if, perhaps, from what we've discussed, are seeing a convergence between the public and private markets. Whether there is this continued evolution in private credit will mean further product development, sectoral expansion, or perhaps, and we touched on this briefly, a shift towards more bespoke capital raising strategies that incorporate certain private credit elements to them. Jake, where do you see the most attractive investor opportunities in the near future?

Jake Pollack: Yeah, so I think the most attractive opportunities tend to go to investors and investment vehicles with the broadest remits, right? So like those that can enter different market opportunity sets when those opportunities strike. So obviously if you can only buy treasuries, for example, you're limited to opportunities presented by dislocations in the treasury market.  Private credit is an exciting topic because it tends to mean different things to different investors. Direct lenders tend to define private credit, as we've been discussing. Sub-investment grade corporate credit essentially loans to borrowers typically with like a B3 Moody’sequivalent rating. And these loans are originated by, typically, sourcing opportunities directly from sponsored-owned companies. So I expect this market to continue to grow but I think if you expand the lens a little bit there's some other exciting opportunities in areas of private credit. We talked briefly about investment grade private credit. That's one example of a growing space. Infrastructure. There's alternative credit solutions. There's asset-based finance in private credit. I mentioned our financing vehicles, right? We've basically syndicated these vehicles to investors and that's an example of investment grade private credit. So I think these are areas that are still nascent and require creativity and a level of structuring expertise to provide clients with the solutions that meet their needs and meet their LPs needs. So I would say J.P. Morgan is heavily involved in all of these areas and we've created some interesting distribution partnerships with clients that are looking for exposure in these areas. And yeah, I mean, look, we expect these markets to grow significantly over time, so the opportunity set is certainly robust.

Lee Price: Understood. And some great market insights as we try to determine what comes next for private credit. But it sounds like you and your team will be quite busy in the very near future here. Jake, I'd love to continue this discussion but we're about up on time for today's episode. Luckily we've covered a lot, from the growth of private credit, the evolving competitive landscape, the potential risks and regulatory developments, and finally, some investment opportunities. It'll be really exciting to see where this market is headed and how J.P. Morgan participates in the space. Thanks so much for joining today.

Jake Pollack: My pleasure. Thank you for having me.

Lee Price: And to our listeners, thanks for joining us on Market Matters and stay tuned for more FICC market structure and liquidity strategy content on J.P. Morgan's Making Sense podcast. Until next time.

Speaker 3: Thanks for listening to Market Matters. If you've enjoyed this conversation, we hope you'll review, rate and subscribe to JP Morgan's Making Sense, to stay on top of the latest industry news and trends. Available on Apple Podcasts, Spotify, and YouTube. The views expressed in this podcast may not necessarily reflect the views of JPMorgan Chase & Co, and its affiliates, together J.P. Morgan, and do not constitute research or recommendation advice or an offer or a solicitation to buy or sell any security or financial instrument, are not issued by Research but are a solicitation under CFTC Rule 1.71. Referenced products and services in this podcast may not be suitable for you, and may not be available in all jurisdictions. J.P. Morgan may make markets and trade as principal in securities and other asset classes and financial products that may have been discussed. The FICC market structure publications, or to one, newsletters, mentioned in this podcast are available for J.P. Morgan clients. Please contact your J.P. Morgan sales representative should you wish to receive these. For additional disclaimers and regulatory disclosures, please visit www.jpmorgan.com/disclosures

© 2024 JPMorgan Chase & Company. All rights reserved.

[End of Episode]

Eloise Goulder (00:02):

Hi, I am Eloise Goulder, Head of the Data Assets and Alpha Group here at J.P. Morgan. And today I'm delighted to be sitting down with my colleagues, Edwina Lowe, Product Specialist and Luca Rainero, Head of the Data intelligence team, both within our wider data assets and Alpha Group. And we are here to discuss the evolution of the retail investor and retail investor behavior post-COVID. So Edwina, Luca, thank you so much for sitting down with us today.

Edwina Lowe (00:30):

Thank you for having us, Eloise.

Luca Rainero (00:32):

Very excited to be here with you both today.

Eloise Goulder (00:34):

So Edwina, could you start by setting the scene? I think it's well known that the retail investor has increased in share of market activity through and post-COVID, most notably in the U.S. and most notably through those 2020 to 2021 years. So Edwina, can you provide a bit more context on this, and also how has retail activity evolved in more recent years and months?

Edwina Lowe (00:59):

Certainly, Eloise. So if we look at the U.S. specifically, pre-COVID retail share of volumes is estimated to be in the high single digits. And really from that low starting point throughout 2020 and 2021, we saw a significant uptick in retail share of volumes to around, at times 25 to 30%. And what was driving that? Well, it was a combination of factors. We saw a significant recovery and then enormous rise in share prices, and then an increase in social media participation from the retail investors who are talking about the stock market and talking about single stocks. And then alongside that, the prevalence of low-cost and no-cost brokerage apps all contributed to that significant uptick that we saw over those few years.

(01:49):

And I think there was a perception that perhaps as life normalized post-COVID, that we would see retail share of volumes go back to pre-COVID levels. But it's become clear where we are now in the second half of 2024, that that really isn't the case, and that we saw a marked and persistent shift in retail activity. And just to be clear, Eloise, this is all U.S. specific, we could perhaps go into other regions where the retail investor is active later in our conversation.

Eloise Goulder (02:18):

That's fascinating stuff, Edwina. And I guess January, 2021 was the most high profile period for the retail investor when we saw meme stocks, but also heavily shorted stocks rally significantly. In fact, our most shorted basket of more than 50 stocks was up more than 50% in that month of January, 2021. But coming back to today, given that the meme phenomena isn't as prevalent, and heavily shorted stocks certainly aren't rallying to the extent they were back in 2021. Edwina, how do you see evidence of the retail investor in U.S. markets today?

Edwina Lowe (02:53):

So we can see in the U.S. flows analysis done by our QDS research team that the retail investor is particularly active in consumer discretionary names, and technology names most notably including the Mag 7. Now, the Mag 7 has rallied considerably over the last few years, and now makes up about 30% of the SPX by market cap, and has driven about two-thirds of the gains seen in the S&P 500 over the last three years. We've also seen sharp swings in the meme stock names, and had a recent resurgence of this just earlier this year. That is clear evidence of the high participation of the retail investor within the U.S.

Eloise Goulder (03:33):

Thank you, Edwina. So the retail investor is clearly important to continue tracking. So Luca, over to you. You've analyzed how the retail investor trades, and also discusses stocks on social media. So at a high level, what observations have you made?

Luca Rainero (03:49):

So we did spend quite a lot of time looking at social media data, and we combine it with other types of data sets like the U.S. retail flow that Edwina just mentioned. It's really hard to generalize when we talk about retail investors. There's so many different types, and you can think about different wealth, different experience, different age, different trading platforms. Nonetheless, overall we did see signs of herd behavior, and I can give you three key examples from my perspective.

(04:14):

The first one, which is probably the most obvious is they tend to crowd in certain stocks. Again, there's no hard rule for defining what the meme stock really is, but there are some common traits like, very strong personality of the founder, CEO. And in general this company tend to have a narrative, a story. These are the ones that, uh, Chris Andrews called in, in this podcast a few episodes ago, the familiar companies. The second herd sign of retail investors is that they tend to follow the market, and they do that on both sides. They sell the deep, they buy the trend. And when they act, they're not really that price sensitive. The third quite interesting point is that they love to talk about what they do on social media, and they're strongly influenced by strong personality like the super influencer that driven the stock price, and all these meme phenomenon. It's quite peculiar to retail investor if we compare with the more institutional investor's community.

Eloise Goulder (05:06):

Thank you Luca. And you say there that the retail investor often follows the trend in both directions. So do you see the retail investor as a leading or a lagging indicator for stock market returns? And therefore how can we use this information to help predict future market returns?

Luca Rainero (05:24):

Well, that's a very complicated question. (laughs) The real answer is a little bit of both. Looking at both end of day and intraday data, we do see some leading signals. And sometimes these are very strong, but it really depends on the market regime. And let me explain what I mean by that. On the one side we have this regime that we call high retail participation, and this feature strong retail flow, loss activity on social media. Just think back on the first day of the pandemics or even like April, May this year. What we see in this space is that retail investors clearly follow a trend, but then they prolong the trend and they support this trend through time. So what does that mean? Is that if you're able to pick up the spike early enough, the first few days where it happens, then their activity becomes a leading indicator of the price action in the next 5 to 10 days.

(06:12):

On the other end, there are periods, let's think about 2022, 2023 where the activity on social media is less intense, and even from a net-flows perspective we don't see such a strong activity. When we look at these periods, we need to be a bit more nuanced in the way we look at their activity and their contribution to the market. The net directional trend that we hinted about in the first part is not as sustained, but we still have ability to capture signals from their behavior. In these periods we were able to detect other trends, different trends, but still very powerful. And I'll just mention one for the sake of brevity. We looked at this trend while retail investor actually lost interest in a stock. And what we noticed, if we are able to buy the dip, to buy those stocks that have been invested into by retail investor, but then they lost interest, they start to sell. You could argue they actually oversold some of them. Then in these scenarios we're still able to get alpha over a 10 days horizon.

(07:10):

And to conclude, I think worth mentioning that what I've been talking so far is just the number of retail mentions of specific stocks on social media stand alone. If we decide to layer on other angles like short interest, like positive returns, or even the retail flow that is published by our colleagues in QDS, we see that the alpha generated by this strategy increased significantly. And I think this is one of the key differentiating factors of what we are doing. Our ability to combine these datasets with other source of data that we produce, both internally and externally, to generate the best alpha.

Eloise Goulder (07:44):

And it's worth clarifying that we as a team make both the social media volumes data, and also the strategy signals available to our clients via the Fusion platform. So just taking a step back. Luca, can you explain a bit more about how you filter the millions of social media mentions to screen for single stock references? I mean, I imagine there is a lot of noise in here to decipher.

Luca Rainero (08:10):

You're absolutely right. Like, noise is the right word to use in this context. And (laughs) let me allow for a quick pun. How can we make sure that we are not comparing Apple the company with apple's the fruit? And we have put (laughs) a lot of time and effort into creating a set of queries for these 3000 U.S. companies, broadly speaking the Russell 3000 to make sure we are hitting the right spot. And we were able to do that thanks to the help of our partners in the Machine Learning Center of Excellence in JP Morgan who specialize in this area. And therefore we can say with quite a level of confidence that we've been able to distinguish references to Apple, the ticker, and people who just enjoy talking more generally about the groceries. (laughs)

Eloise Goulder (08:48):

(laughing)

Luca Rainero (08:49):

And let me be honest here, we did find some posts about people liking to eat apples.

Eloise Goulder (08:54):

(laughing)

Luca Rainero (08:54):

Clearly, no model is perfect and we do appreciate that there is some residual noise, but we gain confidence from the fact that our back testing is quite solid.

Eloise Goulder (09:02):

That's all really encouraging Luca. So Edwina, back to you. You mentioned at the outset that we've seen quite different trends from the retail investor in other regions outside of the U.S. So what exactly have we seen in Europe for example?

Edwina Lowe (09:17):

Yeah. That's a great question, Eloise. And it's certainly harder to extrapolate retail order flow outside of the U.S. It's worth noting that both Chris Andrew and Clare Witts who cover market structure in Europe and Asia respectively have both been on the podcast talking about exactly this. But if we look at Europe specifically, generally retail share of volumes is a lot lower, albeit there are some pockets with slightly higher participation. So for example in Italy and Germany it's roughly 20% and 16% respectively. If we look at the UK, it's much lower, more like 5 to 6%, although they are a bit more active in mid-caps. And really if we think about why we see lower retail share of volumes in Europe versus the U.S., we can summarize three core reasons. One is that we don't have the same model of no-cost, low-cost brokerage apps. Two, I just don't think it's quite ingrained in our culture in the same way that it is in the U.S. to participate in the stock market. And three, we just haven't seen the same performance in the stock market over the last two or three years or so.

Eloise Goulder (10:23):

That makes a lot of sense. Thank you Edwina. And then over in Asia, I think the quite different.

Edwina Lowe (10:28):

Yes, that's absolutely right. I think the story in Asia is really fascinating. So just to highlight a few regions. In Korea, onshore China, and Taiwan, we see retail share of volumes being in the region of 60 to 65%. However, it's even higher if we look at small and mid-caps specifically. I think another region that's really interesting and certainly a growth story is the retail investor in India. It's exploded over the last three years or so, driven by a rapid rise in retail brokerage apps. So it's gonna be fascinating to see how that continues to evolve.

Eloise Goulder (11:06):

Absolutely. And Indian stock market returns have obviously been very strong over recent years, which will have helped that trend.

Edwina Lowe (11:11):

Definitely.

Eloise Goulder (11:13):

So Luca, back to you. I mean given everything Edwina has just told us about the retail investor in other countries outside of the U.S., are you thinking of developing a social media data set more globally? And more generally, what's next on your pipeline for data set development?

Luca Rainero (11:31):

So what we discussed so far today is mostly focused around like 3000 U.S. companies, and the number of social media mentions for each of them. But there's clearly more we can do in that space, and we want to be client-led. So we could go international, but there are few challenges in that space. The first thing that we need to be aware of is that most of the model that we use have been developed thinking about the English language, and accuracy substantially decreases the moment you move to other tongues. Moreover, while the U.S. has as lots of other data available, we can use to cross-validate what we do and our deductions. When we move to other regions there's less of this data, so we need to be a bit more careful in the way we approach these regions.

(12:12):

But before we go there, there are also other obvious steps for us to make. The first thing we really want to dive into, is to try and understand better the sentiment around these mentions. Can we actually deliver an enhanced predictive power the moment we try and layer the sentiment on top of the number of mentions? Another area that is worth exploring is what can happen? Are we able to improve the alpha of our strategies when we increase the frequency of our monitor? It's certainly true that end-of-day mentions do have predictive power, but can intraday give us more?

Eloise Goulder (12:45):

Thank you Luca. While there's certainly so much to focus on. So I'm looking forward to following this and checking in on this podcast series as you have more developments. So Edwina, Luca, thank you so much for joining us today. It's been really helpful to hear your perspectives on the retail investor behavior.

Edwina Lowe (13:02):

Thank you for having us, Eloise.

Luca Rainero (13:05):

It was fantastic to be here, Eloise. And looking forward to chatting again in the future.

Eloise Goulder (13:08):

Thank you also to our listeners for tuning into this bi-weekly podcast series from our group. If you'd like to explore our social media data set, or if you have feedback or questions, then please do go to our website at jpmorgan.com/market-data-intelligence, where you can reach out via the Contact Us form. And with that we'll close. Thank you.

Speaker 4 (13:33):

Thanks for listening to Market Matters. If you've enjoyed this conversation, we hope you'll review, rate, and subscribe to J.P. Morgan's Making Sense, to stay on top of the latest industry news and trends, available on Apple Podcasts, Spotify, Google Podcasts, and YouTube.

(13:54):

The views expressed in this podcast may not necessarily reflect the views of J.P. Morgan Chase, & Co and its affiliates, together J.P. Morgan. They are not the product of J.P. Morgan's research department, and do not constitute a recommendation, advice, or an offer or a solicitation to buy or sell any security or financial instrument. This podcast is intended for institutional and professional investors only, and is not intended for retail investor use. It is provided for information purposes only, reference to products and services in this podcast may not be suitable for you, and may not be available in all jurisdictions. J.P. Morgan may make markets and trade as principle in securities and other asset classes and financial products that may have been discussed. For additional disclaimers and regulatory disclosures, please visit www.jpmorgan.com/disclosures/salesandtradingdisclaimer.

Speaker 5 (14:48):

For the avoidance of doubt, opinions expressed by any external speakers are the personal views of those speakers, and do not represent the views of J.P. Morgan.