Investment Strategy and Future Outlook

Today's animal Spirits, Talk Y your book is brought to you by First Trust. Go to ftportfolios d. com to learn more about the F Trust, NASA, clelean energy, smart grid Infrastructure ETF. that's Ticker grid Great ticker, GRID. That's ftportfolios d. com leararn more Welcome to Animal Spirits, a show about markets, life, and investing. Join Michael Batnick and Ben Carlson as they talk about what they're reading, writing, and watching All opinions expressed by Michael and Ben are solely their own opinion and do not reflect the opinion of Ridhol's wealth management This podcast is for informational purposes only and should not be relied upon for any investment decisions. Clients of Rrid Hol's Wealth Management may maintain positions in the securities discussed in this podcast Welcome to Animal Spirits with Michel and Ban, Michael you and I have been talking in recent weeks about the someomewhat surprising winners and losers. from the AI trade. I don't know that anyone really assumes that utilities are like this fast growing up and coming innovative sector. This would be one of the ones to me that I would have never figred out when it first started The whole AI boom that utilities would go crazy and the buildout for the power would be kind of a ceiling on this whole thing. He, I thought you were a pick and shhovelless guy. Is this not part of pixs and shovel? That is picks and shovel. If I was on CBC, that's what I would say, yes. That's what you want to own Fixing the shovel and this is it And It is interesting because if you just There was a Robert De Nerro movie, I don't know seven years ago or something. And he was a guy who built the power lines. Right? If you go Where, whoa, whoa, what was this movie? I can't remember. Bobby D built power lines I mean, he's done a lot of paycheck movies. It was just okay. But if you go in any neighborhood, anywhere in the country and you see power lines everywhere, you kind of think to yourself, how old are these R? They look like they've been here forever. Why aren't they underground or something And it sounds like the whole AI buildout has made many people realize that we need to This Wh did did there? So Ben, I asked Claude what movie you're talking about and Claude said, I think the movie you're picturing is life on the line I think Sam Michel may be in it. But the star is John Travola, not D Nera No, no, no. Tk allw the r. I search D Niro's filmography and there's no power line movie in it So it's almost certain naturealol. Everybody's fine, two thousand nine movie Okay, you know what? Oh yeah? What about everybody's fine Jember Sam Rockwell. U Kate Beckensale and Robert De Niro. I never heard of it. Let's see what Clawd has decipher itself U All right, anyway, where you say Anyway, on today's show, we talked to Ryan Isak Kanan. Ryan is a senior vice president, ETF strategist at First Trust and they have a ETF that that is trying to take advantage of not I guess not trying to take advantage It was there well before the AI boom happened build out the power grid because they thought there was necessary to see a big boom in the power grid or a big upgrade in the power grid. And you've got some numbers on this. This fund is growing or has grown like crazy becausecause of AI. But that was never the point because the fund has been around for a very long time. So what did it grow to? It's at a twelve billion dollars fund now just about Anyway, and It's a lot of companies you've never heard of, some of you have, but it's a very interesting thoughtought experiment You talk about what Tawan semiconductor being the the transistor of the governor to hold back AI. mayaybe it also is the electrification of the country for about the data centers. Anyway Fascinating conversation today with Ryan from First Trust. So here's our talk with Ryan Isaan from First Trust. Brian, welcome to the show. Hey, thanks for having me you guys. All right, so we're talking today about the First Trust NASDAQ Clean Energy Smart Grid Infrastructure Fund. The ticker is Gid, Great ticker This thing has been around so all right. I looked on I went on the wite charts as I do and I go to the funund and I see what's going on. whoa, twelve billion dollars. Holy cow. U, this is not a new f sp around for a while U the objective has not changed, the narrative has changed a little bit. in terms of getting the market excited and I say excited because There's twelve billion dollars in the fund And in twenty twenty three, there was a billion dollars. A lot of the interest has come over the last, let's say since twenty twenty five The AUM has, u, sixx toppplled, sixix toppplled. it's up six X I don't if I said that properly, but anyway, what's the story with Grid? whyy all of the interest from investors? I know this is a softball question, but here we go. firstirst one Well, I think it's one of those adjacent themes alongside the buildout of AI. and that's what a lot of investors have focused on recently It's really when we think about where the bottlenecks are and, you know, what could cause AI to not be deployed as quickly as many people might want it to be. it's the demand for power. and of course, you have to connect new sources of demand with sources of generation and that requires the power grid. And so our fund is all about modernizing and expanding power grids. And as you mentioned, it's been around since two thousand nine. so it's not a a new story that we've needed to modernize the power grid Some of the drivers, some of the reasons for that have shifted. When we first launched the fund back in two thousand nine the narrative surrounding why you needed to modernize the power grid had a lot more to do with new sources of power generation coming online whether it was wind or solar, the existing power grid infrastructure just didn't work well It was designed, you know, one hundred years ago for centralized power generation and everything flew or flowed downstream from cooal fired plants. Now you're introducing intermittent source of power generation that came and went as the sun, you know, set in the evening or the wind stopped blowing. And so you had to figure out how to introduce a new power grid, essentially for that course, that's still related. there's still a lot of wind and solar that comes online, but this new source of demand coming from AI has really been a huge driver in the need to really expand and modernize that grid. And so the methodology hasn't changed, the objective hasn't changed, but the driver has really accelerated over the last few years What at what point did you realize like, oh, this our fund is an AI play. Like what was that aha moment for you? Like, okay, this is this is something new now Three years ago my team published a piece where, you know, we had kind of recognized that it was something that was going to create a huge amount of demand and therefore pricing power when you think about how quickly demand has come on for more electricity. You know, when we obviously didn't know that you're going to have AI in twenty twenty two, you know, november twenty twenty two, you're sitting around the Thanksgiving table with your family and trying to figure out what chat GPT was m you know, we had no idea. The grid operators had no idea. They thought that we'd have you know, just that that under a one percent increase in power demand year over year that we'd had over the last couple decades It was really, you know, twenty three, twenty four as those estimates started to get ratcheted higher we recognize that you know, this is something where You're going to have massive amounts of demand if this continues and it's only accelerated since then So it's really been over the last you know I'd say two or three years that we' recognized that this was one of those adjacent plays to the buildout of AI Ben and I been talking a lot about the bottlenecks at every every stop of the supply chain which is a natural governor on how fast these things can be produced which I guess theoretically should should hopefully like keep some of these things from going completely out of control In other words, if demand was able to meet If supply was able to meet demand, then maybe you would say, all right then now there's an oversupply and everything comes crashing down So I think this's like a natural governor in a good way. and the way that we've been framing that a lot is like All right, Taiwan sent me They can only generate So many chips per minute per hour per day We haven't spent a lot of time talking about the power aspect of this. I'm so ignorant to how all of this works. For a layman What do some of the capacity constraints powering these data centers literally look like I think unlike some of you might think of with other forms of bottlenecks O of the differences when it comes to the power grid and the buildout of the power grid has to do with the reality that this this is Um All, you know, you build power lines, it goes through somebody's yard. It goes through somebody's somebody's business. There's a lot of regulation that is required that is just unavoidable. And so that's part of the reason why you start to hear these large technology companies introducing behind the meter and some of these other forms of power generation But I think there's still a massive amount of of actual length to the power grid that you're going to have to add to not just the US, but also Europe, also Asia, also the developing world And, you know, it's a massive, massive amount infrastructure that has to be built. And this is this is an industrial project. This isn't something where you're just building one factory. This is something where you've got to scale out the entire system And these are things that take a long, long time to actually take place. so you have to get the permitting, you have to figure out all the environmental studies. you have to put the lines in place, you have to put the towers in place. you've got to worry about the You know, the transformers and the electrical components, the meters, everything in front of and behind the meter. there's a lot of supply chain that has to be built out. There's a lot of CapEx associated with those supply chains And so, you know, one of the interesting things guys that we as we're talking to investors that that have heard the story before and now it's starting to become part of the narrative ople wonder where are we in the the buildout of this? What's what inning are we in? you know, that's the parlance, right And they wonder is this because I've heard it so much now, is this something that is just about ready to, you know, turn over or are we in the early innings? and we would argue wholeheartedly that we're in the early innings of this buildout because it is such a long project and it is something that requires so many stages to actually take place. And so Along with that, there's unavoidable bottlenecks that are going to be around for a while. Um And, you know, to your point, Michael, I think that is good in terms of Um, you know, kind of as a governor to prevent all the throttle to be down and releasing all the gasoline in the engine, It does kind of slow things down and causes a process to unfold over the next several years Ryan, who is responsible for the buildup? Is it governments and municipalities? Is it these tech providers that are building the data centers? Like who ultimately is on the hook for building these this buildout Yeah, it's a mixture. It's a coordinated effort between the large technology companies that are making these hundreds of billions of dollars of investment along with the power companies, the merchant power companies and the integrated m or vertically integrated utilities along with governments. Governments have to be the ones that actually approve the regulation Um, and, you know, allow for these things to to take place Um, And so if any one of those parts of the system doesn't do its job or doesn't you know, move along, it's it's going to slow things down. And so you have to have the the utilities U adding infrastructure to the system to be able to connect new sources of generation with new sources of demand, you have to have the hyperscalers agreeing to fund their part of what the added cost might be or you're going to have, you know, customers are going to lose their minds over increase utility costs? Are we already seeing that now where people are homeowners? Households are paying more for their electricity because of this? Yeah, I think data centers do have a bit of a PR problem because of that I think the narrative probably doesn't line up with the reality and that's often the case When you think about utilities in our infrastructure has needed investment for a long, long time. And so the cost of that investment to upgrade and expand power grids is already going to increase cost for consumers. There's just no two ways about it. I mean, even in the absence of any of the data center buildout or any of the resoruring of manufacturing and things like you know, all these other trends that are adding to electricity demand, you're going to have increased costs because these are holes and wires and transformers and things that have been in existence for a long time that need to be modernized especially if you're going to integrate new sources of demand or of supply rather, like wind and solar. And soen the question is, well, do you want these large hyperscalers to come in and contribute to that buildout. Um because They may actually, even though costs could go up they could cause costs to go up less because they're actually helping to pay for the modernization of power grids. and even the ongoing operation of those utilities, you know, a lot of a big portion of that is actually fixed cost And these you know, these utilities have an allowed rate of return, there regulated monopolies in many cases. And so if you're able to spread that fixed cost, among more kilowatt hours that are consumed, you could actually lower the cost per kilowatt hour. which you know, counterintuitively means that data centers could actually be better for consumers than they would be in the absence of those data centers. But you know to your point, Ben, I think U data centers have really and AI in general has to do a better job in communicating what those benefits are Ryan, how do you know as much about this stuff? What what's your day job My day job is That's a very good compliment. I am the ETF strategist at First Trust and so we spend a lot of time with my team K kind of investigating they themes are the trends that are going to drive market performance that are not already well represented in broad indexes So you know, we look at what is in the S and P five hundred. There's a lot of semiconductors embedded in the index. and maybe you want to overweight semiconductors, that's great. But there's really not a lot of exposure to many of the themes that have been more popular in the broad index is like the Power Gid, for example. You know, you're not getting a lot of powerower grid companies if you just buy the S and P five hundred. And so we want to know what the stories are, what the drivers might be going forward So I've been with F Trust for twenty six plus years now and I've had the pleasure of working with some really smart people and I just learned from them. This ETF, you're right, looks nothing like the S andP five hundred. There is the top ten holdings are companies that most casual listeners or investors have never heard of thirty two percent of the fund as of march thirty first, twenty twenty six is in electrical components twelve percent is in multi utilities, another twelve percent is in diversified industrials. This is not Micron, Western digit, Sand Disk, AMD, et cetera.ike this is not that I have a broad question When we say what inie is it orr what time is it? or however you want to discuss where we are in the cycle. It's really tricky because There can be a big difference between Where we are, and the cycle it from like actual buildu out and use case of this AI, infrastructure, power, et cetera We can be very early there where this could legitimately have another three years, another fifteen years. like we're just beginning But then there's a stock piece of it. And those might be on different schedules It might be three o'clock here eleven thirty there. And that happened in the dot com bubble And right? like the internet was a thing and it barely had even started when the bubble burst. I'm not suggesting that this is going to follow suit, but like it's a really interesting thing to think about. So when I look at grid, This thing is up one hundred percent over the last three years And I think someomebody might look at this and say, oh I missed it And I think that is probably the way that the average investor thinks And I think the average investor is usually wrong when they think about these things. Now yes, of course, something's tripleing in over three period and you buy the top and they crash. Like, of course it happens all the time But for something like this, I think the general attitude towards This whole thing is it's a bubble And u I mean, I don' I understand that point of view I don't necessarily know that I share that opinion. What's your take on everything that I just said and I know it was a bit of a ramble Yeah. no, I think there is definitely the perception when you've seen something run up that It's easier to think I'm going to wait for it to come back down. I want to wait for a sell off to happen. And I'm sure there will be sell offs between now in the next ten years that invvestors may say, oh, and that was the time that I can get in at a cheaper price. On the other hand, they may say, well, you know, it's going down and it's going to drop like the dot com bubble did when that burst You know, this is going to come back down. So why would I want to own I want to buy these assets as they got cheaper U and you know, that's the whole psychology of investing and that's why most people are unsuccessful at investing, especially in these sorts of themes. The way that we look at it is we're not going to time it perfectly. We know that. Th when we talk about themes like the power grid We very rarely try to make short term calls where we say, you know, we're going to own this for the next month or the next three months we look at this as being Over the next decade, you're going to see massive, massive amounts of capital investment in the power grid and it really is not just dependent on data centers. That's what's driving the narrative now But at the same time, you know, my hometown of Syracuse, New York, we're building the Micron chip fabs there. Theres They're going to build four chip fabs over the next twenty years and they're going to spend a hundred billion dollars doing so. And you've got to supply power infrastructure to those chip fabs There's a lot of manufacturing that's coming back downline. That's driving demand for power grids. There's just failing power grids. You know, every time there's a storm that passes through, people are familiar with losing power And that's because their power grids are old. They're not hardened. They need to be invested in And so One of the things that we like about this way to think about the AI theme is that it's not It's not fully contingent. on data centers. Yes, it's going to benefit from data centers, but if dataenters Um, you know slow down if we decide, you know, we' built enough still have a backlog of demand. There's still a few year backlog of demand for powerower grid. And you know love I love illustrations where you can kind of compare two things. So here's my comparison for you Power grid over the next twenty five years, according to Bloomberg is going to add something like seventeen million miles of transmission and distribution lines. And the comparison is that's enough length to go back and forth to the moon thirty seven times. Oh, Michael likes these ones. This is going to make sixty million miles of length to the power grid and that's basically here to Mars when they're at the closest point to your your points try to cut you off. Yeah. Yeah. In twenty nineteen and twenty twenty, this fund was up more than forty percent. It was up almost thirty percent in twenty twenty one. So that's before Cet GPT was even a thing. and you had really great performance. So I'm curious because if you look at like the just the top ten holdings in this in this fund, there are some some names that you recognize in the top twenty five holdings, but the top ten Maybe some companies that people are aware of, but not certainly not household names. So maybe you could just go through us with the process of how you go about picking the fun because it looks like, I don't know, just eyeballing at the top Five or six companies at least make up, I don't know, forty percent of the total or so Yeah, it is a market cap weighted fund And really, we work alongside our index provider, which is NSDAq, they consult with a firm called Clean Edge. and all they focus on a clelean Edge. and they've been you know working as a consultant to the index since we launched our fund back in two thousand nine. they created the index slightly before that. But what they're focused on is identifying companies that generate a substantial amount of their revenue from what we'll call power grid related activities. And so these are, you know, the things that we've been talking about, the electrical components U the transmission lines, you know, those materials, the cabling, so, you know, companies like Prismian U the grid engineering, so Qanta would be an example Um, you know, that the all that electrical equipment, companies like Eaton and Schneider Electric and ABB and Johnson Controls and all these names that are very, you know, you don't think of these as sort of the sexy semiconductor names. The index provider is screening for revenue and essentially it's eighty percent goes into pure plays, market cap weighted, twenty percent goes into sort of businesses that have some involvement in the power grid but they're not driving the revenue. For example, they're not the main driver of the revenue. So you know, Nvidia has had a small position in the fund capped at two percent. And that's because NvIDia has very important grid related software. if you want to manage efficiently your flow of electricity, NvidDia's got Amazing solutions for that And so we do have some exposure to companies like Nvidia. So why is Nvidia have a cap on it? Just because they're not a pure play in terms of a grid related component of. So there's like there's guidelines or things you have to check in a box to be a certain weight in the index. Yeah, exactly. The revenue coming from NVIidia's, you know, powerflow management software is not anywhere near what they're generating from their GPU's And so yeah, we do have a cap to incorporate some of those important companies there involved in the power grid, but they're not They're not the most important driver to the business What do the earnings of these companies look like? So we've been talking a lot about The storage and the memory companies, Micron and SK and the others where the earnings were nine dollars a share a year and a half ago, and now they're one hundred and thirty five dollars a share like explosive growth. Do it look similar here and then As a follow up, what do the valuations look like Yeah, the growth level is not what you're seeing in, you know Micron. The pricing power and the revenue that Micron and some of the other chip companies have had over the last several quarters has been nothing short of remarkable. It's been explosive to your point. And a lot of that is because they're so supply constrained in terms of what they're they're putting out there. They can charge whatever they want to. When it comes to the growth that we've seen for some of the companies in our portfolio, it's more like fifteencent, twenty percent earnings growth on s the as a portfolio Um And so, you know, the good news is it's it's not explosive, but it is fairly consistent U and as we look forward you know, I think the apply constraints that you have for some of the chip names It's really no different for you know, some of the companies that are in our portfolio You're not going to have the ability to meet that supply for maybe a little bit longer time. But as a result, it is a bit more steady. So not the level of growth that you're seeing with the chip names, you're also not paying the valuations that you would with some of those names. You're trading as a portfolio at about twenty four times forward earnings. That is when you look at the overall portfolio towards the upper end of the range over the last decade, but I think that reflects just the realities of the situation where you're seeing the potential, you know this relatively robust earnings growth, potential for upside going forward, I think is reflected in that slightly elevated multiple So I think one of the cool things about ETFs in general, especially this decade is just the growth in thematics and the ability to invest in a cetor like this, if you have a belief. What would you say to someone who says, well, why wouldn't I just buy the utilities ETF? I'll just buy a utilities sector? What's the difference between that that sector fund versus what you guys are doing When we create a thematic ETF, it's not really necessarily constrained by what um, you know, GSCI says or some you one of the one of the uh Um, indndex provider says is involved in a sector. It's really often spanning a variety of sectors. So this fund in particular has Um, you know, it some industrialss, some utilities, some international companies, some US companies Qion is different. It's not How do you represent a specific sector? It is how do you benefit from this trend that's playing out over the next several years? And so it's a very U it's a much more tailored focus when you're talking about thematic funds than it is when you're investing in sector funds. sector funds definitely have their place. We have a lot of sector funds at F Trust. Um, but but that's when we're thinking about themes, it's What is the trend? How is the trend playing out? And what sort of companies are going to benefit? And then can we create a portfolio that represents those companies Damn you' good Is the way that things go now with the building of the power grid, arere there any alternative energy sources that could come into play to help? Or is it like, no, this is just kind of the way things go and the alternative energy sources are so far out of the future, it wouldn't make a dent in any of this. One of the great things about a power grid fund is that we don't really necessarily care what the source of power generation is That being said, I think there's amazing technology that's on the horizon, whether we're talking about cold fusion, which is always, you know, for the last few decades has been ten ten years off So we'll see if that comes to fruition or whether it's small modular nuclear reactors. And you know There's huge promise for all these technologies. having more efficient ways to generate power, but they all still need the same sort of infrastructure if you're going to build them into the system. So if those clean energy sources do come, your your fund is positioned to benefit either way. I think so, yeah. ye, especially because the current power grid system is not positioned It wasn't created for those sorts of sources of generation It wasn't it was it was the power grid was patched together over the last century to manage generation that was centrally located from burning coal or something like that. And then everything flows downstream When we think about the new power grid that has different sources of generation different intermittency of that generation Um batteries integrated two way flow of electricity because, you know, someone generates solar power and they want to sell it back ono the grid. All of that requires a different kind of power grid. and a different set of technology and And yeah, so I think either way, we're well positioned with this fund to benefit from that buildout Perfect. Ryan, if we want to have people learn more about the fund, where do we send them? A great place to find more information on the fund would be our website, which is ftportfolios. com. I don't know if I can give a plug for the F Trust ROI podcast while I'm on your podcast, but there's another place where you pcast are four We've been hosting our podcast for the last few years. And that can be found on all the podcast platforms as well. So we talk about these things and other topics on the podcasts that I host Thanks so much for Ran. All right, thanks guys. Okay, thank you to Ryan,emember, check out fpportfolios. com to learn more about grid. Email us animal spirits at compound News. com