The Electrified Future: ETFs for the AI Data Center Megatrend

And so we're seeing, at least from a forecasting perspective, electricity demand growth in the United States that is expected to be greater than what we've seen in decades.

In fact, going back to the 1960s, >> I'm Thalia Hayden with ETF Guide.

It's nice to see you again.

We'd love for you to join our community by hitting that subscribe button along with posting your comments.

Joining us now is Paul Bayaki, head of fund sales and strategy at SSNC Alps Adviserss.

Great to see you again, Paul. >> Nice to see you as always, Dalia. >> Yes, first and foremost here, we are seeing a dynamic shift toward electrification.

Some experts foresee a 50% increase in electricity demand in just 15 short years.

We know that's the focus of the Alps Electrification Infrastructure ETF, ticker ELFY.

Why should investors be bullish on electrification? >> Well, we think at a high level the electrification theme is one of the investment mega trends that advisers operating on behalf of investors have to pay attention to.

And the reason we believe that is because you've got this convergence of a number of massive social and economic trends that are shaping this mega trend.

So when you think about AI, and we made a little bit of jokes about AI on the precall, but the amount of electricity demand coming from AI data centers alone is mind-blowing.

Depending on what you look at, you're talking about multiple cities of Philadelphia in terms of just electricity demand coming from data center footprints from some of the bank seven companies or some of the grid hyperscalers that are ultimately trying to build out the AI infrastructure needed to support all of the adoption of AI that's been forecasted.

And so you've got that massive driver of an increase in electricity demand.

You've got these social trends where people are switching from internal combustion engines to EVs.

That's increasing electricity demand at the margin.

And then you're switching from things like gas stoves to induction stoves, which again increases electricity demand.

You're trying to move people from their typical heating unit to a heat pump, which again increases electricity demand.

So you've got consumer level, institutional, the reshoring of manufacturing that's driving electricity demand up along with AI data center demand which is also driving electricity demand up.

And so we're seeing at least from a forecasting perspective, electricity demand growth in the United States that is expected to be greater than what we've seen in decades, in fact going back to the 1960s.

And so all of that requires additional capacity.

It certainly requires additional grid investments.

One of the the key quotes that I've seen recently, the NRG CEO said about the grid, we're building the plane as we fly it.

And what that means is we don't have enough grid capacity to accommodate the increase in electricity demand.

So what do we need?

We need some of the raw materials to support the electrification theme.

We certainly need massive investments in utilities who are tasked with providing the electricity both to consumers and to institutions and to commercial enterprises including AI data centers.

And so what Elfie does and is unique among the electrification thematic ETFs in the marketplace is it looks at only companies with five billion or more a market cap.

So you're not looking at sort of pre-profit companies with a extremely small market cap.

So you've got some established companies in there.

It's it's pulling from 18 different IC subindustries.

So it's very much a textured view of the electrification themes.

There's nuclear companies in there.

There's utilities companies in there.

There's components companies in there, industrials, materials, technology.

So it's a textured way to play the theme on a long-term basis.

But importantly, it also equal weights the portfolio names.

So you don't have these massive overweights based on larger cap companies in the portfolio.

So it gives you comprehensive balanced exposure to the electrification theme, which again, as we talked about at the beginning, we feel is the biggest mega trend that's going to play out in capital markets as well as the economy over the course of not just the next 5, 10, 15, but really over the next 20, 25, 30 years.

It's huge for sure.

For income seeking investors in high tax brackets, how does the Alps Intermediate Municipal Bond ETF ticker MNBD compare to other MUN strategies? >> Well, first of all, it's a national strategy.

So, it's not state specific, which I think a lot of investors in say California or New York might go to their adviser and say, "Build me a a MUN ladder with only credits from my state because of the tax benefits of doing so." But MMBD is national in its portfolio.

It's run by Brown Brothers Heramman, which is the oldest private bank on Wall Street.

They've got a heritage of investing in the municipal market through an SMA strategy, through trust portfolios, as well as a mutual fund.

And the ETF allows investors to tap into that experience and that expertise in the ETF rapper.

But importantly in terms of the approach, what Brown Brothers prides themselves on is knowing all of the nuances.

Municipals are one of the most diverse categories in all of fixed income.

There are different bond types, there different issue types, and they also apply a level of conservatism and patience that they think benefits investors in this category.

So when you think about certain credits in the municipal space that certain managers don't necessarily like to invest in because of a lack of liquidity or because they take time to sort of realize the long-term total return profile, Brown Brothers prides themselves on their ability to go out and pick and choose individual credits and maybe go into categories where other municipal bond managers aren't willing to do.

And it just crossed its three-year live track record.

The relative performance in its category has been nothing short of spectacular.

And we feel strongly that MNBD is a product that fits a varied set of needs for a varied set of investors.

Certainly the municipal bond category relative to other fixed income categories has lagged year-to- date.

And and we view that as an opportunity from a mean reversion perspective, but also for investors to your point who are in higher tax brackets looking to maybe decrease their tax burden in the fixed income sleeve of their portfolio, but also tap into a management team that has been doing this for decades and has expertise in one of the most complicated segments of capital markets.

And MMBD is just a product that we believe wholeheartedly is going to grow consistently over the course of the coming years and decades. >> Okay, makes sense.

Switching gears a little bit, Paul.

With growing focus on energy transition, how are midstream companies adapting and how is the energy infrastructure ETF ticker ENFR capturing that? >> Yeah.

So, what's interesting about midstream is in some ways it's drafting on two mega trends.

So, we've talked in the past, Alia, about the energy transition and the important role that natural gas is going to play into it because ultimately natural gas is the most important input into our electricity generation needs in the United States.

It's upwards of 43% of our electricity generation, which is likely to increase as we continue to sunset higher carbon emitting sources like coal.

And it's really a a bridge to a future where we integrate wind and solar and other renewable sources and perhaps even nuclear down the road in terms of meeting our electricity demand needs.

And it also plays on this electrification theme whereby as our electricity demand increases, we need reliable sources of electricity.

And we're seeing it play out.

So, for example, one of the largest MLPS, an AMLP, actually struck a deal with a cloud computing company down in Texas who's building an AI data center to build a lateral pipeline to provide natural gas specific to that data center.

So the idea is is that data center wants to ensure that anybody who uses it when the prompt is entered into the LLM that they can't return some error message that says actually we don't have electricity right now so we'll get you an answer in 48 hours whenever we have electricity and natural gas is abundant here in the United States it's relatively cheap and of course it's reliable and the companies in ENFR the companies in AMLP are the ones that are tasked with providing the network of infrastructure that connects production in natural gas to consumption in natural gas.

And increasingly consumption in natural gas is in the form of increasing electricity demand from these large data center projects.

It's also increasingly a global story as we're increasing our export capacity for things like liqufied natural gas.

And when we think about ENFR, which 70 75% of the revenues in that portfolio are tied to natural gas servicing activities.

So meaning transportation, storage, processing, fractionation, liquefaction, all of the various businesses that are in the mid-stream category within natural gas are dominated by the companies in ENFR.

And if your thought, as we talked about earlier in the conversation, is that increasing electricity demand is going to increase increased natural gas demand.

Well, then these companies really sit at the heart of connecting the upstream to the downstream.

And the downstream is increasingly hyperscalers who are building AI data centers that are in desperate need of reliable electricity generation.

And we've seen adjacencies and that's how we're positioning midstream in some ways is an adjacency to AI adjacency to the electrification story.

And even companies like GE Vernovo, which is building those gas turbines, has seen a three-year backlog in demand for those gas turbines, which are being built on these AI data centers and other facilities in order to accommodate increasing electricity demand.

And often what we see is the pipeline company is tasked with building a pipeline that connects directly to that gas turbine.

So the portfolio case for Midstream for ENFR and AMLP historically has been it's a relatively defensive stable segment of energy that provides a relatively high yield.

It's over the course of the past 5 years improved its fundamentals dramatically.

It trades at a very stable valuation in terms of enterprise value to free cash and free cash flow yield.

But importantly, these companies are starting to benefit from some of these mega trends that most people think only benefit large technology companies or companies providing chips to AI data centers or AI oriented companies.

The reality is it's really a mixture of exposures you need to tap into the long-term AI trend as well as the longer term electrification trend.

And that's why when we talked about Elfie, we spoke about the mosaic approach, the textured approach to building that index and in turn the portfolio. >> Let's talk commodities.

Now, commodities have been strong performers this year, yet they are still consistently under represented or missing from many portfolios.

One potential solution is the Alps core commodity natural resources ETF, ticker CCNR.

How can CCNR plug uh that gap?

Well, so at a high level, commodities have been a important portfolio diversifier.

If you look at a basketbased futuresoriented strategy like say SDCI, what you've seen historically is it has low to negative correlation to fixed income.

It has low correlation to equity markets.

And what CCNR does is it takes the basket of global commodities and natural resources oriented equities.

So, not just companies here in the United States, but companies around the globe and mixes and matches exposures within that bucket to provide a diversified portfolio of companies that stand to benefit from increasing commodities demand for things like copper, which we talked about.

They even have exposure to some of the raw materials companies providing the inputs to the development and manufacturing of solar panels and to wind.

And so in many ways what CCNR does is it provides you with a big basket 300 or so stocks of global global companies operating in the natural resources segment run by a team with a great track record of doing so.

But importantly these are companies that a lot of people don't typically own through their core equity allocation.

If you think about the S&P 500 materials companies are less than 5% of the S&P 500 by weight.

If you look at a global acqubased benchmark, things like materials and even energy equities aren't a big slice of that global diversified portfolio.

And so going out and seeking these companies who stand to benefit from some of these mega trends in terms of demand for the raw materials going into EVs and batteries, demand for the inputs to improving and modernizing the grid, demand for the commodities that we live and breathe and require in our day-to-day lives.

Those are the companies that are positioned to benefit from some of these mega trends.

Again, maybe in an incremental or maybe even in an adjacent way.

But importantly, what CCNR does is it gives you exposure to a management team who has real expertise and lives and breathes the commodities landscape as it relates to the equities portion of that portfolio.

And the relative performance to other portfolios that target this segment of the market either domestically or globally has been strong as well.

And so we view it as a portfolio diversifier in a market where we're at record highs and investors are starting to look for opportunities to maybe ratchet down the risk or importantly to turn turn down the dial on some of the overweights they have to the sectors that have been driving the market higher >> and REITs facing challenges from rising rates and changing commercial real estate trends.

How is the ALTS active REIT ETF ticker REIT positioning to manage those risks? >> Well, the portfolio manager on REIT, Nick Tenura, loves to say when we get them in front of advisors that people don't realize, but REITs are the best performing sector of the market over the course of the past 25 years.

And so, if you zoom out enough, REITs are incredibly important for portfolios.

They're a diversifier.

They've typically been a portion of the portfolio that provides relatively high income.

And importantly, they've evolved with the market over the course of that 25-y year period.

And so, although they've been the worst performing sector in the S&P 500 over the course of the past five years, history does tell us that REITs are an important portfolio tool.

And if you're looking for a mean reversion case, REITs are one of those categories where public REITs traded a relative discount to net asset value.

If you look at some of the fundamentals on the REIT category, they're attractive relative to where they've been.

And in many ways, the the REIT space, public REITs specifically, have been caught up in the headlines around commercial real estate and empty buildings, as we've talked about previously.

And the reality is is public REITs don't have a lot of exposure to commercial real estate.

If you look at the S&P 500 for example, there's really only one commercial real estate REIT in that portfolio.

The rest of the portfolio is made up of things like cell tower REITs, data center REITs, industrial REITs, self- storage, all of which have very different economic dynamics that drive their relative performance and their profitability profile.

We've talked about the data center demand and that segment of the market has been extremely strong over the course of this cycle.

But importantly, when you think about REIT, what you tap into, and it's similar to the story around MMBD, it's similar to the story around CCNR.

You've got a portfolio management team that knows this space inside out, lives and breathe REITs every single day.

And the relative performance of REIT compared to the the sort of typical allocations that people make in terms of passive beta oriented REIT strategies has been tremendous.

And so you're you're looking for opportunities in a market that's all-time highs where stuff either hasn't moved or it's underperformed and maybe you're reallocating to other segments of the market.

REITs certainly check that box and then you're able to leverage a portfolio management team which has great expertise and a strong track record in this category.

That's a nice marriage for adviserss and investors who are trying to allocate to the category.

And then the other piece is that we've seen this steady wave of redemptions and gating and private reach strategies.

People piled into private reach strategies, tried to get out, were unable to get out.

We've seen some strong relative performance of public REITs relative to private REITs.

And so for investors who either have no exposure REITs, have just been defaulting to the benchmark which has in some cases hundreds of names, some of which are low quality, some of which are high quality, some of which might be benefiting from some of these strong economic tailwinds, some of which may not be.

And then you're also maybe that subset of investor who's been in a private REIT strategy, understands the benefits of investing in real estate but is looking for opportunities in the public sphere.

That's really where REIT comes in.

And again, if you look at the track record of performance and the opportunity set for REITs on a go forward basis and the makeup of public REITs compared to where it was say 20 or 25 years ago, it also stands to benefit from some of these economic mega trends. >> Paul, we've learned a lot today.

Very informative.

Thanks so much for your timely insights. >> Thank you so much.

Always great to see you. >> And that does it for today's episode.

For more information on the ETFs discussed today, you can visit alsadvisors.com.

And if you did enjoy the show, please let us know in that comment section below and hit that like button.

I'm Talia Hayden with ETF guide.

Thanks for watching and we'll see you next time.