Live Chat: Who Judges Advisor Choices? What's A K-1?

May 23, 2019

[Editor's note: Join us for a weekly Live Chat! with Managing Director Dave Nadig.] 



Dave Nadig: Good afternoon!
Welcome to LIve!
As always, you can enter your questions below, and I'll get to as many as I can in the next 30 minutes or so.
We'll post a transcript at the end of the day in case you missed anything, maybe with a little video if I find the time!
But let's get going on the questions ...


Bob the Builder: Soundtrack?
Dave Nadig: Ra Ra Riot on shuffle:


Todd Rosenbluth-CFRA: Hi Dave. Yesterday SPHB shrunk in size by half and has approx $150M in assets. Are you surprised that a high beta alternative to offset the billion dollars of assets in lower vol SPLV and USMV has not garnered more interest for those seeking a risk on equity approach? Thanks.
Dave Nadig: Hi Todd!
So, SPHP is sort of the anti-low-vol fund. It specifically goes after high beta stocks -- those that go up or down MORE than the market overall.
I think the reason it hasn't found the traction of the low-vol funds is pretty simple: There are a lot of ways to increase your risk and still just get core equity exposure.
And those are ways I think people already know: buying underdiversified themes, buying small caps, buying growth or momentum ETFs.
Those all serve a similar purpose.
So I think "high beta" adds a layer of complexity to a thing people already have a lot of intuition about.
It's much less obvious for most investors how to get marketlike returns with LESS risk, which is why we have successful dividend funds, and low-vol funds, and even the defined outcome funds.
Maybe that's a bit of an obvious answer, but it's how I'd see it.


Jacob S.: How long do you think the SEC’s information-gathering period will last re approving a bitcoin ETF? Isn’t approval ultimately inevitable? I mean, do folks interepret that they're dragging their heels, or do you think they are genuinely operating out of an abundance of caution toward investors?
Dave Nadig: I think the delays on bitcoin are prudent, actually. As much as I'm a big fan of clever and innovative, I completely understand why the SEC is seemingly slow playing this.
I mean, if you think about it, there's not an easy way to stick the genie back in the bottle.
So doing a LOT of thinking and comment gathering, and having what amounts to a very slow dialog with the crypto community makes sense to me.
I do agree: I think it's somewhat inevitable. But the dialog could take a long time.
If I had to make an over/under bet, probably like November would be where I put the over/under.


Judy Larkin: Hello Dave. As an editor, I can’t be objective about my writing, so I have people I respect review my work. This makes me wonder if financial advisers ever get an expert to review their own portfolios, or if they largely solely heed their own advice. Thank you.
Dave Nadig: What a great question!
I do know quite a few advisors who do portfolio reviews with colleagues, and the advisor community in general talks a LOT among themselves about everything from how to react to angry clients to how to react to angry markets.
But it's also the case that the "advisor as portfolio manager" model isn't necessarily the default. A lot of advisors, whether they're RIAs or working for a large wirehouse, lean on models.
Those models in turn are often from either big, qualified in-house teams, or from a big external firm with a well-documented process and track record.
The best folks I know, though, are CONSTANTLY second-guessing themselves, and exposing themselves to new ideas, challenging their sacred cows and so on.
That's part of why I enjoy interacting with the advisor community on financial Twitter and conferences so much: folks like Ritholtz, or Meb Faber, or Nate Geraci, etc. They're always in a dialog about what's going on and how it affects their clients.


Melissa: Inasmuch as the slow march of time changes many things, like ETFs gaining ground on mutual funds, who’s doing better right now: active or passive managers?
Dave Nadig: Well, from both a performance and asset-gathering perspective, it's been a long, long time since active managers as a class have had a good year. There are definitely some who do well, but as a class, they continue to underperform, and they continue to lose assets to passive.
I think the interesting question is whether we get a natural shakeout that improves both the story behind active, and the reality, in terms of performance.
I suspect it will take more time. But it's great watching some of the newcomers to the ETF space that are truly active -- Davis, ARK, etc. -- have some success. I think it's healthy for the business.

Eustace: Did MJ’s issuers retain most of their investors once they changed that ETF from a Latin America fund to a marijuana fund? Was such action even legal (or considered above board)?
Dave Nadig: So when ETFMG (the firm behind MJ) migrated the LARE fund to MJ, there were only a handful of large investors. The largest one of our reporters contacted said they had NO IDEA the fund was even changing (and weren't happy about it).
MJ gathered assets so fast, the snide answer would be "it doesn't matter."
I don't think if they'd retained all, or lost all, it would have made a whit of difference on the growth of the fund.
As for whether it was legal -- yes it was all done legally. Whether it was "above board" is a judgment call. I think it was odd.


Art MacCombe: I’m struggling to understand why President Trump issued $16B more in farmer aid since the tariffs are what’s hurting them. What am I missing?
Dave Nadig: I don't think you're missing a thing!
Fact 1: Countertariffs from China have a huge impact on (particularly) soybean farmers.
Fact 2: The admin is going to buy a lot of soybeans using taxpayer money.
Now, one could say, "Yes, we're collecting money from the tariffs we put on though!" to which my response is, "Yes, but that ultimately still gets paid for by the American consumer."
So essentially, we're taxing with the left hand, and spending it on soybeans nobody wants to buy on the other.
It's not that surprising, and also not that economically sensible long term. It never makes sense to subsidize something people don't want to buy.
(My opinion; I'm not an economist.)


Jerome P.: What types of ETFs are subject to K-1 tax forms? I've heard those are onerous. Would investors do best to steer clear of any funds that require those?
Dave Nadig: Hi Jerome. So K-1 partnership forms are what you fill out when you are a partner in something. Technically, most commodity funds are actually structured as limited partnerships.
So that's the short answer: commodity pools.
However, there are now a lot of commodity ETFs that get around this by structuring themselves as '40 Act mutual funds that sit 75% in cash, and invest 25% in a Cayman Islands subsidiary, which in turn buys the underlying commodity futures, with enough leverage to give you notional 100% exposure.
So your dollar of investment = a dollar of exposure.
They do that to avoid the K-1.
But it's worth pointing out that the K-1 is really just a once-a-year headache. It's not lethal.


Charles B.: In your ETF 101: Back to Basics webinar yesterday, one of your slides said: “Transparent? Creation/redemption requires transparency.” So: 1) do the new nontransparent active ETFs not require creation/redemption? 2) What is the benefit to an issuer in offering nontransparent ETFs? Wouldn’t they want investors to feel their vehicle is transparent (also since that’s supposed to be one of ETFs’ the key features)?
Dave Nadig: So there is for sure some nuance here.
First, Vanguard is not, by my definition, transparent. Because their ETFs are share classes of mutual funds, they generally only disclose quarterly.
(And again, some nuance, because their ACTIVE ETFs -- their factor ETFs -- do disclose daily.)
And the new nontransparent funds won't disclose to us daily, but they will disclose to the special "agent" who sits between the AP and the fund.
So it's getting a bit trickier.
But it's fair to point out that while historically, creation/redemption required transparency, it's been chipped away at so we now have some exceptions.
But overall, we now EXPECT ETFs to be transparent, and if they're not for some reason, it's the oddball one.
OK, going to wrap up with this last one:


Freedom Fighter: Any thoughts on the new FRDM ETF?
Dave Nadig: Love love love this new launch, which is from Life & Liberty Indexes in combo with Alpha Architect.
The core idea here is pretty simple: one of the big concerns about emerging market investing is that you end up with a lot of unintended consequences -- investing in places you might not want to, investing in giant state-owned companies, etc.
And many EM countries are in fact problematic, for all sorts of reasons.
The L&L index that FRDM is based on looks at measurable data around freedom: economic freedom, freedom of the press, capital movement, personal freedom, etc.
And it creates country weights based on that, then it picks the top 10 companies by size in each country, excluding anything state owned.
What you end up with is a local large cap EM portfolio that differs quite dramatically from most EM ETFs.
We have a great article up on this fund right now here:
Over time, this is a strategy that really delivers, so far, lowering risk and increasing returns by just enough to really be worth looking at.
Over the last year, for instance, it beats EEM by about 2%. Over five years, it turns EM from an 8% loser into a 6% winner, etc.
(And yes, that's not live, as the fund just launched, but the indexes have been kicking around for quite some time. This isn't a whacky new idea. They've been developing this for YEARS, and it's had its tires kicked by some of the very best quants in the biz).
So overall: big fan.

OK, that's a wrap for today. Thanks everyone for joining us. We should be same time/same day next week. Have a great long weekend everyone!

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