Live Chat: The ETF Void That Needs Filling

December 19, 2019

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


Dave Nadig: Howdy folks. Welcome back to Live! Probably the last one for a few weeks, so we'll try and make it a good one!
As always, you can enter text in the box below anytime, and I'll get to as many as I can in the next 30 minutes or so, and with any luck, record a bonus video after as well.
But enough preamble; let's get rolling.

MusicMan: Soundtrack for the day? Xmas tunes?
Dave Nadig: Not a huge Xmas music fan, so instead I'm all about the new Foo Fighters EP drop. Great cover of an old Pink Floyd tune in the mix:

Astrid: What do you think will be the key criteria for the SEC to have clear “oversight” into ESG funds, since so many ESG factors are subjective?
Dave Nadig: I have to say, I'm a little disappointed with the SEC's initial foray here.
On the one hand, it’s great they're looking at what's inside things.
But their initial comments seem to just kind of ignore that there are trillions of dollars globally following SRI/ESG guidance.
So to be as dismissive as they've been, I don’t know. It's hard for me to see how they come up with any kind of comprehensive rulemaking that actually matters.
If I had to make one prediction, I would suspect someday we end up with a paragraph in prospectuses or SAIs that says something like "ESG goals may not be positive to your absolute performance in all time periods" or something equally worthless.
And it will end up on page 22, and nobody will ever read it.
But I'd challenge them to even come up with a definition of what they're talking about. That would be a good first step. As you say, it's entirely subjective. Not just "so many," they're all subjective, except for maybe a few governance issues like "are you actively being sued" or "do you have felons on your board."

ESG Allocator: With NUHY (Nuveen High Yield Bond) & EMNT (Pimco Ultra-Short Bond) now available, creating a globally diversified ESG portfolio is even easier. Although, the missing piece seems to be a comparable ETF to BNDX or IAGG for the international bond exposure. My question is, would one of the green bonds ETFs—VanEck/iShares—be a good proxy for BNDX, at this point, since they hold mostly international bonds?
Dave Nadig: This is a pretty complex question.
Green bonds are really quite a narrow slice of the market, and they have unique characteristics. So it would be wrong to think you can just buy green bonds and somehow have an ESG-AGG.
Sure, you'll be more ESG on the scorecard, but you’re not getting the same mix of risks.
Yes, a lot of it looks pretty familiar: some BofA, some Merrill, some Fannie, and so on.
But the mix is nearly accidental, because it's based usually on issuance.
Among other things, the corporate side is very slim—which maybe you want, maybe you don't.
So by all means, dig in and do the research, but this isn't like swapping SPY for IVV, or even like swapping EEM for IEMG. They're very different portfolios in the end.

Cleo: Hi Dave, any specific ETF predictions for 2020?
Dave Nadig: They're not "big news." I think we see a continued "playing defense" stance from investors, so flows and product that let people stay invested while lowering risk will be popular.
We've seen that a lot in the last six months: min vol, dividend growth, defined outcome, and so on.
The periodically disclosed ETFs will get rolled out in Jan/Feb, and I suspect some will come with large assets (institutional) out of the gate.
But really, that's all I got. I don't see anything that’s super exciting on the raw ETF market front, which is fine by me, because I think it's going to be exciting enough in 2020 without some giant ETF story to worry about!

Bill Donahue: Dave, Happy holidays and New Year to you and your family. Lots of focus on ESG by issuers; however, the announcement of an ongoing SEC sweep exam last week likely will make some issuers pause. In my view, most firms do a pretty good job with the G; however, there’s a lot of subjectivity with the E and S in terms of how far down you look at it (e.g., Walmart selling guns). Europe is by far a leader in the ESG space in terms of taxonomy, disclosures, regulations, etc., whereas the U.S. has a long way to go to catch up to them.
Dave Nadig: The SEC can do what it likes, but I think this ship sailed decades ago.
ESG is not new. It's just new to retail.
As you point out, Europe is over this discussion. It's just how money is managed there, and how companies are evaluated. It's like breathing.
So while I'm happy they're looking, I don't think it's going to have some sort of chilling effect. SUSL isn't going anywhere.

Nate Geraci: It's always tough predicting what politicians may do, but do you think Congress will ever reconsider the tax laws (or some would say, “tax loopholes”) around ETFs? 2019 is yet another year with minimal cap gains distributions from ETFs.
Dave Nadig: Literally the only people I have ever heard discuss this are ETF nerds.
It's quite literally never come up as an area of concern in any conversation I have ever had with a regulator or a politician.
If the SEC wanted to have any input, they missed it in the ETF rule. The only regulator actually involved on the tax side is the IRS. So unless the SEC or someone changes the structural process (which they went out of their way not  to do, because they recognized that clean, custom creation redemption is overall good for investors), it just isn't going to happen.
Unless, magically, the IRS becomes a proactive rather than reactive part of the picture.
I just don't see it. I supposed in five years, two administrations from now, it could be on a tax overhaul agenda.
But in the next five years? Nah.

Jameson Locke: Do you see zero trading fees having a positive impact on the ETF space? Perhaps more people will have an incentive to participate in the market now?
Dave Nadig: I definitively think it's a positive.
I used to have all these slides in my "stump speech" deck where I explain ETFs, where I talk about the biggest disadvantages of ETFs being frictional: whole shares and per-trade or per-share commissions.
This was, for decades, the one big advantage mutual funds have.
And it's gone, at least at Schwab, soon to be Schwab/TD/Voltron.
So the reason mutual funds have left to exist is 12b-1 fees, which fund recordkeeping in defined contribution plans; they can be nontransparent (which is rapidly eroding) and they can close.
The latter is the only really important one in my opinion.
K-plans can be funded with explicit fees for the same net cost to participants.
So the ability to say "sorry, we're full; no new money" makes the mutual fund a good bridge for a high-intensity manager, between a hedge fund and an ETF. So there remains a small niche.
But overall, once we have enough of a pullback for people to capitulate out of mutual fund positions with huge embedded gains, that taxable money is just going to flow into ETFs faster than ever. It's exactly what we see in every market pullback.

Delvin: How can a retail investor without an advisor buy a balanced ETF portfolio? Is there an ETF for that or a provider of a bundled ETF product?
Dave Nadig: T
his really hasn't been a strong suit for ETFs.
There are a small handful of balanced ETFs. Like AOM from iShares, but really, it’s a desert.
It's relatively easy to understand why: The vast majority of balanced mutual funds are used in 401(k) plans.
There are literally no target-date ETFs anymore, and yet they're the No. 1 most-used selection in most 401(k) plans.
If you want a full portfolio of ETFs, but want just a tiny bit of handholding, consider a robo. There are a ton out there now (from all the major brokers, and also independents like Wealthfront and Betterment.
Some are technically free (like Schwab's), but there's usually a catch (house funds, too much cash), but still, they all get the job done, and even the ones that charge are very reasonable and provide real value.

Ted: Have you heard anything on a possible crypto ETF?
Dave Nadig: Most folks know that Matt Hougan at Bitwise and I are pretty close, so we have several bets active on this front. My current prediction is 2021 for approval. I just don't see the movement in the next 12 months.
Matt's saying inside that.
I think eventually it happens. But the pressure is definitely off. The SEC wants I think, more than anything, a bit of time to pass. A few more boom/bust cycles to shake out. A few more custodial players, and so on.
So I wouldn't hold my breath.

NY Captain: Are you excited about Derek Jeter being named as a key note speaker at InsideETFs? Michael Lewis was outstanding last year.
Dave Nadig: I will show my stripes and just say: I'm not a baseball guy. I like games live, but it's never been my sport. For me it's F1, and e-Sports. So if they had Lewis Hamilton coming to speak, I'd be knocking over old ladies to get to the front row, or possibly poisoning the moderators’ food so I could do it.

Todd Rosenbluth - CFRA Research: Hi Dave. Happy new year. These chats are always informative. Most of the time ETF nerds like us get asked for what went well in 2019, especially given strong flows and performance. So let me flip it around: What has been a surprise disappointment to you in terms of lack of demand (despite a good product) or underperformance despite investor demand?
Dave Nadig
: That’s tough, because I don't want it to sound like I'm down on something, but I'll give you my honest answer: FRDM.
That’s the Alpha Architect Freedom 100 Emerging Market ETF.
I absolutely love this fund’s position, its methodology, the portfolio you end up with, and the enthusiasm of the person behind it (Perth Tolle).
I genuinely believe in the approach. And yet it's only managed to scrape together $15 million in assets this year.
So I'm personally disappointed, but the product itself is not disappointing. I'm just sad more people haven't heard about it.

Curious George: Does the version of the SECURE Act that was passed allow for the inclusion of ETFs in 403(b) plans?
Dave Nadig: I was wondering if I'd get this one, or a version of it.
Here's the thing, as far as I can tell (and I could be completely wrong). I troll all the time (because I'm super interesting at dinner tables). They have yet to post the full text of the half of the deal (the nondefense side) that will actually be going for signature.
And I haven't been able to find a draft I believe is truly final yet.
From what I've read, what's included is some/most of the original SECURE act, along with parts of some other senate bills, but not all of it.
So I can't say definitively what’s in or not. There are several things that could be in that would be interesting.
The barrier to ETF inclusion inside plans hasn't been regulatory so much as structural (fractional shares).
What could be really interesting is if one of the inclusions allows variable annuities to own ETFs.
But I don’t believe that will make it in.
The overall impact of SECURE is going to take some time to flesh out. On the surface, it's a gift to insurance companies, because it creates safe harbors for using annuities in retirement plans.
Whether that's actually good for investors is a huge unknown, because the devil’s in the details.
Good annuities are fantastic tools for managing personal risk.
Bad annuities are lighting wealth on fire.
So, I guess I'd say, "we'll see."
Mostly I'm just sad nobody's legalizing tontines. I still think it's the solution to a lot of problems.
OK, with that, we'll wrap on Live Chat for 2019. Really appreciate these dialogs; they always make me think. Expect more and better in 2020!
Have a great holiday, and a great rest of the year!

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