Real-World ETF Questions

May 17, 2017

While I generally speak at institutional- or advisor-focused conferences on ETF topics, I make a point to do at least one Money Show event a year. If you’re not familiar with the Money Show brand, it’s a series of events specifically targeting active individual investors.

These are huge, cacophonous events full of everything from firms hawking cannabis investment newsletters to sage advice from big-league market pundits.

More than anything, however, the audience of the money show is the real world. Over the years, I’ve met folks from all walks of life, and it’s always surprising. I’ve met grandmothers managing multimillion-dollar options strategies from their kitchens, and college kids trying to day-trade their way through school.

A few years ago, most of the attendees didn’t know much about ETFs—or care to. They were there for stock tips and trading strategies. This year was shockingly different. Every time I turned a corner, I was buttonholed by investors who had substantive questions about ETFs—questions that a lot of institutions and advisors probably should be asking too, but don’t.

Here were the most consistent and smart questions I got this week:

How Do Levered ETFs Work?

This is an active investor universe, so it’s not surprising that many folks here are interested in leveraged and inverse ETFs. They’re a new trading tool for them to use, in a market where getting a short-locate or significant margin can be a challenge.

What was surprising was that the questions about leveraged and inverse funds weren’t the ones I’m used to answering. These folks understand the mechanics—that holding for more than a day can lead to vastly different performance than you might naively expect. What they wanted to know was how the funds actually achieved their returns.

That’s a smart question to ask.

When I told folks how most levered funds use swaps, or a combination of swaps and stocks, they asked really smart follow-up questions: Who are the counterparties? What’s my real risk there? Do I need to monitor them? I’ve heard some say that “nobody cares” about these issues. Clearly, some investors do.

 

What About Covered Calls?

A consistent theme here has been concern that we’re in for a bit of a correction, but a real reluctance to just sell everything. Capping upside with options, to generate more income, was a common theme. I was asked multiple times if there was a buy-write ETF. There are several I’d point out: the PowerShares S&P 500 Buy Write ETF (PBP) and the Horizons Nasdaq-100 Covered Call ETF (QYLD), in particular.

The questions continued to get smarter. Most of these folks already know how to trade options, so they wanted to talk about the pros and cons of doing the covered call writing themselves versus paying a fee to an ETF to do the same trade for them.

They asked about economies of scale, and maintaining exposures. Again, these are the right questions to ask.

How Illiquid Can I Go?

In multiple contexts, investors here wanted to understand how to evaluate the real liquidity of an ETF. More than asking about specific niche-ETF tickers, they wanted a process to use to help evaluate whether an ETF was “too illiquid” to consider. We talked rules-of-thumb, and how to look at spreads and volumes with a weather eye.

And then, more smart questions. What about junk bonds in a market crisis? What about MLPs? Should I be worried about ETFs that track closed-end funds? How can I monitor spreads on a long-term basis to know when something changes? I wish every investor were smart enough to know these were the right places to be looking.

Lessons Learned

There’s a tendency in the investment management industry to be a bit dismissive of the retail investor. People put them, by default, into the “under-informed” category, or “less-sophisticated.”

I know I’ve been guilty of that myself. But I think that’s changing. The education playing field seems to be leveling these days. I am used to getting asked rudimentary questions by folks running hedge funds, or advisors running billion-dollar books of business. Nobody comes out of the womb understanding all the nuances of ETFs. That’s what we’re here for.

But now I’m getting asked the interesting, hard questions by dentists and retirees. The industry would do well to take them just as seriously as they take an institution.

At the time of writing, the author owned none of the securities mentioned. You can reach Dave Nadig at [email protected].

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