Live Chat: Active Vs. Zero Fee Funds

September 05, 2018

[Editor's note: Live! with Managing Director Dave Nadig happens weekly at 3:00 p.m. ET.]


Dave Nadig: Good afternoon and welcome to Live! As always, you can enter your questions in the box below. I’ll get to as many as I can in the next 30 minutes or so.
After we’re done, we'll post a transcript at this same address, in case you missed something.
So let's get started with Todd:


Todd Rosenbluth - CFRA research: While the top 2 ETF providers again gained most assets in Aug., what are some exciting up-and-coming firms gaining share to you?
Dave Nadig: This is actually a fun question. (Not that they aren't all fun.)
For those who like keeping score, we actually publish a weekly league table  ... 
... as part of our flows reporting. And as you can see, there are a LOT of small firms out there right now.
Just eyeballing it, it's what, something like 40 firms at least that are under $1B in assets under ETF management.
A lot of these "little guys" are doing some pretty interesting stuff. A few that come to mind right off the top of my head (not dissing anyone!) -- GraniteShares.
They're basically just going after the big guys on price in a few areas, like gold, and they're doing it aggressively.
Moves like that are great for investors, even if you aren't buying one of their funds.
Because it keeps the pressure on.
I also think that the funds Innovator has launched recently -- the defined-outcome funds that have "buffers" to protect you from some of the downside risk -- are really interesting.
I worry they might be a bit complex for mom and pop, but they're super cool under the hood.
I also think some of the active management shops are making some big waves: Ark, in particular, and Davis, come to mind. Natixis is also putting some interesting strategies out.
It's actually almost dizzying, the pace of new ideas and new products. But those come to mind.


Zack Truman: Hi Dave. Why does active seem to keep being the route investors think is wisest? Seems like that idea keeps getting debunked, yet on it reigns over passive.
Dave Nadig: Well, I'm not sure the data would support your assertion.
If you look at flows across product types: combine mutual funds and ETFs -- the flows are really going one way ever since the financial crisis: out of active, into passive.
We're in a bit of a creative destruction moment on that front.
I think you'll see continued carnage inside the ranks of active management, and in a few years, we'll look back and realize what we've done is weed out the low-conviction, low-active-share, overpriced, benchmark-hugging version of active.
Which is a LOT of the funds out there, honestly. And good riddance.
And what we'll be left with is folks that are at least TRYING to do something very different, and some of them will be quite successful. (See also: Ark, above!)
But even granting you your point, it's pretty obvious. Nobody likes being average.
And buying index funds is guaranteeing being average.
I'll combine a few questions here:


Charlotte R.: So Fidelity's zero-fee funds saw about $1B in their first month. Does that amount surprise you, or is that about expected in this era of price wars? Is that amount per month sustainable?
lebowski: Is it possible to have zero-fee ETF? .... Fidelity's new zero funds are mutual funds.
Dave Nadig: I'm not that surprised they pulled in $1 billion. Remember, firmwide, this is an enormous company, with a lot of very dedicated customers who have a big relationship with Fidelity.
And Fidelity has spent an ENORMOUS amount of money marketing these things.
There are indoor billboards in Grand Central Station, they're doing 30-second spots on ESPN, the ZERO campaign is honestly the biggest one I can recall them ever doing.
I have an account, and I got lots of enticements too.
So, clearly they're pushing it hard.
As for an ETF, well, there's certainly no structural reason you can't run a zero-fee ETF. In fact, there are some that have no fee because they invest in other ETFs that do have fees -- I think that's how at least one of Cambria funds works.
The issue is the economics -- Fido can do this because you have to be a Fidelity customer to get access to these funds. So it's a way of getting folks to open Fidelity accounts.
Once you have an account at Fido, they have LOTS of ways to make money -- financial advice, other funds, insurance products, you name it.
If they had, instead, launched these as ETFs, well, I can just buy them in my random brokerage account, and Fido won't ever even know who I am.
So the economics become punishing.


Alex Romeo: This is more a statement of frustration rather than a question, but I am looking for a good source for asset flows into ESG/SRI ETFs to demonstrate the rising demand for these products. I am surprised that ESG/SRI isn't even a separate topic in the Category/Focus/Niche filters on this website, as well as its own category in your monthly ETF asset flow analysis articles. Not to be a tree hugger, but the demand for ESG/SRI products is real and growing!
Dave Nadig: Hi Alex - so, we do cover ESG off and on as it's relevant here at
We also feature a full suite of ESG data in our finder, so you can see the various funds' scores on anything from impact to carbon.
But, your point is well taken.
ESG ETFs have been a bit slow to catch on, and I think the reason for that is a bit simple.
ESG investments tend to be long term, not traded, and they tend to happen when money changes hands.
What issuers are relying on is the generational wealth transfer that is slowly moving $30 trillion from the baby boomers down to their kids.
What we see in study after study, is that tends to be when the ESG conversation comes up.
So I'm a believer, but I think it's a long, slow process, and we tend to be pretty short-term-focused in the ETF realm.
I think we'll see the products sneak up on us over time.


Eleanor: I'm trying to understand the pricing, how can an tech ETF such as QQQ, consisting of shares like Apple, Google, etc., be less than, say, $200? If I were to create a portfolio of 5 blue chip stocks, 1 share each, the cost needed would be a lot higher, right?
Dave Nadig: So this is an interesting question.
Since an ETF is just a fund, it follows the same rules as pretty much any mutual fund.
The VALUE of the fund is the sum of all its assets. So, say it's $1 billion. It's got all sorts of stocks in it, thousands of shares of Apple and so on.
So that's the denominator -- $1billion.
The numerator, however, is just how many shares exist.
And when they launch the fund, they can make that number anything they want.
So if you launched with $10 million in seed, you could theoretically say, "let's issue 10 million shares" and then each share would be worth $1.
Or you could say, "let's issue 1 share" and it would be worth $10 million.
And by splitting/reverse splitting, they can change the value anytime they like as well.
So for instance, if the trading price of an ETF gets to $1,000, well, that might make it hard to trade, so they can just split it 10-1, and then it's magically priced at $100, and all the existing shareholders go from owning 1 share to owning 10.
It happens all the time actually. Almost weekly.
Hope that clears it up.


Neil P.: what's the difference between target-date and target-risk and target-outcome ETFs on your site?
Dave Nadig: Hi Neil! So, there aren't any target-date funds left in ETF-land, but there are target-risk and target-outcome. Which is confusing, I get it.
These come from FactSet's classification methodology, which you can find here: 
But to directly answer your question, it's based on what the fund literally SAYS it's trying to do in the prospectus.
If it's an asset allocation fund that is trying to, for instance "beat the S&P," well, that's a target outcome.
If the fund says "the goal is to maintain exposures to three asset classes, based on their measured risk over time" or something, well, that's target-risk.
It's a somewhat arbitrary way of bucketing up the asset allocation funds, which, as a class, are often trying to do some interesting things -- flipping between, say, stocks and bonds.
(Going back a question: we do have a socially responsible channel, which you can see here:


Jerome: Hi Dave, Do you think that investors new to the ETF space might be overwhelmed by how many there are, and just focus on the trendiest names?
Dave Nadig: Heck *I* am overwhelmed by how many there are!!!
I think what happens is actually the same thing that happens when we all read the news. We all have a filter of some sort.
Maybe you just read the Times, and you use that as your filter.
Maybe there's someone you follow on Twitter whom you agree with, and they post news stories, and that's what you look at.
But we all have SOME sort of personal filter.
I think choosing funds -- or any investment -- actually works a bit the same way.
Maybe you're a Schwab investor, and so you naturally gravitate to what they present to you.
Or you have a financial advisor, and they're your filter.
Or, you read, and you use the ratings we have on the fund reports.
Certainly, we know there's a real risk that retail investors chase performance -- and institutions too; don't kid yourself there.
But I do think in the end, it all comes down to who the investor's "trusted filter" is to separate the good choices from the bad ones.
At least with ETFs, there are only 2,100. In mutual funds, there's something like 8,000!


Alex L.: I don't get duration when it comes to bond ETFs. Is it an average of all the bonds' durations? Is it a median? Does the ETF somehow have its own duration? How does this work?
Dave Nadig: OOooh, very tricky question.
So, if you go back up to that link on methodology, you'll see the info on how the specific stats we report from FactSet are calculated -- like duration and key-rate-durations and so on.
And ultimately, yes, it's "rolled up" from the duration of the individual bonds.
BUT, there's another interesting angle here, which is deep-end-of-the-pool stuff.
The more interesting way to treat a bond portfolio is to actually take ALL the cash flows from EVERY holding and then create an aggregated cash flow -- essentially turning the ETF into one giant virtual bond.
Once you do that, you can plug it into any kind of analytics engine you want, and get duration, convexity and so on, all from there.
This is, in fact, what the ETF industry has been doing specifically for the insurance industry, which needs to be able to do this to consider a bond ETF a bond from a capital allocation perspective.
The good news is, you don't get radically different answers, and the portfolio roll-up durations you see are great guides for comparing funds, especially if your apples/apples using a single data provider (like, say, us/FactSet).
OK, time for one or two more:


Danny: Hello Dave, Why do you think the rising dollar has't revived interest for currency-hedged ETFs?
Dave Nadig: You know, I think this is a bit of a puzzler, but here's my theory.
Currency-hedged ETFs caught fire in the LAST run-up in the dollar.
"Japan without the yen" and all that jazz.
But, then we had two-ish years of flatness, and then 2017's decline (at least on the euro).
So I think some investors may have had their fingers burned a little bit, and thus aren't coming back.
At least, that's my theory.
Also, remember in the last run-up, the distinctions were REALLY pronounced.


A. Munson: Dave, do you have an opinion on which is better: lump-sum investing or dollar cost averaging?
Dave Nadig: Well, in general, investors are terrible at timing.
So, certainly sitting on a large pile of cash, waiting for the perfect moment, has historically been a great way to not beat the market.
Unless you're specifically trading to trade -- speculating -- I think DCA is almost always going to lead to better outcomes for most types of investors.
I think that the payroll deduction defined contribution plan may be one of the world's greatest financial innovations, frankly, because it does this for us all.


Dave P.: Hi Dave. Ben Johnson at Morningstar has a piece out on the overrated traits of ETFs. Among them, he says, liquidity, tradability and transparency. ( Do you think we pay too much attention to these things and miss the bigger picture?
Dave Nadig: Thanks for pointing this out -- Ben's a good friend, and I think he's spot-on about a bunch of this.
It's not that things like intraday liquidity and transparency are irrelevant, but I do think sometimes we make a lot of noise about them.
MOST investors aren't going to trade every day, and shouldn't.
MOST investors aren't going to look up what their ETF holds every day, and so on.
But, these features create optionality and possibilities that otherwise don't exist.
Things like selling short, or using margin, or plugging a bunch of ETFs into an optimizer to look for overlaps.
Those are actually really valuable to certain classes of investors. But folks should go watch the video there; he's got some great points.
Yes, I think we miss the big picture -- which in this case is exposure. Exposure ultimately trumps absolutely everything else.
Being in a cheap, intraday trading, fully transparent fund is utterly meaningless if it's the wrong exposure for your portfolio.
OK, I'm afraid I have to wrap there for today. If I didn't get to your question, please come back next time!

In light of everything going on today, I’ll give a quick shout-out to our new stock finder tool. You can go directly to any stock just by entering it into the address this way: 
Which will show you, for instance, that the Global X Social Media ETF (SOCL) has a whopping 12.3% allocation to TWTR.
Thanks everyone; we'll see you next time!

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