Live Chat: 401(k) Choices & Bond ETF Flows

December 11, 2019

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

Dave Nadig: Good afternoon, and welcome back to Live!
As always, you can submit questions in the box below, and I'll get to as many as I can in the next 30 minutes, give or take.
We'll have a transcript up shortly after the session, in case you have to hop out.
With that, let's get started.

Marv: Just wanted to thank you for conducting your webinars on ETFs. Saw the one yesterday on defined outcome funds. I find them really informative.
Dave Nadig: You’re very kind. I do like doing the webinars on camera. I think it makes it more lively. For anyone who missed it, you can watch replays on our site pretty easily here:
Replay of that one will be up in a few days.

John: Why do I not have ETF choices in my company's 401(k) choices? Not asking you to speak for the company, but I think that's the case for a lot of people's 401(k)s.
Dave Nadig: Well, there are a few reasons for this. Probably the biggest is that, historically, you couldn't buy fractional shares of an ETF.
So if your contribution was $300 for a given paycheck, splitting that across 3-4 ETFs would be quite hard, and inaccurate.
Second, historically, there were commissions involved.
Both of those are starting to crack open: commissions have largely disappeared, and Schwab at least is talking fractional share trading.
But the third big reason is money. Most mutual funds in 401(k) plans have 12(b)1 fees. Those fees are used to pay for the record-keeping and other expenses of the 401(k) plan itself.
If you replaced all those 50-100 bps mutual funds with 10 bps ETFs, someone's going to have to pay.
This isn't totally the reason of course. Many plans have very cheap index funds in them (and in general, those will be a great choice for folks).
And it's not just you: I've NEVER had a 401(k) that had ETFs in it. It's exceptionally rare.
I do think it will change over time. But don't diss a good cheap index mutual fund. They get the job done too!

Amani: Hi. I am a day trader and I want to attend the conference in Florida.
Dave Nadig: Hi Amani! You totally should. It's a great event. I should point out that no longer actually runs the event in any way (InsideETFs in Hollywood, Florida, coming Super Bowl weekend).
But we pretty much all attend, and it’s become a real anchor point of the year for the ETF industry. I think any investor would find a lot to learn there. The sessions are great.
I know I always learn a TON.

Drew Fallon: Hi Dave. Has “smart beta” been trumped for some new investing “trend”? Like non-transparent ETFs, or …?
Dave Nadig: Well, smart beta flows have been pretty good, actually, so I wouldn't say it’s gone by the wayside. I don't consider it a fad; I just consider it a new label for quant and factor investing, which have been huge for decades.
You could probably say, from a pure headline perspective, that ESG (or bitcoin, or cannabis) took some of the column inches away.
I DO think 2020 will be the year we talk a lot more about active, though. So maybe not yet, but it's coming.

Brynne M.: So much discussion re whether or not this bull market has more room to run. Your thoughts?
Dave Nadig: While I don't advocate market timing, I think it's reasonable to ask once in a while "how the markets are" if you're thinking about new allocations. I tend to be pretty simple in these things. I really focus on two buckets: valuation, for which I generally look at the CAPE ratio. It's sitting about the highest it's ever been, but for the dot-com boom.
Here's a good chart, and a link:
So that says we're pretty fully valued.
And then broad economic data, which has honestly been mixed.
Every time I tweet something economic, I get accused of being political, but I'm just looking at numbers. We seem very thin on good economic data.
Yes, the consumer remains super strong given everything else, and BLS numbers continue to look good.
But manufacturing and a dozen other data points are weak, so ....
I’m cautious here.

Suze: This year more than half of ETF inflows went into bond ETFs. Is this the first year that’s happened? Why now, what’s different?
Dave Nadig: I'd need to double check, but it sure feels like the strongest bond flows I can recall in the past decade.
Why? I think it’s a combo of "risk off" trading (people are nervous about all the stuff I just typed above), and the continued underperformance of active bond managers, as a class.
Of course some bond managers will outperform, but the SPIVA data suggests that picking that outperforming bond manager for next year is just as much of a mug’s game as picking stocks.
So some of it's just pent-up active-to-passive switching, and some of it’s just risk off I think.

Nemo: Why has GLBY seen so little interest? The world bond ETF space seems pretty sparse, and Vanguard's entrant BNDW seems to have gained assets easily enough. The U.S.-only older sibling AGGY has about $1 billion in assets, and performance chasers should love the record, which is only three months shorter than BNDW. Add in a reasonable expense ratio and the fact that WisdomTree actually has a reputation for currency-hedged products, and I just don't get why this fund has gained essentially no assets since launch.
Dave Nadig: So, it's always hard to prove a negative, but I suspect that it's just a tough niche ...
GLBY owns AGGY, and then some global stuff, and a currency hedge.
But GLBY and AGGY have performed essentially identically since GLBY's launch.
AGGY has $1 billion in assets. So it's the logical audience for a global version of the same strategy.
But there hasn't been any real proof that it adds anything but uncertainty to your portfolio.
I think the idea is sound. But in the year since launch, it just hasn't really proven out.
I’m not suggesting you should chase performance here. I'm just suggesting it hasn't created any real differentiation against its bigger brother (which is also, I think, cheaper).

Keith Rodriguez: Should retired investors have different ESG securities in their portfolios than non-retired investors do?
Dave Nadig: I think the decision about whether to use ESG in your investment screening is a deeply personal one, so it's hard to be prescriptive about it.
But if you're (as an example) investing with a bent toward clean energy and away from carbon intensity, I don't see any reason that would be particularly different at 50 than at 70.
Your overall asset allocation, of course, should probably be quite different (less risk/more bonds/etc.)!
But the skew you've chosen from an ESG perspective, I think could be precisely the same.
Ultimately, ESG (my opinion) is either about risk reduction (lots of evidence there) or it's about your personal, not-necessarily-economic decisions.

Chris Braithwaite: Why is December the strongest stock market trading month of the year? Are investors trying to avoid tax issues, or secure gains?
Dave Nadig: A lot to wade into here.
I'm generally very skeptical of people who claim to have "cracked" seasonality in markets.
There are, of course, very real end-of-year issues people have to contend with.
You have fund managers doing window dressing, which often ends up with run-extension: laggards get sold, winners get bought.
You also get tax loss harvesting, which can have the same effect: People sell their losers to book the losses, but may not sell their winners. They may hang on to them until next year to not book the gain.
But of course, the old "January effect" argument (largely debunked) said the opposite—that January was always the rally month of bad Decembers.
So in short, I'd really ignore this kind of rule-of-thumb investing.
The actual state of the economy—or corporate earnings, or valuations—they all matter so much more than the calendar.

Mari D.: Hello Dave: Why lately has trading in ETF options been swelling in volume? Is this some niche of ETFs that’s only recently been getting some limelight?
Dave Nadig: As people get nervous, we see increases in vol (not much, I admit), and we also see people looking to get clever with shaping their returns.
Options are great for that, whether it's raw speculation (buying way out-of-the-money calls or whatnot) or whether it’s pure risk control (covered calls, protective puts, etc).
I think it’s fascinating to watch, but I wouldn't read too much into the tea leaves.
FWIW, there's a great rundown on ETF options here:
It's the only Bar Chart page I have bookmarked, because it just presents the data so cleanly.
As you can see, the vast majority of volume is in options on ETFs that have become proxies for whole investment areas: SPY, GDX, EEM, FXI.
They're great short-hand vehicles for expressing opinions either with leverage, or in a hurry.
So I don't think it's niche funds at all driving it, it’s all the big names.

Tactical vs Defined Outcome: Hi Dave, I listened to your defined outcome webinar yesterday. Curious, in a hypothetical portfolio: Would you prefer to have an ETF of a top tactical manager, who can possibly get you out near the top and back in near the bottom, or would you have a defined outcome ETF where you know exactly what your risk/reward profile is before investing, which would give up some upside and could fall below the buffer?
Dave Nadig: So, the challenge is, of course, knowing who that tactical manager is ahead of time. Every time we have a big market swing, heroes are nominated and goats are slaughtered.
But it’s very rare that folks get these things right several times in a row.
So, if I were certain that Bob Smith was going to get me out, and back in, within a few percent of tops and bottoms, of course I'd give Bob my money. But you can’t be certain, and in fact, the math would suggest that the Bob Smiths of the world are quite bad at this.
That's where a defined outcome product comes in. You have 100% certainty on the pattern of returns. You may not know your entire downside potential, but if you buy a fund with a -15% buffer, you know for certain that you have to have a pretty bad year to experience any pain at all.
That’s the attraction. But they're not magic: You're selling upside to secure downside. The packaging is fantastic, but the concept isn't unique or original.
People have been using options for decades to do just this.
Jon: Hi Dave, it seems like there has been a lot of talk about direct indexing. I see the value from the perspective of having certain beliefs and letting those beliefs play out in your portfolio. It just seems like a lot to manage for each individual account on top of the risk of trailing benchmarks significantly aka active risk!
Dave Nadig: So, I guess it depends on how it’s done.
The whole point here is that the complexity gets solved by software, just like anything else.
So if it’s a huge pain to manage each investor’s account, or if it’s a huge pain for the investor to manage their positions/taxes/reporting/whatever, then this isn't a direct indexing problem, it’s an implementation problem.
The platforms that are good at this (there are lots, but, off the top of my head, the ones I've seen from Optimal, Parametric and Canvas seem to be good) solve this problem through good reporting tools, and good onboarding processes.
And they also present you with ways to measure, select and monitor that active risk.
In Canvas, for example, active risk is something you choose; it's not an accident.
You can build the Russell 1K minus one stock, and that's pretty much going to track. Or you can build the R1 minus 100 stocks, and you’re going to get tracking error. You can make that choice.
So it's not one size fits all—and that's the whole point.

OK folks, that's a wrap for this week. We're Thursday next week again, 3 p.m. ET.

Thanks for coming, as always, and have a great rest of the week!

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