Live Chat: 5 Key Trends For 2020

November 20, 2019

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

Dave Nadig: Howdy folks, and welcome back to Live!
As always, you can enter questions in the box below and I'll get to as many as I can in the next half hour.
Fair warning: Having some RSI from typing too much, so I might be a little slower than normal. Bear with me please!
And we'll have a transcript up on the homepage shortly after we're done.
So let's roll.

Tunes: Soundtrack?
Dave Nadig: Been on a "new big rock" phase, so today it's Bleeker:

Grace L.: Hi Dave. For some time now, it seems passive investing has really become the preferred choice over active management. Are the new nontransparent ETFs an attempt to reverse that trajectory, or …?
Dave Nadig: Hi Grace! So, all the new structures are certainly an attempt by the traditional active managers to reverse it.
And I think they'll be mildly successful. If an active manager is adding real value, they really have to deliver that value in a modern package.
And the ETF is the modern package.
I suspect the slow transition away from the old mutual fund structures will also weed things out. I'd expect active firms to "bring their best" to the new structures. So I'm hopeful this is at least giving investors choices some of them want.
But I don't think this is some sort of pendulum swing, where in 15 years we're going to be talking about how indexing was a fad.
It's been 40 years or so, going in one direction. I'm willing to call that a trend (grin).

George Ralls: I often ask myself, where are people in the industry investing? What % is in cash, bank notes, etc. Since editors, analysts, fund managers expound on why their offering serves investors well, are they invested in their own portfolios? What is’s position on personal investment transparency? Thank you.
Dave Nadig: Hi George, great question.
We follow basic conflict of interest disclosure rules: If one of us owns or is otherwise connected to a fund we're writing about, we disclose that.
I can't speak for what every employee is doing with their investments, but I can say for myself (and have occasionally).
Like many people, I have some retirement accounts stuck in different places, but if you amalgamated it all, I'm in low-cost index mutual funds from big well-known firms, generally captive to those retirement plans.
I don't own any ETFs—a decision I made 10 years ago to make it easier to talk without any appearance of conflict. My asset allocation is extremely boring, and I don't touch anything but maybe once a year for a rebalance.
Sorry it's not more exciting.

Quinn: Does “corporate social responsibility” appear as much as “impact investing” “ESG” and “socially responsible investing” in ETFs?
Dave Nadig: Hi Quinn, You're hitting a core issue. Nobody agrees what "ESG" or "SRI" or "Sustainable" or whatever buzz-phrase you want to use even means.
There are definitely funds that use corporate actions (whether it’s donations, community programs, investments, board construction, HR policies, etc.) in their scoring of how "ESG" a company is.
And that gets captured in the MSCI data we show on our site as well. I'd say it permeates almost all ESG methodologies—what does the company do?
This then gets added to things like the industry the company is in and so on.
But then building a portfolio you personally agree with is tricky.
Because, for instance, maybe some solar company has awful HR policies. Or maybe some gun manufacturer is hugely philanthropic on the side, etc.
Things can easily cancel each other out.
It’s for this reason I think ESG is where direct indexing will continue to catch hold, because it’s so personal by nature.

James Naughton: I’d seen for years the phrase “you can’t invest directly in an index; you can only invest in a fund that tracks one.” Yet this new direct indexing seems to allow you to do that after all. How did that reversal occur, and how exactly does it work?
Dave Nadig: Picking up on that thread
Generally speaking. there are two models. One is where you literally deposit your money with a firm (say, Parametric) that builds you a customized portfolio of securities, starting with an index as the core, and then tweaking it based on your desires.
So maybe you get the S&P 499, minus Apple, because you’re Tim Cook.
That tends to be very high (seven-figure) minimums.
The second model uses someone like Schwab or TD as the custodian (like most financial advisors do already) and then the direct investing company directs the trading in the account on your behalf, buying up, say, the same S&P 499-Apple.
With the change to zero commission, and fractional shares, this could theoretically become economical even at very small dollar amounts. But it’s not gelled yet; it’ll be a few years yet before this becomes a mainstream option.
I'd expect it to follow the same pattern as robo advisors did, starting out with some niche, proprietary companies, and then getting swamped by giant firms like Schwab and Vanguard.

ETF Doc: I’d read your earlier interview with Investopedia about what you think are the current biggest ETF trends. Of the five mentioned, is this the one you see as the top trend, or were those five in random order: “Choices for investors are increasing rapidly.” Tx
Dave Nadig: I think you mean this article
I highlighted five key trends, which are honestly not that insightful; to me they see pretty obvious:
1) Choices for investors are increasing rapidly.
2) Assets in ETFs may surpass mutual funds in five years.
3) Rising competition offers challenges for new ETFs.
4) Actively managed ETFs should become more common.
5) Technological advances will reshape the asset management industry.
To me they all interact.
So, choice improves because of competition, active and tech. Assets will rise because investors respond, etc.
So, to me that's really just a "state of play" list, not some sort of rank ordering.
I think we underestimate how much the tech side matters. Software opens up all sorts of new product areas. Just look at the defined outcome space, or the cool AI-based products we're seeing. And tech will also enable the ESG/direct indexing move we talked about in the previous questions.
It's easy to think "this is the end state," but it never is. It's always shifting, which is why it’s exciting.

Merv Alwyn: What types of investors benefit from ETFs?
Dave Nadig: Hi Merv!
So the pat answer from a dude whose business card has "ETF" on it would be "everyone!" but that's probably oversimplifying.
The real question is, how much do the ETF advantages matter to you?
So briefly: tax efficiency, low cost, tradability, transparency, choice.
If you’re investing just in IRAs, and you trade once a quarter, and you’re doing simple asset allocation, ETFs still might be helpful on cost, but most big indexes are available just as cheaply in mutual funds.
But, if you’re investing taxable money, or you’re trading even a little bit, or you’re doing something more tactical than my dumb-and-boring portfolio, ETFs have advantages, whether that’s a $1 billion endowment or a $10K individual.

Don Hagan: I saw a press release last month that the SEC approved in-kind transactions for the new ETFs that hold flex options, yet I see a number of the Buffer ETFs just published short-term and long-term capital gains. I thought in-kind transactions eliminate capital gains?
Dave Nadig: Hi Don!
So, the key thing for the ETF tax advantage is specifically in-kind redemptions; that is, when money comes out of an ETF, the ETF pushes out low-basis securities, to avoid having to later sell those and book the gains.
That takes time, and it takes redemptions!
So, going forward—say, 2020 tax season—I would expect Innovator to really be able to minimize or eliminate distributions of gains. But it can't just happen overnight; it takes time.
For example, I'm sure that when someone redeemed back in, I don’t know, August, before this was all approved, the funds had no choice but to sell positions at gains, and those are now booked capital gains.
You can't then wash those away, unless you also sell something for a loss.
And there just hasn't been time (or market conditions) for that to be likely.
So: Big deal going forward, but needs time to work.

Todd Rosenbluth - CFRA Research: Hi Dave. Are you surprised SSGA expects to have zero ETFs with capital gains in 2019? While iShares and Vanguard have minimal, that’s impressive.
Dave Nadig: Well, iShares has (checks notes) a billion ETFs. So of course some of them are going to have some gains. Speaking broadly, Vanguard's the land of buy and hold, and if everyone holds, it's harder to do the redemptions to raise your basis (see above).
It's particularly hard in tenored bond funds, which have to sell when bonds get to their lower maturity bound (selling two-year paper in a three- to seven-year fund, for instance).
Also generalizing, many of the SSGA products are used aggressively by traders and have big volumes. That tends to translate into a lot of two-way flow, as authorized participants arbitrage out price discrepancies. That in turn makes it easier to keep the gains out.
So, in short: Not too surprising, just based on their product lines, and how those product lines tend to get used by investors.

B. Moe: Hello Dave. Amazon seems to be the biggest FAANG company in most consumer discretionary ETFs. Is that something you think will “hold” or would, say, Google usurp that position?
Dave Nadig: I was looking quick for the link, but Rob Arnott (Research Affiliates) has a great chart where he shows how the top 10 market cap stocks shuffle positions shockingly fast.
So history would suggest—not that Amazon is going to tank or something—but that their reign at the top of any list would be short-lived.
There's a real question of whether companies can just get too big to be well-run.
People used to think GE was going to be the conglomerate that took over our lives. That fell apart. Same with MSFT. Heck, I’m old enough to remember dot-com darlings that were at the top as well.
So I guess my answer is: I don't think anything ever holds for long, measured in years.
OK, one last question before my tennis elbow kills me:

George Ralls: With the U.S. markets reaching what’s considered by leading market info sources overpriced and recommend that investors focus on international markets, is planning to expand its geographical boundaries by helping subscribers identify international ETF opportunities?
Dave Nadig: So this question confuses me a little bit. We cover international investing all over I mean, we have a country map on the front page.
If what you’re asking is, are we going to cover ETFs listed in other countries, the short answer is "a bit." While we don't have the data set to reproduce our big fund screener or the individual ETF pages for every market, we do cover big issues in other markets—a little.
Canada is the most logical, because Canadian investors use U.S. ETFs a lot—we know they come to the site.
But to do it right would require some on-the-ground staff, in Toronto, London, perhaps a few other places. And at the moment, we're just not staffed for that.
But it's on my wish list, for sure.

OK, with that, I'm going to wrap up. Thanks for joining us. I'll be back next week, again on Wednesday I believe.

Until then, have a great rest of the week!

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