Live Chat: Banking With FAANGs

March 28, 2019

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

Dave Nadig: Good afternoon! Welcome back to Live!
As always, you can ask questions in the box below, and I'll get to as many as I can until my fingers fall off (or about half an hour).
We'll post a transcript a bit afterward here at the same URL in case you miss anything.
With that, let's get started. (Oh, and before I even read it -- the soundtrack for today is Paul's Boutique by the Beastie Boys.)


Ron: If you had to pick one ETF for int'l equities, what would that be?
Dave Nadig: So, there are a few great global ex-U.S. ETFs, mostly from Vanguard and iShares.
There are slight differences, but if I had to pick one, it would probably be IXUS -- it's at around 10 basis points. Not the very cheapest, but very liquid and only a BP higher or so than the cheapest.
I'ts not a terrible way to approach your non-US exposure. The big variable is how much emerging markets you get.
IXUS is around 12% or so.
If that seems high or low, that's when you might want to consider breaking your developed-markets exposure from your EM exposure.
Rob Arnott at Research Affiliates claims that 50% of his portfolio (!!) is currently in EM.
So ... by his take, we're all probably massively underweight!


Richard Turnhill: If passive indexing basically always provides a higher return than active management, why do so many investors still rely on active?
Dave Nadig: Hi Richard -- so, the problem isn't that active managers ALWAYS underperform, it's that it's very hard, if not impossible, to know WHICH active managers will outperform.
The S&P Index Vs. Active report (SPIVA) would suggest that, over time, fewer than half of the managers can beat the market, but there are 30-40% who do ... just not predictably and consistently.
Some folks think they can pick the manager that will beat, and that hope drives them to keep the faith.
But also, the appeal of indexing just doesn't resonate with a lot of people. I mean, who wants to admit they're going to be completely average?
Because that's what cap weighting basically says -- it says you're willing to put up with being the most boring, uninteresting investor at the cocktail party.
Meanwhile, there's a lady over by the shrimp who's telling stories of buying Tesla at just the right time, or that guy over at the cheese dip talking about how "his manager" got him out of EM at just the right time (that the other 50 people at the cocktail party trailed isn't what anyone remembers).
Shrug. But honestly, indexing is winning -- the flows definitely show that.


John K.: I recently read that you don't own any ETFs. Really? A chef who doesn't eat his own cooking! What's up with that???
Dave Nadig: Hi John! Totally legit question, with a simple (perhaps cowardly) answer.
I spend most of my time writing and talking about ETFs. If I held ETFs, I would have to make the normal disclosure of whether I owned the ETF I was talking about every single time I spoke or wrote.
So for instance, I'd have to say (No, I don't own IXUS) in the answer above.
I decided a long time ago that I would just stick what money I have in the most boring low cost index funds I could find and forget about it.
If you care: like many people, I've ended up with accounts at several places because of different jobs and so on, so I have a combination of Vanguard, Fidelity and Schwab index funds, all extremely boring and cheap.
I haven't made a change other than a rebalance in years.


Dayna Clement: Hello Dave. Is every exchange-traded product based on indexing? So indexing first came on the scene when SPY launched?
Dave Nadig: Not quite, but close.
The first ETFs (SPY, then the WEBS products, which became iShares country funds, the QQQs, etc.) were all index-based.
But there are active ETFs -- some quite big ones actually. Something like PIMCO's BOND is actively managed, for instance, as are ARK and Davis' equity funds, and so on.
So you can get some active in an ETF wrapper if you want it.
And SPY definitely wasn't the first index-based product.
There were Vanguard mutual funds before SPY, and there were a lot of institutional commingled funds and separate accounts that were indexed going back into the 1970s.
(Arguably, the first closed-end fund in the 1600s was indexed, but that's a different discussion!)


Nemo: When Bruce Bond was on the Animal Spirits podcast, he said  they lower the upside after using the dividend to pay for the initial part of the buffer in the defined-outcome ETFs. How low would the upside cap need to be if they didn't sell the dividend and instead targeted the S&P Total Return Index?
Dave Nadig: This is a puzzler -- I didn't hear Bruce on the podcast, so I don't know precisely what he said, but the Innovator funds ONLY own FLEX options. They never own stocks, so they don't "collect" any dividends that they could then "spend."
FLEX options are based on the price movements of the underlying index (in this case, the S&P 500) largely as a matter of convenience.
But this ultimately is just reflected in what people are willing to pay for the options themselves.
If the expected return of the thing you're tracking was higher (say, a total return index), then that gets baked into the premium.
If dividends are included, then you end up with various pricing/expiration issues.
(This is deep-end-of-the-pool stuff, but at the end of the day, the price you're paying as an investor washes out, in the sense that the options prices ... which the fund pays ... are baking in that it's the price movement, not the total return).
I totally get that, as an investor, that seems weird. The important thing is just to know what you're buying -- the S&P yield is about 2%, so your return expectations for the product should be adjusted. If you don't think that's worth it, well, that's your call.


L. Tremayne: Are the FAANGs getting into banking? What would be the pros/cons for investors?
Dave Nadig: One of my favorite topics. To me, there's little question that Google/Amazon (in particular) will get into financial services of SOME sort fairly soon.
Banking/cash management is an obvious place to start, which is what Alibaba did with its ANT financial division (currently the largest money market fund in the world, at something like $170 billion).
I actually think they may go more the robo/direct indexing route first.
But that's just me speculating. The bigger question is whether they move in with half steps (say, partnering with a big bank, like a JPMChase or Wells) or if they go it on their own.
I'd be a little disappointed in the former, honestly -- much less interesting.
But I'll go out on a limb and say SOMEONE in the tech/online retail space announces something cool this year.
I'll bolt a few of these together:


Winston Riggs: Good morning Dave, Can you explain the significance of the yield curve in a nutshell?
M. Dashiell: With the recent bond yield inversion, are certain ETFs giving investors better yields?
Dave Nadig: So, in a nutshell, if the yield curve is inverted, banks lose a core source of return. One thing banks do is arbitrage maturity. They take in short-term money (deposits) and they loan out long-term money (mortgages, and so on).
Another way to think of that is they are constantly taking in the "T-bill" money and going long the long bond (notionally).
If there's no (or negative) money in that trade, it's bad for banks. This is especially true the smaller your bank is.
After all, Citibank has a LOT of ways to make money, and this ends up being a small part of the overall picture for them. Some savings and loan? It's basically their whole business.
As for what to DO about it, it depends much more on what you think will happen going forward.
If you believe we're in global-slowdown mode, and the yield curve inverts further because of that, then you can actually gain by buying the long bond (say, TLT, the 20-year Treasury iShares ETF).
Because by definition, the 20 will come down in yield, which means the price of the bonds goes up. So you make money from the appreciation.
(In other words, it's just a targeted falling-rates play.)
But that's a pretty big call, honestly. I don't think there's a free-lunch obvious play on it. If there were, everyone would immediately pounce and it would get priced out.
I'm going to take half of this long question:


Larry: I am wondering how the index provider landscape is changing with things like the fee wars, with companies like iShares developing their own indexes, and with (probably) lower barriers to entry for more index providers to enter the business. Any thoughts about the state of index providers? Thanks!
Dave Nadig: The core of the question is: Everyone's getting squeezed; what does it mean for index providers?
Short answer: They're getting squeezed too.
The fees on vanilla indexing are around 1-4 bps; specialty providers can maybe get away with a few bps more ...
So there's not a LOT of room.
And of course, lots of folks are doing self-indexing now.
Vanguard's move to CRSP indexes was a big part of this as well. They saw a way to shave a fraction of a percent and they took it.
We'll just see more of it, honestly. More self-indexing. More fee wars across the space.

BondCurious: Hi Dave. Is it better to invest in bonds, or bond funds?
Dave Nadig: A time-honored question!
The advantage of buying an individual bond is you basically can hold it forever, and you know EXACTLY how much you're going to get every single coupon payment.
If you buy it for $1000 and its paying 2%, well, you know you're getting $20 a year, and you're going to get $1000 at maturity, and you can literally ignore what happens with bond prices.
The downside is, it's hard and often inefficient to buy individual bonds, and you aren't diversifying at all.
The latter doesn't matter much if you're buying Treasuries -- a Treasury ETF has the same credit risk as a single T-bill.
It matters a LOT in corporate bonds.
The "splitting the difference" approach is target-date bond funds, of which there are a ton now. So you can buy an ETF that holds bonds that all mature in, say, 2025. And you basically get the experience of owning "a bond" but the benefits (flexibility, tradability, etc.) of owning individual bonds.
Once you get outside of Treasuries, however, I think the diversification benefits are overwhelmingly in favor of funds.


Todd Rosenbluth - CFRA Research: Hi Dave. Lyft is going public this week, and more high-profile companies are likely coming. Given how most ETFs are index-based and iShares can't just add these to their growth funds, do you think this could drive interest in active equity ETFs like ARKK that has more discretion? It owns Telsa and Twitter.
Dave Nadig: Hi Todd. I absolutely think that a revitalized IPO market is good for a handful of ETF players.
ARK/Davis/etc. -- they can (if they want) buy IPOs day-of. Heck, they could get allocations if they wanted them badly enough.
I also think IPO funds like IPO can really benefit, obviously.
(The huge caveat of course is that chasing hot IPOs isn't necessarily a great idea, but that's not the question you're asking).
ARK, as an example, made noise by being the first to include any kind of bitcoin exposure by buying GBTC.
While I'm not a fan of GBTC (sort of a fake-ETF-alike that's just a company under the hood), it was (being cynical) good press for a while!
I know they didn't buy it for that reason at all -- I've talked to the PM about it. But it had that side benefit.


Deirdre: Is it ironic that Vanguard may soon be the top ETF flows recipient since Bogle was so against ETFs?
Dave Nadig: I think Bogle's dislike of ETFs has been slightly exaggerated by the press, honestly.
He was concerned not that there was any inherent flaw in ETFs, just that they were a very sharp tool to be handing investors, who could use them to get into trouble.
That is, to say the least, very "on brand" for Bogle. His whole career was about concern for the little-guy investor.
But he spoke regularly at events, and graced the pages of our magazine many times. He was always willing to engage in the discussion.


Bob: Saw the news about Schwab launching a monthly subscription-based financial planning service. Thoughts?
Dave Nadig: I LOVE this move by them.
Rick Ferri had a tweet where he called the idea of a 1% advice fee the last bastion of "gluttony" in financial services, and I have to agree.
I don't think paying $40 a month or whatever is the right move for everyone. There are some folks who may be better off with a different fee structure.
But I absolutely love the idea of paying directly for advice, instead of going through an AUM-based fee.
If I have $2 million in assets and you have $1 million in assets, am I really getting twice the "advice" you are? Do I take up twice as much mental real estate with my advisor?
It's just sort of the wrong scale.
I think ultimately, paying directly -- whether it's retainers or hourly or subscription-based -- makes so much more sense for the actual investor.
It's a bit of a mental shift though. A lot of investors don't think about what they pay explicitly when the fee is baked into assets.
But I suspect most of them would pay less if they actually paid by the hour.


Gregg F.: Would abolishing the ACA affect health care ETFs?
Dave Nadig: Oooh boy, that's a big hairy question.
The conventional wisdom is that deregulating the insurance industry (which is the most immediate corporate impact of an ACA dissolution) would be good for their bottom lines. So I guess "yay BCBS?"
But the amount of chaos implied in such an outcome is difficult to even wrap my head around. There are SO many unknowns. If millions and millions of folks now don't have insurance because, say, all Medicare expansion goes away, that likely has profound economic impacts on everything from consumer spending to drug company profits.
So I don't personally feel like this is a thing you can "play" with in an ETF. It's just frankly too big, and too much of an octopus.
It's an ENORMOUSLY large part of the overall economy to just toss into a bin and shake around to see what happens.


BlockchainNewbie: Why did CEDEX procure physical diamonds in planning to launch its diamond ETF? Is this usual practice for launching (“commodity”) ETFs?
Dave Nadig: So, a lot going on under this question.
My understanding is that they basically bought up an inventory in order for people to trade against that inventory in shared lots on their blockchain-based exchange.
I don't THINK (and honestly, it's been hard to follow), these are specifically to seed $50 million in an ETF.
BUT, if they follow the model of something like GLD/IAU/BAR -- they do need a facility to move diamonds in and out of the ETF, and there's not really the equivalent of the London gold buillion market, with its established vaulting system.
So I think they're trying to kind of build their own ecosystem for it all.
I'll be honest, I'm skeptical of the whole thing.
OK, last question:


Worry Wart: Any ETFs for escaping potential impending recession?
Dave Nadig: Well, ultimately this is just a raw economic cycle question.
If you believe in the global slowdown story, the question is, "so what"?
In one scenario, all risk assets around the world get hammered (sort of a 2008/2009 model).
That would imply you should get super conservative, hole up in bonds/cash.
The problem with that is that timing is everything.
We could be facing a mediocre global recession and the S&P 500 could still be up for the year.
You could also pull the trigger now, and miss a 20% rally. Stranger things have happened.
So I'm not a fan of trying to tweak your portfolio constantly based on your week-to-week assessment of the global economy. That's frankly just a form of market timing.
And you could be very right about the 2- to 4-year window, and still do poorly because you pull the triggers at the wrong time, which is why the boring answer is: Stick to a diversified global portfolio, rebalance on some frequency, and don't try to time things -- is the one that generally works best over the long term.


OK folks, that's it for this week. Thanks for joining us! See you next week!

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