Live Chat: Brexit & Reasonable Fees

May 30, 2019

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

 

 

Dave Nadig: Howdy folks, and welcome to ETF.com Live!
You can enter questions in the box below, and I'll jam out as many answers as I can in the next 30 minutes.
We'll have a transcript up shortly after.
So let's get rolling; some good questionss in the hopper. But first:

 

Anonymous: Soundtrack?
Dave Nadig: So my friend made a game called "earworm" which is basically Name That Tune as a party game. The playlist has been on repeat. It's awesome/horribly catchy tunes.
https://open.spotify.com/playlist/6fhCd63oF1zAxfx8EIqRVz

 

Todd Rosenbluth - CFRA Research: Hi Dave. Look forward to seeing you at the Inside Smart Beta conference next week. Would you give us hint what you plan to highlight in your session?
Dave Nadig: So Inside SmartBeta/Active ETFs is next week, Monday and Tuesday, in Boston, which is always fun, because we get to talk about the wackier stuff.
I'm doing a session on 10 "smart" ideas in 20 minutes, which is mostly me doing a little myth-busting and highlighting some of the great research that's been done in the space.
So for example: I get to use one of my favorite charts, showing how backtested indexes just "magically" stop producing most of their alpha once they become live products.
Stuff like that. Should be quick and fun. I'll try and make an article out of it when we'e done.

 

Joanna B.: What is an ETF? What does that acronym stand for?
Dave Nadig: So, not as dumb a question as you'd think! "ETF" stands for "exchange-traded fund."
It' in contrast to mutual funds, which aren't traded on an exchange.
The industry has tried to change it to "exchange-traded products" for years, and even I slip into that sometimes. What's the difference? Well, technically, some very big and popular "ETFs" like, say, VXX, aren't even "funds."
(VXX is an exchange-traded note -- a piece of debt.)
And there are a half dozen other "not really funds" categories that we all lump together.
But much like Kleenex, Xerox and smart beta, we're stuck with the term.

 

Tony: Day to day ETF performance isn't a huge risk to an issuer's financials, right? But what if we had a large bear market (say 40-50% downturn)? Would many of these ultra-low-cost ETF issuers need to raise their fees? Such a market downturn would cut AUM by half and then further by risk-terrified investors moving to cash.
Dave Nadig: So for sure if the market goes down for an extended period of time, it hurts AUM in two ways. One, stock values go down, of course, but investors tend not to pile in when we have bear markets.
So not only do the assets shrink, less new money comes in. That puts pressure on revenues for the ecosystem.
In such a world, larger issuers can probably weather it fine without much consternation. Smaller issuers have to find ways of cutting costs or getting revenue from somewhere else.
And since the ETF industry is pretty thin margin already, I'd expect a true bear market to shake out some smaller players.
Or at least, trigger another round of consolidation.
But importantly, these may be threats to those firms, but not to you, as a fund shareholder. You own your fund, and your fund generally has a board that ensures each fund is covering its expenses and so on.
So even if a firm just went bankrupt, while it would be chaotic, the fund shareholders still own their holdings.
This isn't necessarily 100% true. ETNs, for example, are promises to pay by a big bank. If that bank spontaneously went bankrupt, then you're just a debt holder.
Not a huge counterparty issue, but non-zero.

 

Geoff Gourden: What is a reasonable annual fee for an index-focused ETF? There are a lot to pick from. Are there any tools that would useful? like Yahoo Finance, etc.?
Dave Nadig: Well, it's relatively easy to find the baseline: If you use our fund screener, you can sort anything by expense ratio, and that will give you a sense of the market for that given asset class.
Big plain vanilla funds: large cap US equity for instance, are generally under 10 basis points at the cheapest (0.10%).
Anything more interesting -- emerging markets, smart beta, ESG, sectors -- tends to be a little expensive.
I think a rule of thumb is probably "if you're paying more than 30 basis points, understand why what your buying is worth a little more."
And why would it be worth more? A strategy you believe in, a market that's hard to access, etc.

 

Mike Rawson: Hi Dave, I know there are many definitions of smart beta, but how would one use FactSet's ETF classification system to identify smart beta ETFs? I'm thinking "ETF Strategy Cluster" not equal to vanilla. Will that get me close?
Dave Nadig: Depends on your personal definition of smart beta, but in the broadest sense, yes; if you just exclude anything labeled "vanilla" in the screener, it will give you a very very large list.
It will include old factors like growth and value that some folks think of as smart beta, and some don't. But its a good place to start.

 

John K.: Hi Dave - A recent article stated that ETFs are just derivatives. Do you think that is a good description? Your thoughts on that statement?
Dave Nadig: Technically, any security whose price is determined by the price of something else is a derivative -- its price is "derived."
By that HUGE definition, all hedge funds, mutual funds, ETFs, etc., are derivatives.
The common usage, however, doesn't generally get applied to anything that's just a wrapper. So an ETF like SPY or EEM, for instance, is just a fund that holds securities, just like Fidelity Magellan is, so most folks don't call them derivatives.
Things like futures, options and swaps are what most people mean when they talk about derivatives. They don't "own" anything -- they're contracts based on external values.
Certainly many ETFs "own" derivatives, and exchange-traded notes are themselves derivatives by this usage.

 

Rick Trednick: Do you believe Brexit will have a major impact on European ETFs? How would you recommend investing given the shifting political climate?
Dave Nadig: Well, the market has already priced in whatever probability of a hard/soft/non-Brexit it collectively believes. So any shift you make from market weights is a bet that the market is somehow wrong.
That's a high bar to cross, in my opinion. You need to have a "reason" to think you don't want to be in -- a reason beyond "Brexit is still a thing."
For example: choosing a fund like FRDM for emerging markets exposure is a very active bet, because you're saying, "I don't care how big China is; the market is underpricing the value of various kinds of freedom."
If you believe the market is underpricing the impact of Brexit, then sure, just avoid it. There are a dozen eurozone ETFs that skip the U.K.
My personal belief is that local politics in the EU are much more important. It's getting pretty chaotic.

 

Jake Johnston: What are some your recommendations for those of us just getting into ETFs? Should we avoid zero-fee ETFs?
Dave Nadig: Hi Jake. I wouldn't say "avoid all free/beyond free ETFs" just out of hand -- just make sure they're REALLY the exposure you want, because it's only a handful of basis points more to buy giant established funds in the same asset classes.
For truly novice investors, there's no shame in a very simple, broad and cheap asset allocation. Even something as simple as VTI -- which just owns all the stocks in the developed world.
I think sometimes new investors think they need complex portfolios, when in fact, 2-3 funds can get you an enormous amount of global diversification across asset classes.
So, K.I.S.S. is probably the best answer.

 

Derek: Hello David. I would like you to explain us briefly about how UCITS funds/ETFs work? I noticed that both Vanguard and BlackRock offer these investment vehicles in Europe but not in the U.S. or Canada. Why is that?
Dave Nadig: Hi Derek - simple reason: UCITS is the EU equivalent of the 1940 Act structure in the U.S. -- it's a specific regulatory regime for launching and managing funds.
So in the U.S. we'd say "this is a '40 Act mutual fund" or "this ETF is a '40 Act ETF."
In the EU, you'd say "UCITS."
And bluntly: They can't buy ours, and we can't buy theirs.
While the two regimes are largely similar, there are quite large differences that would make it difficult to really access.
There are ways around it, but not easy ones, and honestly, virtually any exposure you can get in one wrapper, you can get here.
Some narrow differences, but mostly, the hassle of trying to expatriate your assets isn't worth it.

 

Anonymous: Why are mutual fund fees so much higher than ETF fees on average?
Dave Nadig: While ETFs are generally cheaper, only a small piece of this is structural. If you're running an index mutual fund and an index ETF side by side, the mutual fund has a few things going against it.
It's got to buy and sell securities (instead of using creation and redemption to handle flows). It has to do shareholder servicing and keep track of who you are, and so on.
The ETF skips all that, but in a large fund, that doesn't roll up to a HUGE difference. Maybe a few basis points for a big fund, tops.
Hence, you can actually get cheap, vanilla index funds from Schwab, Fidelity, Vanguard and others that are just about as cheap as their ETF brethren.
The big difference for the headline numbers for ETFs vs. mutual funds is simply what the firms choose to charge for (often active) management.
If the fund manager wants 1%, well, then that's what they'll charge to pay their rent, fund their active team, etc.
Thats true in an ETF wrapper as well, of course, should we see more traditional active enter.

 

Phil Harrison: Is there growth in the AI/automation sector of ETFs?
Dave Nadig: For sure, although things get conflated.
Here's the tag for it in our system:
https://www.etf.com/channels/artificial-Intelligence-etfs
And we've seen both decent assets and product launches in the niche in the past few years.
So funds like ROBO and BOTZ are direct plays on the companies fueling AI/robotics.
The confusion happens when we talk about using AI to run a fund, regardless of what it holds.
Even in our own list there, you'll find AIEQ:
https://www.etf.com/AIEQ
Which doesn't invest in AI, it uses AI to pick stocks.
It ends up owning J&J and Costco. Not necessarily companies you'd expect in an "AI ETF."
So just be careful to make sure you know what you're getting.

OK, that's going to do it for today's session. Apologies if I didn't get to you today; lots of great questions.

Next week we'll likely do this on Friday, do to some conference travel, but hope you'll join us again soon!

Have a great afternoon!

Find your next ETF

Reset All