Live Chat: Bubbles & Deadbeat Uncles

November 14, 2019

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

Dave Nadig: Howdy folks; welcome back to Live!
As always, you can enter questions in the box below, and I'll do as many questions as I can in about 30 minutes.
If you miss something or have to leave, we'll have a transcript up right afterward.
With that, let's get going.
First; soundtrack for the day has been this new Beck track I like a lot:
Now, let's start in the deep end of the pool:
Taxes, Taxes, Taxes: Was the SEC's Rule 6.9 a game changer for ETF options strategies? Does this ruling now make buffer ETFs a viable consideration for nonqualified accounts?
Dave Nadig: So, Rule 6.9 is a filing made by the various exchanges to allow for funds that hold options to do creation/redemption in-kind.
Until this point, a fund that was invested in options (say, all of the defined outcome ETFs from Innovator, or now First Trust) couldn't do anything in-kind.
You basically had to give them cash on creations.
This meant, among other things, a lot of inefficiency, particularly around taxes.
Rule 6.9 changes that. The impact is mostly around the edges. Theoretically it means these kinds of products can be more tax advantaged than they are right now.
So yes, it means they may be more appropriate for taxable money going forward.
Of course actually achieving the tax efficiency means having steady two-way flow in and out of these funds, because it's the act of redemption that makes the tax liability go away.
But all else equal, it’s a good thing. I'm not sure it’s a "game changer," but it’s positive for sure.
Cecily James: Hi Dave, Do you think we’re in a huge asset bubble? If so, what do you think can fix/change that?
Dave Nadig: Oh, boy, talk about a big topic.
I have a pretty middle-of-the-road opinion for the next year (and I should point out I'm not an economist). I think it's very unlikely we have another huge year in the markets. I just don't see the upside. Yes, we have the chance for some short-term upside surprises around the trade deal
But we also have the massive uncertainty of an election cycle, and mixed underlying fundamentals.
I’m not a permabear: I don’t think we're headed into a 10-quarter recession. But I think a few-quarters recession probably has to be planned for sometime soon-ish.
What does that mean? Honestly, probably "stay the course" and stay diversified.
It strikes me as a bad time to be making BIG CALLS.
Pamela: Greetings Dave: Are more ETF investors buying niche funds, or are they mostly investing in total market ETFs?
Dave Nadig: By flows it's still low-cost, plain vanilla ETFs that are getting the lion’s share.
We occasionally see something more interesting pop to the top of the leaderboard: Min vol has had a good asset-gathering run, for instance. Cannabis ETFs were hot for a while, and so on.
But month after month, it’s big, cheap and boring that gets the flows.
And honestly, that's pretty appropriate.
The niche funds get a lot of headlines, and they get a lot of the new-fund attention. But again, that seems appropriate. Not a lot of folks launching new S&P 500 funds at this point.
The only exception there has really been J.P. Morgan, which came out with a broad, cheap beta line that's done very well
Bill Donahue: Congratulations on breaking the news on periodically disclosed active ETF models by Fidelity, T Rowe Price, Natixis and Blue Tractor receiving SEC approval today. How do these match up in comparison to the Precidian model in your opinion? Do you view it as a 5-horse race? If so, does Precidian have a big advantage given that its model was approved last spring?
Dave Nadig
: Hi Bill! Yeah, hat tip to old friend Tony Baker for sending me the filings today. I don't want to take too much credit.
I know the folks behind the structures will hate me saying this, but I mentally lump the "proxy" approaches together here, versus the "blind trust" approach being used by Precidian.
I'm not 100% convinced one or the other is the hands-down winner here. I think it's largely going to come down to how well individual launches are supported by the market making and AP community.
At the end of the day, if we have funds using all of these approaches and structures, and they all trade well, then for investors, it's sort of a nonissue: They just want exposure.
I think it's a safe bet that the Precidian-based funds will hit the market first (they've had more runway) and thus it sort of comes down to those first few weeks/months.
If everything works and it all trades well, then the proxy folks will need to show they can trade at least as well, and then argue for their advantages.
Ultimately, the products would (and should) matter more than all this plumbing.
Todd Rosenbluth - CFRA Research: Hi Dave. Both on the ETF Prime podcast and in other content you published, you talked about a deadbeat-uncle aspect of traditional index-based bond ETFs. So what are some examples of alternatively weighted ETFs you think warrant more attention?
Dave Nadig: Yeah, bonds are definitely weird. And bond indexes doubly so.
My point which you’re referring to is that most bond indexes are issuance weighted, so whoever issues the most debt gets the biggest place—which is like giving the most money to the guy you know who is always asking for money, which fails the common sense test.
The problem is most alternative approaches haven't actually done better, which is annoying and perhaps paradoxical.
As for specific funds doing something different?
Well, I think Invesco's PCY (its emerging market sovereign debt fund) does some interesting things. It's got a tiered methodology, and it uses some valuation screening.
It’s pulled in over $3 billion, so I'm not the only one who noticed.
But most of the interesting approaches in bonds just sort of end up under the umbrella of active management, whether that’s something like ETC's HYLD, or Natixis’ LSST, or all the PIMCO products, etc.
There are now a lot of active bond approaches that seem viable.
But I'd love to see more on the fundamental side. There just hasn't been the kind of data and research to drive it that we've seen in equities. Like I said, bonds are hard.
Dead as a Doornail?: Mutual funds that is. What's left for mutual funds now that trades are free?
Dave Nadig
: Hah! I've been asked this question almost daily lately.
With the advent of free trading (and potentially fractional shares) the last few advantages for mutual funds do seem to be going a bit the way of the dodo.
All that's really left is that you can close a mutual fund to new money, but you really can't/shouldn't close an ETF for new money.
So if you had, say, a small cap value manager who took big, controversial opinions on small companies, there's probably a capacity cap.
In a mutual fund, you can just stop taking money when you think your edge is gone.
In an ETF? Not so much. You'd break the connection between fair value and market prices.
But that’s a pretty edge case.
With no commissions, fractional shares and the periodic-disclosure active structures coming, it’s getting really hard to be a booster of the traditional model.
They won’t go away; there's too much entrenched defined contribution money, and too many funds that still support the old loaded way of selling. It'll take decades for all that to roll off.
By that point, we'll all just be direct indexing anyway (I say half in jest!).
SRI Guy: Assets into SRI funds seem pretty anemic. Is this all hype and no substance?
Dave Nadig
: I think Eric Balchunas tweeted out today that the growth rate in SRI/ESG ETFs was 100%! But the base is only $7 billion, so, not so exciting.
It's a fair comment.
I think what we'll see is that ESG is a slow burn. Flows will continue to be positive, month after month, as people make long-term allocations.
And as we see this 15- to 20-year window of generational wealth transfer happen, more and more will end up in SRI/ESG funds.
It seems somewhat inevitable to me. But it won’t be spikey.
I don’t think we're going to wake up one morning and see $1 trillion in ESG ETFs. It’s going to grow bit by bit. It won’t be like a fad. It'll just grind its way higher.

OK, that wraps it up for today. As always, thanks everyone for joining us.

Next week I think we're moving to Wednesday, so we'll see you then!

Have a great Friday and weekend!

Find your next ETF

Reset All