Live Chat: Choosing ETFs & RIA 'Prime' Fees

September 19, 2019

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

Dave Nadig: Good afternoon! Welcome to Live!
As always, you can ask your questions in the window below. I'll get to as many as I can before my fingers cramp up.
I'll dispense with the formalities: jamming on the new Green Day drop this afternoon:
Now let's get to work:


L. Brynne: Hello Dave, I’m wondering if the Saudi refinery attacks and ensuing supply situation have affected oil ETFs.
Dave Nadig: For sure. The main ETF tracking crude (USO) immediately traded up 12%, but it's come down a bit as the market has realized the impact will actually be a bit muted for U.S. consumers.
OIH, the big services ETF, also traded up sharply on the day, but not as much (maybe 8%).
Obviously nobody is "happy" when things like this happen, but the reality of U.S. energy consumption is radically different than it was, say, during the Gulf War.
Between fracking, natural gas, and increased alternative usage, the U.S. is just much less dependent on Middle Eastern oil than it used to be.
But of course, the global impact will ripple through. It's not like the U.S. is completely immune; we're just not catastrophically dependent like we used to be.


Eric: When choosing from foreign ETF (ex-U.S.), there are so many! How to chose the winners? Thanks.
Dave Nadig: There are indeed a lot of international funds out there!
I think the premise is a bit misleading, however. I don't think the point of investing is necessarily to pick the "winner." The "winner" say, over the next year, will be a single country fund in a market with a lot of volatility and risk. That's almost always the case.
One year it's Brazil, the next year it's Russia, etc.
But you're getting an enormous amount of concentrated risk in ETFs like that. I think most investors are better off simply working off their home bias first.
So core allocations into a developed market ETF, and maybe an emerging market ETF, is where you should start.
There are tons of great, cheap options there, whether you go with something like the iShares core products (IEFA and IEMG) or equivalents from Schwab and Vanguard.
If you then get the macro-econ bug and want to start really researching specific countries, or different approaches, that's great! But it's more about doing your global macro research than the specific ETFs, initially.


Janus Holssen: Do the results of presidential elections in other countries ever have an effect on the U.S. economy?
Dave Nadig: Lots of big macro questions today!
So for sure, we live in a global world, so geopolitics definately matters to the U.S. economy.
So for example, what's going on in the U.K. right now has a direct impact on us, because the U.K. is a reasonably big trading partner for us. If they have a hard Brexit, well, that makes life really tricky for U.S. companies exporting to the U.K. That's not necessarily bad (who knows what treaty might get done quickly), but very hard to plan for.
That uncertainty means companies here are less likely to make big investments, and that in turn is bad for growth.
That's the main argument against the trade war, not the tarrif per se, but the huge amount of uncertainty it puts in the business environment. Anytime one of our big trading partners has political upheaval, there's an effect.


Eric: How to compare similar ETFs from different issuer? How to find out which one is the best? Thanks.
Dave Nadig: This is actually one of the thorniest issues in ETF due diligence, believe it or not. One of the reasons we built our analytics engine (which we sold to FactSet, then licensed back for our fund pages) was precisely because the "old way"—going to fund pages at different company websites—is really confusing.
Take something as simple as P/E ratio. A reasonable thing to do would be to compare the P/E ratio of, say, a bunch of value funds from different issuers.
But one issuer might include negative earnings, and another might not.
So you'd get radically different P/E ratios even if the funds held PRECISELY the same thing.
So, the more direct answer to your question would be: Look at the core vectors of analysis for each fund: efficiency (mostly expense ratio and tracking difference); tradability (liquidity metrics); and most importantly, fit (the exposure differences).
Exposure differences will generally overwhelm the other two, assuming they're all basically in the ballpark.
(Obviously, if one fund charges 90 bps and another charges 9 bps, you might shortcut the whole decision!)
But mostly, legwork. We're actually launching a "fund comparison" tool hopefully by year end or early next year that should make this even easier.


Todd Rosenbluth - CFRA Research: Hi Dave. I know you are similarly excited for the long-awaited ETF rule to move forward next week at the SEC. Can you recap the big impact this will have on the industry since you have done eloquently in the past? Easy to file/launch, elimination of preferred status for oldest ETFs, etc.
Dave Nadig: Hi Todd! So, yes, the SEC has the ETF rule on the agenda for Wednesday. One assumes they'll vote on it.
I also assume it will pass, but you never know HOW it will pass. It could be tweaked, it could be phased in, etc.
My assumption, however, is it goes pretty cleanly, with a 2020 start date, maybe with phased-in reporting requirements on a few things.
The immediate impact is that it will make filing new stuff a bit easier: essentially "by right" for most ETFs. That should help newcomers get to market faster.
The more important impact is leveling the playing field around custom baskets.
That will make it easier for firms to manage creation/redemption well, particularly around things like rebalances and heartbeat trades to keep tax liabilities in check.
But, the proposed rule has recordkeeping and board requirements, so it will take some work for firms to comply; hence, why I think this will be phased in over 2020, if I had to guess.
We'll be liveblogging the meeting on Wednesday, because we're big ole nerds for this kind of thing.


Tony: ETNs are debt instruments of the issuing bank and have default risk, causing some retail investors to avoid them. But would there be any barrier to an issuer creating an ETF that packaged together an ETN with a CDS on the issuing bank, essentially creating an ETF version of the ETN with the default risk minimized?
Dave Nadig: Well, if you package the ETN (a debt instrument) and a CDS (an OTC derivative) into a "bundle," you're going to run into some real issues.
That basically couldn't be it's own 40 act fund, because you own too few assets, and a lot of a derivative contract.
I'm not even sure what structure you'd have to use.
The math of what you suggest (an insured debt obligation) is totally sound.
But I suspect there's just not enough demand. ETNs get used for pretty targeted, specialized exposures.
They have some real advantages in certain corners of the market, particularly thorny tax or trading-related areas like, say, MLPs or even commodities.
But I don't think the default risk is really holding anyone back much.


Eco Investor: I watched your webinar yesterday. You said “your idea of ESG and mine might be very different.” So it was interesting for me to see this headline this morning: “’Green-Friendly’” ETFs hold shares in groups with coal operations” with the subhead: “Investments by 2 State Street-run funds raise questions over fund managers’ practices." It’s like I read on your site often: “You HAVE to look under the hood; know what you’re buying!”
Dave Nadig: I suspect the funds in question are doing precisely what they promised to do on the tin. Almost anytime you read an article like this, it's not ferreting out anything nefarious, it's just pointing out the difference between headline-driven expectations and reality.
Coal's a great example actually. Is the "green" thing to do to never own any company that's related to coal? Or is it to buy tech companies that are cleaning coal plant emissions? Or is it to buy competitors to coal?
I could see all three being valid.
So yes, you sort of made my point for me here: Especially when you have a specific goal in mind, you really have to do your homework, and you cannot just lean on the name of the fund, and a few sentence's worth of description.


Janelle Sanchez: What’s the difference between factor investing and smart beta?
Dave Nadig: Not much!
In all seriousness, I think of factor investing as a subset of smart beta. Smart beta doesn't really "mean" anything in particular. It's not a term of art; it's a marketing slogan.
But generally the market uses it to mean "quantitative strategies that seek to alter the pattern of returns from a given market segment."
A value fund, a momentum fund, a low-vol fund, or a multifactor fund all fit that description.
But there are other strategies that aren't traditionally thought of as factors that would also work.
So for instance, the Research Affiliates methodology for fundamental indexes: It certainly uses inputs you see in factor strategies, but it's not explicitly targeting "factors."
Same with AI-based funds, or hedge fund replication or "guru" strategies.
Or a commodity fund that manages contango;
Those are all smart beta, but not factor strategies.


Jordan: Loved your talk at Wealth/Stack. In it, you said the future of the RIA fee model would look something like Amazon Prime. Do you know of any firms using a model like this now?
Dave Nadig: Hi Jordan! So yes, this is a pretty open topic of conversation in practice management circles. I highly recommend following Michael Kitces' blog; he talks about this stuff all the time. (
But yes, there are some large firms working on what are essentially retainer-based fee schedules. At Wealth/Stack, Creative Planning (a monster firm) disclosed that they basically have an algo that they punch a bunch of info about a client into (measures of complexity and service levels) and it spits out an annual fee.
That's sort of the high-end version. I think a more mass market version would be something like Facet. You can find good info on both with a quick Google search.
I do think over time, the whole market moves away from AUM-based fees for asset allocation portfolios, and much more toward fee-for-service models. Whether that's "all in" costing like Prime, or whether that's more takeout-menu style, remains to be seen.


Ellery : What was the fiduciary rule and why didn’t it pass? What recourse does an investor have if an advisor recommends a “shady” fund and the investor loses a substantial amount of money?
Dave Nadig: So, the Fiduciary Rule was put forward by the Department of Labor, because they have jurisdiction over retirement accounts. It basically said, "If you advise ERISA-jurisdiction clients (retirement investors), then you have to be a fiduciary."
Fiduciary is the highest standard of conflict-free advice. It means your advisor has to work in your best interest, period. Really without exception.
Essentially all independent RIAs are fiduciaries. Where it gets tricky is with broker-affiliated advisors.
There they work sort of between worlds, and you can get into trouble.
It failed because the DOL got sued, and lost. The claimants argued the DOL over-reached.
Whether they did or didn't isn't really important, because it's gone now.
I still think we'll see a true fiduciary standard in the next five to 10 years, but right now, we're sort of "in the soup." As an investor, you should really ask your advisor, as part of your due diligence, what standard they're under.
If you feel like you got "scammed" somehow, you can report that to FINRA, or even just start by asking to speak to the advisor's boss.
That can be surprisingly effective. Nobody wants a bad mark on their record from a FINRA investigation.


Ron: I saw your webinar yesterday where you were giving a tour of's fund reports and how to read them. What are the first two things you look at when exploring a new fund report? Obviously you have some idea what the fund does
Dave Nadig: If it's an index-based fund that's been out for a while, I look right to tracking difference (under Efficiency) because that bakes in all the costs and the effectiveness of the portfolio management in one number.
If it's truly a brand new fund, well, you're going to be a bit in the dark. I tend to look (beyond the fund description) to the portfolio info, and see how that compares with the segment that it's in. Do the tilts of the fund make sense? Is it getting the exposure I'd expect from the description? That's a pretty good smell test.
Only after that would I worry about trading issues.
Great question.

OK, running a bit long here, and sorry if I didn't get to your question. I'll grab one more here.


Lesley B.: Is liquidity a more important factor than expense ratio when considering which ETF to buy?
Dave Nadig: I love this question.
It's totally dependent on time horizon.
Assuming that the ETF in question is "ownable"—that is, it's not outrageously expensive (say, 1.5%) and it's not completely untradable (a few hundred shares of daily volume or something)—
then the expense ratio matters more, the longer your time horizon.
And tradability (spreads, mostly) matters more the shorter your time horizon.
You can see this all over the market. Just think of gold ETFs.
If you're planning on holding for a week or two, then the incredible liquidity of GLD is hard to beat. You're not going to pay its comparatively high expense ratio for very long, but you're going to book the spread right away.
But if you plan on this being a core holding for a few years, well, BAR, with its 17 bps expense ratio, will save you 23 bps year after year.
If BAR's spread were, say, 40 bps and GLDs were 1 bp, BAR would still be the right call if you were holding for two years.
So it really depends on your use case, and both are important to look at.

OK, that's gonna wrap it for today. I'm on the road the next two weeks, but we'll be back at this in October. Thanks for the great questions as always, and have a great rest of the week.

Find your next ETF

Reset All