Live Chat: Don't Sweat Crowded Trades

August 01, 2019

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



Dave Nadig: Good afternoon! And welcome to Live!
As always, you can enter your questions below, and I'll get to as many as I can in the next 30 minutes or so.
We'll have a transcript (with a video!) up by the end of the day.
But we've got a bunch of fun questions queued up, so let's get rolling.


BioTechGuy: Song of the week?
Dave Nadig: Sleater-Kinney dropped a new 3-song EP which I'm obsessed with:


Matt L.: Dave, as an ETF investor, do I really need to worry about whether I'm invested in something that's now considered a "crowded trade"?
Dave Nadig: Hi Matt - interesting question. When people use the phrase "crowded trade," what they usually mean is "a lot of money is chasing this idea."
So for example, when we were at peak fervor over min vol or low vol investing, lots of ink was spent talking about how "it would all collapse" when all this money left the low vol stocks.
In academic terms, what people usually talk about is "capacity."
So for example, an academic might have a piece of research that says, "If you buy stocks on Thursdays between 10 and 11, when it's raining, you get outperformance."
Well, that's a pretty narrow place to play, and so they'd say this was a "low capacity anomaly."
Can ETFs be targeting low-capacity corners of the market? Sure. People make this argument about various factors.
They make it about things like high-yield munis and so on.
And in fact, there have been narrow moments when ETFs have owned a rather large part of a market. Junior gold miners, for instance. There have been times when Van Eck has been a VERY big part of some of those companies
So you can say "it was crowded."
So it's not insane to be worried about it. But for most investing (outside niches), it's not much of a concern.


J. Maldonado: Morning, Dave. I would’ve thought a rate cut would’ve boosted the market. Why did the opposite happen yesterday?
Dave Nadig: Well, the problem is always what the market expects. It's a bit like seeing a company have a great earnings quarter and trade down. Clearly that means the market, as a whole, expected EVEN MORE.
So in this case, the market expected not just a rate cut, but a strong signal that more was coming.
Instead we got a rate cut and a lot of hand wringing.
Today's action is pricing in another rate cut (or more) even though the Fed isn't saying that.
Of course, this is now extremely intertwined with the announcement of another wave of tariffs, which is killing various sectors.
But, in short: expectations. The market had already priced in more than one rate cut; it only got a signal for one, so it sold a bit off.
But mostly, I worry short termism here is noise.


Courtney: Hi. Could you explain the technical side of how dividends are reinvested into an ETF? What if the payout is lower than the share price ... is it still reinvested? Thank you.
Dave Nadig: Hi Courtney! In the vast majority of cases in an ETF, dividends are not reinvested; they are actually paid out.
So if you own, say, SPY, every so often, you'll get cash deposited in whatever account you own SPY in, as it pays out accumulated dividends.
There are some quirks here: Most funds take the cash from individual company dividends and "equitize" that cash by either buying more stock for a small period of time, or more often, a small position in a derivative instrument that will track the core index the fund is tracking as well.
That minimizes cash-drag from just sitting on cash in between distributions from the ETF to you, the investor.
A handful of ETFs (including SPY) are structured as unit investment trusts, which makes it impossible for them to "equitize" the cash, so they tend to underperform a tiny amount in up markets, and overperform a tiny amount in down markets.
If you want to take the dividend stream from the ETF and reinvest it, you generally have to do that on your own. This is a bit different from mutual funds, where your broker will often just automatically reinvest the dividends you receive. You still get them; you just don't notice them until you get a tax bill at the end of the year.


Tate Markham: Did Schwab buy the entirety of USAA, or a portion? Either way, does this impact ETFs at all? (And are there any specific USAA ETFs?)
Dave Nadig: Hi Tate. Talk about a confusing world. So, USAA signaled some time ago it wanted out of the investment business.
But being a HUGE company, they have LOTS of investment businesses, not just one.
The big interesting chunk, the mutual fund and ETF businesses, were already sold to Victory Capital.
I think that closed a few months ago?
So the USAA ETFs and so on are now all Victory Capital ETFs.
What Schwab bought was (I believe) their wealth management business, and their brokerage.
Both are big businesses, but they're not product issuers.
Hope that clears it up.


Esme: Lately I’ve been reading that some ETFs provide a better return depending on what time you buy and sell them. 1) How many ETFs does this affect? 2) Relatedly, is after-hours trading available to all investors?
Dave Nadig: Well, this is a bit tricky.
Technically, ALL investments can return better or worse based on when you trade them. If you buy a mutual fund on the "wrong" day, you'll do worse than if you luck out and buy it on the "right" day (the right day being when it's down).
If we're talking about TIME - as in, I know I'm buying EEM today, but WHEN do I buy it - then it's a bit of a mug's game.
It is the case that the open and the close are often bad times to trade, as pricing can be fluid.
But in between, for the most part, you're going to get a "fair" price. You're going to get a price based on what the underlying securities are trading at.
So if you buy QQQ at 11 a.m., it will be a "good time" if those 100 stocks happen to be trading down, and at a bottom. It will be a "bad time" if the opposite is true.
None of those things are predictable or knowable, honestly, so trying to game it is as likely to hurt you as help you.
As for after hours, that's based on your broker. Some brokers have robust, trader-oriented access to after-hours markets; some don't. In all cases, BE CAREFUL. Price discovery is a crapshoot in the after hours, and the market makers and APs are generally absent.


Todd Rosenbluth - CFRA Research: Hi Dave. Nice piece on innovation occurring in emerging market ETFs. Do you think there's a time when investors will become more targeted with their EM investments as they do in North America? Thematic funds focused on cannabis, cybersecurity, cloud computing, etc., are being used to be more tactical in recent years. But well-diversified EM ETFs like IEMG and VWO are most popular.
Archie M.: Hi Todd. So do I see a world where we have 400 emerging market ETFs focused on subindustries and factors and all that? Seems far off to me.
In general, we see that at the local level. EU investors have more narrow slices of EU markets to choose from than we have listed here in the U.S.
The reverse is also true: UCITS-based EU ETFs have far fewer micro-slices than we do here in the U.S., of the U.S. markets.
So I think it's just about supply and demand. Demand for thematic products here in the U.S. is already sketchy: Some themes catch (cannabis) some don't (micro-targeted health care ETFs).
Until there's demand, there won't be products to meet it, is my guess (a pretty safe one).


TickerMan: How can interest rates be negative? Isn't that impossible?
Dave Nadig: Great question!
So, when a bond is issued, it's generally got a par value - the amount of money going to the company/country issuing the bond, and a coupon, the interest rate payment.
So, for instance, I could issue a 10-year $10,000 bond with a 1% coupon. You give me $10,000 for 10 years, I'll hand you a check for $100 every year, and at the end of the 10 years, I'll give you the $10K back.
However, there's no rule that says just because I want $10,000, you have to pay that amount - most bonds are issued in some form of an auction.
So let's say you REALLY NEED to own this bond; you could offer to pay me $11,000 for it.
In the end, you will have received $10,000 after 10 years, and $1,000 in coupon payments.
You essentially just barely get your money back.
So the coupon is 1%, but the actual yield to buy it today is zero.
And you could overpay, like in Germany, and have an implied yield that's negative, even though the coupon could be positive.
Better question: Why? Because if you're a HUGE institution, you can't park $50 million in an insured bank account.
Your "cash" has to go somewhere. And in many cases, your investment policy may require you to buy government bonds.
Voila - you have irrational demand that results in irrational pricing.


RiskyMan: Is this a good time to consider buffer ETFs? Any update on First Trust's version?
Dave Nadig: So by buffer ETFs, you're talking about the Innovator Defined Outcome ETFs, which protect X% of downside but cap you at y% upside.
I'm a big fan of these products. They solve a real problem, and they're well designed. They're too expensive, but I still like them.
I haven't heard any updates on FIrst Trust's offerings, but my hope is that some competition drives prices down for everyone.
As for timing, the whole point of buying a buffered product is that you can sort of forget about the timing.
Because your outcome is, well, defined. You know the boundaries, regardless of whether you buy now or next month.


Josh: Hey Dave, given how popular factor investing is these days, is there an easy way to track which single-factor ETF is performing the best this year? And how do I know when I should be rotating factors?
Dave Nadig: Hi Josh. I hate to send people to other websites, but in this case, you simply CANNOT do better than the folks over at Research Affiliates. Here's a link to their smart beta data:!/strategies
You can really dig in deep there and look at the historic valuations and trading ranges of all the major factors, and play around with timing ...
I feel like I've sent so many folks to that link I should be getting a referral fee. Or at least a dinner from Rob Arnott.


Ian Crosthwaite: When the advice is given to “rebalance your portfolio” (yearly?), exactly what is meant: redivvying between stocks and bonds, or …? And does one need to rebalance their ETF holdings too in any specific way (yearly)? Thanks.
Dave Nadig: So if you think about this at the most basic level, let's say you've decided based on your goals and your risk tolerance, that you want to be 90% in the broad market, and 10% in cash "just in case."
Now this year, the market goes up 20%. So your $90 investments all just became $108, and your cash is now still just $10.
You're clearly now way overinvested in the broad market, based on the work you did to decide to be only 90% in the market.
So what you should do is say, "I have $118. I want that to be 90/10, so I need to own about $12 in cash, with the rest in stocks.
Well, you only have $10, so you have to sell some stocks, to get back to your 10% cash position.
How often you do this is really up to you. How much do you care about being over/under your targets? How worried are you that you'll miss out or get overexposed?
If you're invested in, for instance, two highly volatile things you want to keep in some kind of balance, you'll want to rebalance very frequently.
If your brokerage account is basically infinite time horizon and you want it 100% invested in the same thing all the time? Well, there's no rebalancing required.
Personally, I check in with things about once a quarter, and probably make a rebal trade once a year.


Buddy: If an ETF has an "averaged weighted market cap" of $60 billion, what does that mean? The average market cap of all the underlying stocks is $60 billion?
Dave Nadig: Pretty much! Although "weighted" here means you weight the average based on how much of each security you hold.
So if you own 50% of a tiny thing, well, that brings the WAMC of the average holding down vs. owning 50% of a huge thing.
It's a reasonable way of saying "how exposed to size am I?"
It's always better to look with more granularity, if you're curious. So seeing the percent of a portfolio in each of the four main buckets (micro/small/mid/large) is a good second check on it.
OK, running a bit light on time, so I'll take one more and then have to hop.


Edmund Burns: Hello Dave. As investors think about the myriad aspects that can affect their portfolio/retirement, when are YOU personally are going to take Social Security? I know there are many schools of thought on that. If that’s too personal (I see you answer several whimsical questions on here), maybe you would give your 2 cents on if you think it’s going to go bankrupt/when? Thank you.
Dave Nadig: This is actually one of the hardest questions in financial planning. I'm totally serious.
If we all had faith that there would be no changes to Social Security between now and when we die, it's STILL a complex decision.
I'm 52. I could start taking money from SS in 10 years, but my "normal" retirement age is 67. And I could hold off even further to get an implied 8% return for waiting.
If I simply believed all that was fixed, really I think waiting as long as possible is smart, because: I'll likely be in a lower tax bracket in 20 years, and I'll likely not get 8% "risk free" anywhere else.
But of course, you can run the math on taking the cash at 62 and then investing it, so there's a mathematically optimal solution IF you fix all the variables.
But the unknowns here are BIG unknowns: When will I die? How will the tax code change? Will SS remain intact?
I have absolutely NO idea on any of those three.
Luckily, I have 10 years before I have to worry about it (grin).

OK folks, that's a wrap for today. Likely no Live chat next week, as I'll be at a meeting with a bunch of economists, but I'll report back on the site from there.
Just wont be able to do it "live" here.

Thanks for coming, and I'll see you again soon!

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