Live Chat: ETF Trading Practices & Factor Quilts

November 07, 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 at any time, and I'll get to as many as I can before my hard stop at 3:30 p.m.
So let's get started. First: today's soundtrack is David Byrne, because I saw his show in NY last night and it rocked my world:

BufferMan: First Trust's Buffer ETFs are finally available. Why did it take so long to go through the SEC approval process? And, do you have any insights on them? Seems Innovator has gotten a big head start on First Trust with having S&P 500, Russ2000, EAFE and EM available.
Dave Nadig
: So of course I love these products, because I'm a fan of restructuring returns in a way that is actually helpful for investors.
The two sets of funds are extremely similar, but there are some subtle differences. Heather Bell teased some of this out in her coverage this morning:
They both use Flex options: the Innovator funds use them on the S&P Price index, the new FlexShares funds use Flex options on SPY itself (again, price).
I suppose, theoretically, that means you're "eating" the cost of SPY over time, but honestly, that will end up being noise.
Both are expensive enough (I believe Innovator is a few bps cheaper, but they're around 80) that the difference will be pretty negligible.
FlexShares have slightly different buffer targets, and as you point out, right now, are just a few funds vs. the rather large set that Innovator has launched.
I suspect FlexShares will still do well, because they are SO good at distribution. So, yay competition!
Will we see a price war? A feature war? Bring it on, I say!

Todd Rosenbluth - CFRA Research: Hi Dave. You showed a great chart on on the factor quilt on how momentum and small cap factors performed best in some prior calendar years and not others. Is your takeaway that investors in these factor ETFs are better suited being patient (rather than trying to time a factor) or choosing a multifactor approach?
Dave Nadig: Hi Todd, thanks for this. Yes, I think that there's a real challenge in factor timing, just like there's a real challenge timing anything related to the markets.
I’ve talked to quite a few advisors who "roll their own" multifactor exposure by combining min vol, momentum and quality. I imagine if you do that and rebalance and control costs, you can lower your overall portfolio risk and get pretty close to market returns (I've seen math suggesting that at least).
I do think min vol/low vol strategies are unique in that, to a certain extent, you don't NEED to time them. They pretty consistently do what you expect—lower your actual realized risk over time.
The variable I think is more whether that’s also giving you the anomalous outperformance we see in occasional years.
So they may make sense for nervous investors, regardless of regime. I'll be digging into this more on Tuesday on a webinar I'm doing with Alex Pire from Natixis, who's forgotten more about this topic than I'll ever learn.
(feel free to join, it's free, etc:

Thom: Hi Dave, Is direct indexing going to be the new “smart beta” craze?
Dave Nadig: I think that's a bit of a misnomer.
Smart beta is really a marketing phrase/movement packaging quant finance trends that have been real for 30 or 40 or so years.
Direct indexing isn't about what you invest in at all. It's a paradigm shift on how you invest—the nuts and bolts.
It's enabled by technology, more than anything, and now by cost constraint and fractional trading.
So will it be a big deal? I'd argue, like quant finance, it already is. It's just a question of how it gets packaged down more toward the RIA/retail level of assets.
So, yes to big, but I think direct indexing will have legs that last for a generation. Fundamentally, it could just relegate packaged products to the dustbin of history. But I think I’ll be long dead when that actually happens. It'll take time.
Think how long it's taken to really get the commission model buried. It’s getting there, but it's still alive, and discount brokers have been fighting that war for 40 years too.

Byrne Fan: So did you read David’s book, "How Music Works"?
Dave Nadig: No, but it's on my list!
Boomer: With all kidding aside from your earlier tweet: Do you think that there really is something "different" about boomers vs. millennials in terms of investing, other than that which we'd expect from age?
Dave Nadig: It's really hard to say for sure, but the surveys I've read suggest that investors in their 20’s and 30’s are in fact expressing different opinions about investing than we've seen in other generations.
Specifically, there's a real, lasting desire for ESG to be a part of the process.
After decades of a lot of the industry sort of quietly snickering about ESG/SRI, I think it's really going to shift as this generation gets control of larger piles of investable assets.
That's especially the case outside the U.S., but I think it's true here too. The study Scorpio did with FactSet a few years ago was really eye-opening in this regard. Something like 60% of folks in this age group said ESG was their primary concern in investing.
Even if you don't believe them, it’s a very, very different answer than they've gotten from any other age group, and it wasn't true, say, 20 years ago when you asked 30-year-olds. So it's not just a "young folks" thing.

Celia R.: Are there optimal and suboptimal ways to trade ETFs, like does it matter what time of day you do so, etc.?
Dave Nadig
: Hi Celia, great question.
Yes, there are good and bad ways to trade.
First: Use limit orders. So, if your ETF is out there trading at $100 to buy, $101 to sell, don't just put in a market order.
At a minimum, put in the order as a limit at $101. Then you know you'll get $101 or less as a buyer.
If you really need to know your trade will be accepted, put in the order for even $101.50. Obviously you're offering too much, but you’ll get the fill (and likely at $101 anyway).
If you don’t do this, you run the (small) risk of hitting the market precisely as something blows up, and you could get priced far away from what you’re seeing on screen. Limit orders don't cost more, so take the precaution.
It's also generally best to not trade at the open or close.
There's too little information, and the likelihood you get a surprise price is much higher than at, say, 10:30 a.m. or 3:00 p.m.
So those are two good rules of thumb for most investors.

Jake: Have any new trends emerged this year that you are watching. I know you have discussed direct indexing quite a bit, as well as commission-free trading. What else is going on that might make the news in the coming months that we aren’t paying attention to right now?
Dave Nadig: So this isn't so much a product trend as just a market issue, but my inbox is full of requests for comments on how to play defense.
It's outsized compared to the usual flow.
Everyone wants to talk about short duration bonds. Gold. Old-economy dividend stocks. Value. Minimum variance funds, etc., all defense.
I think the combo platter of the political environment, this really, really long bull market, and the mixed data we get on a daily basis makes a little caution understandable.
So I suspect if you wanted to bet on one thing, I'd bet on more uncertainty—probably more market vol—in the next 12 months, than we’ve seen in any trailing 12-month window in the past few years.

Amelia B.: Is the fact that all investors might not know the difference between “ESG” “impact investing,” etc., potentially skewing any results that gurus or media might report about these types of funds; and might investors not be getting precisely the exposure they intended because there is some confusion/blurring of these concepts?
Dave Nadig: I am 100% certain you are correct here.
ESG, SRI and impact investing mean different things to different people. So of course they mean something different between an issuer (or rather, a marketer at an issuer) building the story, and the story an individual investor experiences.
I actually think this is a big part of the allure of direct indexing. It's not necessarily that you get a different set of stocks than you might get in a certain fund, but the process of going through a direct indexing platform will ensure that you understand what you own, and more importantly, why you're owning it.
ESG just isn't once size fits all. So either we need another 500 ESG funds, or people will need flexibility.

High-Yielder: Why is there so much fuss in the news about high-yield savings options from places like Betterment and Wealthfront, when something as easy at “BIL” will pay just as much as what those firms are offering?
Dave Nadig: Believe it or not, my wife asked me just this question the other day.
It's because no matter how low, there's more risk in buying any fund then there is in an actual FDIC insured bank account.
People love knowing something is guaranteed. It's why the annuity business even exists.
So yes, you can get a percent or two in all sorts of short duration fixed income products.
And to be really clear, when a firm like Wealthfront does this, they take that risk.
They're making a guarantee, but they take the risk on the other side, no matter how small it is. Just like your bank takes a risk—no matter how small—when it offers you a CD.

OK, that's going to be a wrap for today. Thanks for the great questions as always, and we'll be back, same bat-time, same bat-channel next week.

Have a great Friday and weekend everyone!

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