Live Chat: Fee Wars & Factor ETFs

February 28, 2019

[Editor's note: Welcome to our weekly Live! with Managing Director Dave Nadig.]


Dave Nadig: Howdy folks! Welcome to Live!
If you're new here: You can enter questions in the box below, and I'll get to as many as I can in the next 30 minutes or so.
We post a transcript up at the end of the day, so if you miss an answer, you can come back to this same URL later.
With that, let's get down to it!


Bob Loblaw: Music?
Dave Nadig: Hillarious. Today is a Courtney Barnett curated playlist:


Todd Rosenbluth-CFRA: Hi Dave. With Vanguard’s latest ETF fee cuts, do you think investors should shift from an iShares or Schwab fund for a few basis points of savings?
Dave Nadig: Welcome back Todd! So, we're deep in fee wars at this point. And the short answer is probably not.
I suppose if you were in a nontaxable account, and you had two precisely identical ETFs (for instance, VOO from Vanguard, and IVV from iShares), and you had no commissions to worry about ... then yes, a few basis points could be worth it over the long term.
But you'll likely lose a basis point (.01%) or so just in the slippage.
By that I mean that you have to pay just a bit more to buy than you get when you sell, even if that's just a penny or two.
Also, there are timing issues. If you're sitting on buying power in your account, you could do a simultaneous trade, but otherwise, you'll have to wait for the sell to settle before making the buy, and you could lose a lot more than a few basis points being out of the market.
So in general, it should take more than 1-5 bps to make you trade.
Just my thoughts there.


C. Talley: Did factor investing experience bad performance in 2018 because it's been overhyped?
Dave Nadig: So, "factor investing" didn't experience bad performance in 2018. Not really.
You can find this in any number of places (BlackRock does a quarterly survey on it), but the 2018 numbers are roughly down 4.5% for the broad U.S. equity market,
Now SOME factors, like value, did quite badly. Value was down something like 11% LAST YEAR.
But many min-vol strategies ended up on the year by a few percent.
And momentum in general still outperformed the broad market.
So it's always down to "which factor" when we talk about factors.
As for whether its overhyped? Sure, we got a lot of smart-beta talk for the past few years, but this has been the institutional approach for decades. So I don't think it's some sort of fad.
It's evolution.


Taryn Fulmer: Many say smart beta has run its course. Yet last year those ETFs took in $80 billion, its biggest year ever. So isn’t it still front and center?
Dave Nadig: Yep: Reports of The Death of Smart Beta has been greatly exaggerated.
At the conference a few weeks ago, basically nobody was pitching low-cost beta. Y'all may still be BUYING it, but the ETF-industrial complex is still pushing an ABMC agenda (anything but market cap).
Some of that focus has turned toward ESG, and some of it has turned toward active (witness Vanguard's active "smart beta" offerings).
But it's very much still alive, and I expect it to be more so this year.


Jim: Regarding ETFs, would you explain exactly what a “spread” is?
Dave Nadig: So picking up on the topic Todd brought up: Anytime you're buying and selling anything, from used cars to real estate to ETFs, you expect to pay a bit more than you get when you sell something. That gap is the spread.
So you can think of any "round trip" as costing you the spread amount in execution costs, all else equal.
So if you buy a fund for $100, you might only be able to sell it for $99, a 1% spread.
You should take that cost into consideration when picking any investment: a stock, an ETF, an individual bond, etc.
In traditional mutual funds, since you actually don't buy and sell (you create and destroy shares), you're not paying that spread, because you transact at the net asset value at the end of the day.
(The trade-off of course is, you have no idea what price you're getting until after the fact.)
OK, more thoughts here on fee wars:


J. Gross: Hello Dave, Vanguard recently updated its website (today) with the most recent annual reports for many of its biggest funds/ETFs, and they show big reductions in expense ratios for the ETF share classes. The S&P 500 and the Total Stock Market ETF will have their expense ratios cut in half from 4 to 2 bps, for example. Do you expect another round of fee cuts from the other providers (iShares, Schwab) because of this? Some of the iShares core funds are starting to look expensive by comparison, for example.
Dave Nadig: So first a bit of a correction (unless I missed something).
I don't believe Vanguard's S&P ETF (VOO) had any changes, at least not that was in its press release:

And VT - its total market ETF - dropped 1 basis point (.01%) from .10% to .09%.
BUT, all that said, to answer your question: Indeed, there are some pretty pricey "default" ETFs out there now.
Consider iShares' EEM at .67% -- that's outrageously expensive compared to the cheapest competitive fund.
Schwab's offering for very similar exposure, SCHE, is 13 bps, if I recall.
So that begs the question, why would you pay FIVE TIMES as much for EEM?
The short answer is: Because you're not planning on holding it, you're planning on trading it.
EEM is incredibly liquid, and has a well-developed derivatives market. If you're running an HFT algo, or even just planning on trading in and out a few times this quarter, that liquidity advantage can overwhelm the cost disadvantage.
So: EEM might be a bad call for a buy-and-hold investor, but IEMG or VWO or SCHE might be better.


Harold F.: Are investors skeptical of actively managed ETFs?
Dave Nadig: I think investors are skeptical of claims, period, and should be.
And active management is always a claim: "We're going to do better (by some measurement)."
Managers that show they deliver tend to do well, whether they're in an ETF or not.
So we've seen some real successes (ARK, Davis, PIIMCO, DoubleLine).
But the math is never on the side of active managers, writ large, so I think it's always a battle, regardless of the wrapper.


Mojo: Why can't I buy some ETFs like VXX ETFs and some leveraged/inverse ETF on my BAML account? If the SEC says it is good to go, why would a brokerage put up gates to what has been OK'd by the SEC?
Dave Nadig: This is a phenomenal question and one we don't talk about enough.
Quite a few brokerages have "gates" over certain trades. Whether that's a regulatory one (you can't trade futures until you fill out CFTC paperwork) or a less transparent one (I don't think you can buy MJ at Merrill either).
It's shockingly hard to find out what's on these banned lists. It's a bit easier if you're an advisor, because often there's a separate communication channel to affiliated advisors.
But as an individual, you really won't know until you ask, and it's a moving target.
After all, with 300 or so new ETFs a year, someone's making choices upstairs.
It's actually for this reason firms like Interactive Brokers exist: They get entirely out of the way, and if you blow yourself up, you blow yourself up. But many investors don't want their experience that stripped down.
Most folks with a BAML account, for instance, also have other financial relationships with the firm than just ETF trading.
So it's protectionism. To make a short answer too long!


Julie: “Sustainable investing” used to be considered niche investing. Would you classify that area as officially mainstream now?
Dave Nadig: $13 trillion in U.S. money is pretty darn mainstream.
That's the number from the big SRI research firms. The vast majority of that is institutional. So where it's not really mainstream right now is in the quintessential "mom and pop" accounts.
There's always a lag from institutional to retail, and the rise in SRI/ESG/impact Investing is just following that pattern.


SM: Hi Dave, The industry keeps saying that active and passive go together, yet the SPIVA reports show that active management has failed to deliver. In which segments does active makes sense? And are ETFs the right way to get that access?
Dave Nadig: Boy, big question.
You are correct that the math is just bad for active -- as a group.
The problem isn't that nobody beats the market, it's that it's hard to figure out WHO will beat the market.
And when you look at legends (Buffett, Marks), they win over LOOOONG cycles. Longer than most individuals can stomach losing.
The traditional wisdom is that active should do well where information is scarce: emerging markets, junk bonds, etc.
That's the standard answer. But the math suggests it almost doesn't matter.
You tend to see "reported" outperformance in bonds most often, but that to me almost always comes down to picking the wrong benchmark. If you're benchmarking off the AGG and you're running a duration 3 portfolio that's half corporate debt, well, you're not outperforming anymore than my Miata "outperforms" my bicycle.


George: With so many NL MFs being offered, are passive ETF’ still the best strategy?
Dave Nadig: I think the mutual fund headcount is well over 8,000 in the U.S., and ETFs are at about 2,000.
A few things: For most passively managed ETFs, there is a no-load mutual fund equivalent out there somewhere. Chances are it's more expensive, and you may pay a fee to get in and out of it (depending on where you trade).
So apples to apples, cost will usually be in the ETF camp, and ETFs are generally just more tax efficient because of their structure. So there are reasons to own both:


Mom & Pop: In total invested $, which holds more $: ETFs or MFs?
Dave Nadig: The number right now is something like $3 trillion in ETFs and $12 trillion in mutual funds (off the top of my head).
My prediction is that we see parity in about 5 years.
Mutual funds are still a great choice for things like 401(k) plans because they don't worry about taxes, and you can do fractional shares really easily.
So MFs don't go away; ETFs just take in all the new nonretirement money.


Rian: What ETF launched in the last 6 months will have highest AUM by year end?
Dave Nadig: I feel like this is a cheap answer, but probably VXXB (which replaced VXX). People still wan to trade vol.
(Obligatory disclosure: VXXB is based on the VIX, which's parent company, Cboe Global Markets, created.)
Not an endorsement of course: I just think it gets back into the billions.


Lane Sumner: Hi Dave. What would you say are the most common ETF misconceptions?
Dave Nadig: That all ETFs are indexed, low cost and tax efficient.
MOST are, but there are enough exceptions to make due diligence incredibly important.
You can buy an ETF that costs over 1%, has exposure you don't expect, pays out capital gains and is probably actively managed.
With so many new products coming to market, the wrapper isn't getting in the way of old tricks.


Jake: SPY is dying? How can that be the case for the world's largest ETF?
Dave Nadig: Well, it's not the cheapest anymore, and because it is structured as a UIT (not as a mutual fund, like most ETFs), it can't reinvest dividends.
So it will, by design, underperform a similarly priced newer-model ETF like IVV or VOO.
There's quite literally nothing SSGA can do about that.
So we've seen money just slowly run into the cheaper, better-structured products.
It's not SPY's "fault" -- it was the first out, so it went with a structure the SEC would approve, and that everyone could make function.
It's just old-school.
Here's a big one to close on:


George Ralls: Good day; I'm 70 yrs. old and need help building a portfolio based on 2019 economic expectations, volatility. I'm open to suggestions, with exception of bond ETFs due to lack of knowledge of different bond types and risks. Currently own individual equities related to 5G rollout: Cisco, Qualcomm, Erickson, Intel, etc. Thank you.
Dave Nadig: George: So glad you could join us. My actual suggestion is that you consider working with an advisor, even if it's an "automated" advisor.
Chances are, your current broker has a very inexpensive or free offering that can get you into a diversified portfolio of ETFs appropriate for your time horizon.
Schwab and Vanguard have offerings, and certainly many of the broader platforms (BAML, Fidelity and so on) have referal services at a minimum.
Since you're in individual equities, I'm projecting here, but I'm guessing you enjoy that part of investing. And that's great.
But most advisors would suggest you bucket off some "fun money" to trade stocks with that's a fraction of your overall portfolio.

And with that, we're going to wrap it up. Sorry if I didn't get to your question this week. Will hit them again next time!

Thanks everyone for joining, and have a great afternoon.

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