Live Chat: From Fees To Free & Bitcoins ETFs, Too

February 14, 2019

[Editor's note: Live! with Managing Director Dave Nadig happens weekly at 3:00 p.m. ET.]


Dave Nadig: Good afternoon!
Welcome to Live! As always, you can ask your questions in the box below.
I'll get to as many as I can over the next 30 minutes or so (maybe a bit longer today as there are a lot already!).
We'll post a transcript here when we're all done.
Let's get rollin'!


Outsider: OK, I'll bite this week: Soundtrack?
Dave Nadig: Heh. Too funny.
So, Josh Brown turned me on to the Beastie Boys Book this week, which I've been listening to, so I have this DJ Kool Herc playlist up:
OK, real stuff now.


Marly Hanover: Favorite moment(s)/best takeaways from Inside ETFs?
Dave Nadig: So this week was the Inside ETFs conference in Florida, which is now FOUR DAYS long. And as exhausting as it sounds.
If I had to take one thing away: I was SHOCKED at how much ESG discussion there was. I know I talk a lot about ESG, but the assets haven't come in a big way.
So I expected it to be a bit in the corners. But nope. EVERYONE was talking about it.
It helps that Paul Tudor Jones gave a pretty passionate delivery talking about what Just Capital is doing (it's a nonprofit that surveys Americans about what they care about when it comes to governance).
I guess my second would be that smart beta is far from "over." If anything I would say the definition has now grown to "Anything But Market Cap," so almost every new product launch and hot topic could be wedged into that bucket.


Larry: As we all know, most AUM goes to the lowest-fee ETFs. But there have been a few strategic-beta ETFs that charge (very) low fees, with Goldman Sachs' GSLC being the poster child. Recently, Legg Mason just threw in the towel on their three "Diversified Core" ETFs that start at comparatively high fees of .30, .40, .50. With all the ETF infrastructure in place, why don't fund companies throw a "hail Mary" and drastically lower the fees of failing and poorly priced funds in the hopes they might gain AUM and save the ETFs? Couldn't you do this for 4-5 months and see what happens? (Surely you will make less money -- at least initially -- but you can't make any money if you don't have anything to sell.)
Dave Nadig: Well, to some extent, we have seen that happen.
We see a pretty continuous stream of fee reductions. Almost every week, someone's taking their 70 basis point strategy down to 50, or whatnot.
Whether it's a hail mary or not is of course depending on whether they then let those funds sit for long enough. Just being cheap isn't a guarantee of assets.
However, if you look at what's happened with GraniteShares, their focus on cost really does seem to have paid off.
So it can work, but the flip side is -- you need to be able to run a very lean shop to compete on price, or to have a very large asset base already to amortize across.


Dale: Macro picture on issuers increasing their numbers of commission-free ETFs?
Dave Nadig: So one of the big announcements this week was Schwab and Fidelity expanding their commission-free platforms a lot. Up to about 500.
It's a clear rebuttal to Vanguard effectively taking the whole marketplace free to trade. So that's just the next corner of the price war.
The challenge is that at the end of the day, someone pays for trading.
In the "old model," the issuer would pay something to the broker to be part of the no-transaction-fee marketplace.
But obviously if everything goes commission free, the broker-dealer themselves is on the hook for some cost.
Firms that have enough other stuff to sell can make it up around the edges, just like Fidelity selling zero-fee mutual funds. They make it up because they expect you to buy some nonzero product as well.


BitAlready: Will the fact that RealityShares is also filing for a bitcoin ETF influence SEC’s decision any sooner solely because more and more issuers are filing, seemingly making this an eventuality?
Dave Nadig: I don't think 100 filings would somehow make the SEC say "OK, we'll do this thing we don't want to do."
That said, the rumor mill is rampant with "it's coming soon!" hype. I don't have any inside info, but certainly even the public comments suggest the SEC is continuing to work the problem, and isn't just flat out saying no.
So I truly do suspect it's just a matter of time.
The only questions are, does it approve everything, does it publicly "anoint" a particular kind of filing and give everyone time to get on the same page and refile, or does it approve, say, a single fund?
I would be very very surprised if it did the latter. It generally doesn't like making monopolies if it can help it, even short term.
So my bet is that we get guidance about what a crypto ETF has to look like, and then all the players get on board. Then it's really just a marketing race.
OK, here is possibly the nerdiest question anyone has ever asked:


John: Is the fee to the SEC to launch an ETF $121.20 for every $1 million in net asset value per ETF? I'm trying to understand if there are standards fees of how is it calculated.
Dave Nadig: So, this is deep-end-of-the-pool stuff I can only partially do from memory. I don't know of a per-million "launch" fee (I could be completely wrong).
What I do know is there are transaction fees, for sure. When people talk about "the SEC Fee," what they mean is a per-million transaction feel, which is I think $13.
Then there are also per-share FINRA fees.
And then there are various filing fees, but filings don't have AUM associated with them.
So while there might be a $121.20 fee I don't know about, I'd be surprised if that were the case.
Then of course, various exchanges have other fees as well.
And here's the follow up:


John: Also, as with mutual funds, a custodian is not required if the mutual fund is willing to be audited 3 times a year. Does this also apply to ETFs?
Dave Nadig: Also deep nerd-pool here. So this part I think I mostly know, but it changed like six years ago. This is 17F2 in the '40 Act. It's the part that says how a mutual fund (or ETF, or UIT or CEF) has to custody its assets.
It usedto be quite complicated, but now it pretty much says "either you have to use a bank that's regulated, or you have a few other hoops to jump through."
I don't believe the auditing requirement is part of that rule, but the board due dilligence requirements go way up.
(This is relevant mostly for cannabis right now, as banks don't want to custody pot stocks, so MJ uses a nonbank, and I'd expect any new filing to use a nonbank as well.)


Todd Rosenbluth - CFRA Research: Do you think we're going to see some other large asset managers move off the sidelines and launch active ETFs in 2019 with PGIM setting a good example of how to do it?
Dave Nadig: Hi Todd! (For anyone not at the conference, Todd did an Epic Rap Battle during our Best New ETF panel.) I hope you've recovered.
So, I will add active as my third "BIG TREND" from the event. There are tons of active product now on the street, not just a few fixed-income funds. Lots of folks putting out pretty interesting high-conviction products.
Legg Mason, for instance, has a handful of 50-80 stock funds and so on.
So it seems the barrier around showing holdings is falling pretty fast.
I believe a lot of new funds in the next year will be in a similar vein.
The issue (and this is where, for instance, Vanguard, who is a huge active manager in the mutual fund side) is capacity.
Any strategy you're worried can't grow indefinitely you basically can't put in an ETF, because you just can't close an ETF to new money the way you can a mutual fund.
So, not everyone, but I expect a lot of big new issuers in the space this year, or expanded product lines.


ETF Fan: Can you link us to a video of Todd's rap battle?
Dave Nadig: (If Todd sends me a link I'll paste it here.)


Henry Hill: Can you explain what a put/write strategy is to someone that is a retail investor, and is that considered a hedge?
Dave Nadig: Hi Henry! So both put-write and buy-write strategies sell options, and collect the premium from that.
The traditional put-write (in a fund like PUTW, for instance) basically writes the puts "naked": They sit on cash, and then sell a put, usually at today's prices.
That means that if the market goes up, you've collected some premium, and the options expire worthless.
Long term, what you end up with is a generally positive income stream.
The risk, of course, is if the market goes down a bunch, your puts come due, and you end up with equity exposure in a declining market (bad).
I don't consider either a "hedge," but rather a way of changing the pattern of returns from the equity market into an income stream.
There are other complications, most notably taxes. Options strategies are generally taxed at a split 60/40 long-term/short-term capital gains rate, which can get complex.
So, definitely an area to read up a bunch on before jumping in.

Here's Todd's "performance":
Speaking of the smackdown:


Goldie: So, I was at the "smackdown" this week. You had some pretty harsh things to say about AAAU in a very small amount of time. Care to elaborate?
Dave Nadig: So first off, the way that panel works is we each pick a fund or series of funds to promote as our favorite launch of the year (I picked the Innovator defined-outcome funds), and then we are assigned one of our competitors to "take down."
So even if I loved AAAU with all my heart, I had a job to do, which was to try and poke any holes in it I could.
So without having to be on stage: AAAU is advancing the fee war in gold. In general, that's great! Also, it's an alternative to London-bank custody, which, if you're a gold bug who really cares about such things, is also great!
The holes I poked in it were really around security: the Perth Mint is not a bank, has a very different regulatory structure, and had some real cybersecurity issues in 2018. Those are just true.
But I don't think it's a terrible fund - i was just doing my job!


Donna Lui: I keep reading opposing views about whether we’ll have a U.S. (or global) recession this year. What’s your opinion? How might such an event impact ETFs?
Dave Nadig: With the HUGE caveat that I am not an economist, and generally don't believe I could successfully make a timing decision on something like this, as an investor.
I actually do think we have a rough year (whether its actually negative GDP or not, who knows).
But the impacts of the trade war are real, and even if we had a solution tomorrow and a big relief rally, I think there's long term damage being done that won't get wiped out in a one month rally.
So I think it could be a pretty rough year or so.
at least from a corporate perspective.


FactorCity: Why is momentum investing such a popular strategy?
Dave Nadig: Well, the annoyingly pat answer is "people like owning winners."
The slightly more nuanced answer is that momentum investing is pretty much the first thing you learn when you're becoming a student of the market from a technical perspective.
While a sophisticated technician (which I am certainly not) employs all sorts of tools to analyze and implement strategies, the core is "find the trend" and an upward trend (momentum) is the easiest to spot, and pile into.
The challenge with any momentum strategy of course is timing. At some point, a momentum stock or a momentum index stops being momentum, so you need to get out and do something else.
this is whats behind "flipper" funds like the Pacer Trendpilot series, or just a plain old self-run 200 day moving average strategy.


Jeremy T.: Are there any “given” attributes that predict ETF fund performance one way or another?
Dave Nadig: Only one I know of: cost! All else being equal, the cheaper fund outperforms the more expensive one. It's quite literally the only thing you know for sure 100% in advance.
It would certainly be nice to say something like "momentum" or "relative value" or something, but ultimately, every quick stat or rule of thumb is imperfect. That's part of why really really boring passive strategies are so popular: At least they do what they say they're going to do!
OK, lightning round, going to do a couple here very quickly:


ETF_Fan_22: Anything surprise you in BBH’s latest ETF survey?
Dave Nadig: Yes! I was surprised that ESG rated stronger in the U.S. than in the rest of the world. Also I was surprised by how strong the appetite was for smart beta.
Here's the link:


Terry Falchuk: I not only frequently read (and learn from) your articles, but like the art you use on your site. Especially your Valentine’s Day image in today’s Hot Reads. Keep up the good work, all around!
Dave Nadig: Thank you!


Gavin: Thoughts on yesterday’s headline: “ETFs Offer A False Haven From a Nonexistent Storm”?
Dave Nadig: So that was a Bloomberg article. Here's the link.
That was actually coverage of the BBH/ survey I linked above.
They were pointing to the strength of demand for smart beta and singing a cautionary tale that the strategies can be complex, and require some real understanding.
I agree with that part: Smart beta is far from a panacea.
But I also believe investors in those strategies are smart enough to do a little reading and understand what they're buying. So I thought it was a bit of hyperbole.


John: Is there a white-label provider that is willing to sponsor for a flat fee instead of a % of AUM?
Dave Nadig: Not that I know of. I think that would be a hard business to run. It's possible that folks like ETC will just "rent" you their umbrella with no upside, but I suspect you'd have to pay more up front than you might be willing to do.
AUM-based fees let you lower the front-end costs ... it's a trade-off.


Direct Indexing: Hi Dave, at InsideETFs, you discussed direct indexing. For U.S. equity, I get it. But won't it be hard to do it with international and emerging market equities? You can direct-index with ADRs but many brokerage firms don't have access to all securities in, say, IEMG or VEA. If this trend takes hold, could it be the case where a good portion of the investor's allocation is still in ETFs, e.g., international, emerging market, bonds?
Dave Nadig: So, this is a good point. To truly do a separate account that mimics, say, the world total market, you need a broker/custodian who can easily and efficiently trade all those markets and securities, which is why it hasn't happened everywhere yet. But ultimately this is a software/operations issue, not a regulatory or entrenched structural one.
So I think it gets solved.
Same thing for accessing derivatives, bonds, and so on.
In my slides, I said the winners here have brand, deep pockets and nerds. The deep pockets is partly to pay to solve all those problems.

OK folks, ran a bit long today. Sorry if I didnt get to your question, but we'll be back same time, same day, next week.

Shameless Plug: We redesigned our ETF finder, and I think it's even cooler than it was (it includes fund flows now too!). You can find it at the same place:
Check it out, let me know your thoughts.

Thanks everyone, see you next week.

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