Live Chat: 'Go Away In May' Myth & Fee Wars

May 02, 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 in the box below, and I'll get to as many as I can in the next 30 minutes or so, and post a video shortly thereafter with something I think that's juicy.
We'll also post a transcript right here.
With that, let's get rolling.


Jamie T.: Fee wars have been ratcheting up for a couple years now. But is that only on ETFs, or other investment vehicles (mutual funds …)? Tx.
Dave Nadig: So the short answer here is YES, there's pressure all over financial services.
Even insurance products.
I think that pressure is predominantly because of ETFs, honestly. ETFs, while being cheaper, are, more importantly transparent.
People have now been trained to expect to be able to find out things like how much they're paying.
I think that rise in transparency has actually been across the economy.
Even buying a car is a more transparent (if not actually more enjoyable) experience than it was a decade ago.
Morningstar actually just published a big new study on this:
Lots of similar questions today; I'll bunch a few up:


Marcus Jeter: Has that “sell in May and go away” maxim been debunked?
Doug Idzell: Is summer ALWAYS a weak period for energy equities and crude oil? If so, do their corresponding ETFs slump then?
Dave Nadig: So, this is one of the great "maxims" of all time, and the problem is that it works, except when it really doesn't.
If you run a simple experiment of doing the "sell in May, buy in October" thing, and you run it back 30 years, it indeed beats just holding forever.
But, there are a lot of caveats to that -- depends a lot on whether you reach far enough back to catch the '80s, or if you skip the '90s, and so on.
It has pretty decisively stopped working for the last decade or so.
At least since 2013, I believe it's failed miserably.
And like any barbell strategy, it's entirely dependent on outliers. You miss one great June, or you catch one terrible November, and it all falls apart.
In general, my thinking on any of these non-market-data systems is they can only work if there's a kind of collective delusion. If we ALL agree to never own stocks on Thursdays, well then of course, Thursdays will tank, week after week.
So the more market participants there are, the harder it is for these fairly silly systems to have any validity, which is part of why I think they've stopped working: too many people NOT playing the same game.


Todd Marronne: Hi Dave, what’s specifically a “separately managed account”?
Dave Nadig: So, pretty simple: Your brokerage account is a separately managed account or "SMA," in finance speak.
Any time a big investor wants their money managed just a little differently, or has some contractual reason its assets can't be commingled with other investors, they'll use an SMA.
Big investment managers (say, BlackRock) will set up an SMA for pretty much any strategy you want, if you're large enough.
Back in the day, for instance, the precursor (Wells Fargo Nikko) to BGI/BlackRock used to run GIANT SMAs for the federal employee retirement system.
The reason NOT to use an SMA is to share costs across more assets; hence, mutual funds, ETFs, and so on.


ETF Bro: Japan markets have been closed for some time. How do APs facilitate creations/redemptions during periods when underlying markets are closed? CIL? Settlement dates adjusted?
Dave Nadig: So, it's just a settlement timing issue. Remember, when an AP leaps at a "too low" price for a Japan ETF, they're counting on being able to hedge that right now, somehow.
So they might buy at that "too low" price, and then hedge that with futures contracts on Tokyo, or even another ETF that's trading more fairly.
These are obviously imperfect hedges, and consequently, spreads tend to be larger for asynchronous markets.
So after they book the trade, using the imperfect hedge, they can decide if they're going to do a creation when they submit to do the creation.
(In this case, they would have had to be selling at a "too high" price, but the math still works.)
When they do the creation, they can then buy up the securities they need tonight (when Japan opens). But they'll have some slippage; hence, the wider spreads, managing both the time delay, and the imperfect hedge.


Donna Hanley: Any predictions re this weekend’s Berkshire Hathaway meeting? And since the co. always has such reliable earnings potential, why has it so long underperformed the market?
Also, I just noticed we can now live-stream the Berkshire Hathaway meeting. How long has this been the case?
Dave Nadig: So, Mr. Buffett has been pretty clear that even HE thinks Berkshire won't beat the broad market reliably anymore, so much so that he's unwound the old restrictions on share buybacks. To me, it feels like he's sort of winding it all down.
As to why he's underperformed since the financial crisis, he's mostly avoided tech, and that's been a huge performance driver.
Yes, he now has a large Apple position, but he was late there too.
(As for live streaming, I think it was 2017 that I first saw the stream.)
But long story short: Long term stock picking is really hard, and markets have gotten really, really efficient at pricing in information.
So Buffett's "edge" has eroded as markets get better.
Just my theory.


Chucky: Do you use a financial adviser? You are certainly an ETF expert but you also have said you don't invest in ETFs because of conflict on interest with your job.
Dave Nadig: I do not use a financial advisor. I do, however, talk to a LOT of financial advisors. I actually don't think a day goes by I don't talk to someone who has an RIA shingle out somewhere.
And I for sure tap those folks for info and advice. So I guess that makes me a freeloader?
But fundamentally, I'm a pretty boring customer for an FA. I supposed I could use a robo, but inertia is a hell of a drug.


Todd Rosenbluth - CFRA Research: Hi Dave. While most ETF expense ratios are steady or go down, in latest ETF Watch included some like EGPT and SCIF where fees went up. Do you think this happens more than investors realize?
Dave Nadig: So most funds fall into one of two buckets (either mutual funds or ETFs).
In capped funds, the ER is essentially just a persistent cap.
And in un-capped funds, the advertised ER is actually a forecast of the coming years' actual expenses.
Uncapped funds go up and down CONSTANTLY.
Vanguard does this it seems like monthly, tweaking the ER to recognize economies of scale.
But if money doesn't flow IN to a fund, and instead flows OUT, the ER can sneak back up.
For a while, iShares used to display TWO expense ratios for some funds: one that was backward looking, and one that was forward looking.
I haven't seen that for a while though.
So yes, it happens quite a lot, but it's usually a basis point or two for uncapped funds.


Leila: Hello Dave: Is a stable economy necessarily better (overrated?) for ETFs’ performance, or can volatility be just as impacting a factor, depending on how you play it?
Dave Nadig: So, remember, ETFs aren't an asset class -- they're just a wrapper.
So a stable, low-growth economy might be great for, say, a utilities or financial sector stock, or even for stocks as a whole.
But it could be awful for, say, gold ETFs, which tend to do well when people are panicky.
And of course, there are ETFs that specifically target volatility, and those respond as you'd expect.
(And there are inverse versions of all of these too!)
So, too broad a brush, with 2,200 funds on the market, to say that something is good for "ETFs" as a whole, performancewise.

James: I saw the article about ETF "HeartBeat" trades and how it helps Vanguard funds. Since you wrote a bit about the last article -- anything jump out at you on this new one?
Dave Nadig: OK, so this is probably from this article that hit the wire today:
Which connects the dots on two different things.
The first is just the idea of heartbeat trades, which we've covered a lot:
But briefly, ETFs use creation/redemption to minimize capital gains distributions by doing large trades around index reconstitutions or rebalances.
The Vanguard thing is just an extension. Vanguard has a patent on the idea of using a share class of an existing mutual fund and "turning it into" an ETF.
So when you buy VOO, Vanguard's S&P 500 ETF, you're actually buying a share class of a GIANT mutual fund. The other share classes are admiral shares, and a dozen other weird share classes that might even be used inside annuities and so on.
But overall, all those share classes have claims on one giant pool of stocks.
Only one of those share classes -- the ETF -- regularly does creation and redemptions.
And the benefit -- getting rid of your low-basis stock -- accrues to the entire pool of assets. There's not a separate segregated bucket from an accounting perspective that allocates certain stocks to certain share classes.
That's really the nut of it: that the tax efficiency of ETFs bleeds over into fund shareholders at Vanguard.
Those patents expire in the next few years though.
OK, last question.


Henry: Always wondered: Why do traders wear "smocks" on the trading floor?
Dave Nadig: Quite simply for identification. It's not a fashion statement.
If you go to the Cboe pits, for instance, you see everyone in their jackets, and they all have a nametag that's usually three letters on a big giant plastic badge.
In an open outcry system, you need to be able to quickly look and note who the counterparty to a trade you just made is.
The jacket says, "This guy belongs here," and the badge says, "It's Janet from Schwab" or whatever.

OK, that's going to do it for this week. Thanks for stopping by, and see you next time!

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