Live Chat: Hidden Costs & ESG's Future

November 01, 2018

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


Dave Nadig: Good afternoon and welcome to Live! As always, you can enter your questions in the box below.
I'll get to as many as I can over the next 30 minutes or so, and we'll post a transcript at the end of the day.
With that, let's get to the stumping of the chump (that would be me!)


Lee McDermott: I understand you don't own any specific ETFs, for impartiality, but if that weren't an issue for you, are there any types you would look to own: leveraged, fixed income, emerging markets, ESG ...?
Dave Nadig: Fair question! So, the good news is that there are!
So I'm not in a lot of 1.5% active funds or anything.
I think the most interesting "ETF only" or "ETF-focused" strategies are around alternatives.
So for instance: commodity exposure. ETFs (and ETNs) are great for that kind of exposure. Much trickier, or at least less obvious, in the mutual fund space.
I think there are also some derivatives-focused products, like the Innovator defined outcome products that are pretty unique.
Last, in bonds, particulary junk bonds, ETFs make a lot more sense, and are much more fair in terms of taxation and particularly transaction costs.


Heather Rainey: If consumer confidence is at an 18-year high, why has the market been falling so much?
Dave Nadig: So, not specifically an ETF question, but my opinion: we were/are still at pretty high historical valuations, but CAPE standards. Add to that the potential frictions of trade policies, unease about geopolitics, and it's not super surprising to me.
Consumers aren't the same as investors -- the investor class includes day traders and hedge funds and sovereign wealth funds and insurance companies ... and and and ....
retail investors are just a small piece of the overall market puzzle.


Mark D'Angelo: What's one key thing you would point to about safeguarding/maximizing your retirement portfolio? Or a key thing NOT to be doing?
Dave Nadig: Great question.
Some somewhat obvious basics: most people don't invest enough, early enough, regardless of how they end up managing the ultimate retirement portfolio.
I tell younger folks all the time that if you're not at LEAST taking full advantage of your company match, you're doing something very wrong.
As for once you have the money in an account. I think most people, even if they deny it, think they can time the market.
Even if they just make 2 trades a year, or even one, they're probably hurting themselves over the long term.
Individuals are awful at timing markets. Literally every study ever shows this.
But we all feel the pull to do so.
So dollar cost average in, rebalance once a year or maybe twice, and then ignore your portfolio as much as you can stand to do so.
I had a friend who told me, when he retired, that the single best investment decision he ever made was forgetting the password to his Fidelity account.
There's some truth there.


VolMan2000: So, crazy month in the markets. Did ETFs contribute?
Dave Nadig: Fair question. The odd thing is I actually think October gives us some evidence of precisely the opposite.
I'm working up the numbers, but so far, my read is that on several of the big down days, we actually had creations -- positive inflows -- into the related ETFs.
Why would that happen? Well, if the stocks in the S&P are selling off HARD -- say, down 4%, and the ETF is "only" down 3.95%, that's an arbitrage opportunity.
And the way a market maker makes money is by BUYING the stocks and SELLING the ETF. At the end of the day, they turn in the stocks to get the shares of the ETF they sold.
That actually puts upward pressure on the stocks, just when everyone's panicking.
So, in short -- the immediate evidence suggests ETFs, if they did anything, have helped smooth out what has been a heck of a wild ride.


SM: Just wondering, for an asset class like gold, why would anyone choose a higher-priced GLD versus a lower-price IAU? How much truth is there that liquidity for GLD is higher? How about the newer version of GLD?
Dave Nadig: So, a few things here:
The first thing is - not all costs are in the ER.
Trading, especially if you are institution, has a real impact.
I'll give you two examples.
IAU and GLD have handles -- prices -- that are 10X apart.
IAU is $11.82 a share. GLD is $116.63 a share.
If you are an institution that is paying a small per-share trading fee instead of a block commission, putting $1m to work in GLD can actually be substantially less expensive.
If your holding period is only, say, a few weeks, a pure speculative trade, then those costs may matter a lot more than the difference in expense ratio.
Similarly, they both trade basically as well as anything can, a penny spread.
But a penny on GLD is less than .01%
A penny on IAU is .09%.
If you're trading a lot, that will matter. A lot.
We see this even in the S&P funds. SPY vs IVV/VOO.


Derek Kim: Expense ratios seem to be the most transparent cost for ETFs, but I hear there are also hidden fees. What are those, and how can investors best find them?
Dave Nadig: Good follow-on question.
The trading costs above aren't "fees" -- in the sense you aren't paying them to the ETF issuer. But they are real costs to you as an investor.
Even if you pay zero commissions.
Once you get INSIDE the ETF wrapper itself, there aren't really any "hidden fees" -- the advertised expense ratio rolls them all up, transparently.
A given expense ratio of, say 0.50%, might include a bunch of smaller fees (a management fee, a transfer agent fee, etc.) but the ER rolls it all up into the number you should care about.
BUT ... that doesn't mean your experience as an investor will be precisely 0.50% behind whatever index you think you're tracking.
On our fund pages, we show a stat called "Tracking Difference."
If a fund is PERFECT, it will lag the index it's tracking by exactly its expense ratio - because indexes are "free."
But no fund is perfect, so there can be slippage, because of things like optimization, or internal trading hiccups.
You can also do BETTER than you expect, again, because of internal trading, or optimization, or getting fees for loaning out portfolio holdings.
So it's good to look at both: ER and tracking difference, and then separately, trading costs.
Here's a piece on this:


Jacques: ESG seems like a great way of not only investing but also ensuring that your investments help the planet (and perhaps even align with your own personal values). Why do you think the ESG space has not grown in recent years? Is it simply a matter of investor education, or is there a lack of diverse ESG ETF offerings?
Dave Nadig: Hi Jacques, I'm a big fan of ESG ETFs.
And I do think we'll continue to see a slow trickle.
I think the challenge is you have to, as an advisor or as an issuer, make two sales.
First, you have to sell the investment strategy (buy U.S. large-caps!)
Then you have to sell the ESG strategy (we kick out the gun stocks! We avoid carbon offenders!)
That's not an impossible sale, but it is a delaying issue.
So I think we see the slow trickle. A lot of institutions have ESG mandates, and we'll continue to see them "drive the bus" here for the next few years. But I predict in 10-15 years, ESG will be a very large chunk of flows, month after month. It'll just take some time.


Bill Donahue: Good afternoon, Dave. What are your thoughts on the SEC sub-committee recommendations about ETP labels? Any significant positives or negatives?
Dave Nadig: Hi Bill!
So, there have been a lot of "labelling" initiatives over the years.
And I'm all for clarity.
But the problem is, we already have some of these labels, and for the most part, the market ignores them.
I mean (points thumbs at self), we're called ""
But we cover exchange-traded notes too.
We've chosen not to cover "exchange-traded managed funds" (ETMFs).
There are other folks out there who chose not to cover leveraged or inverse ETFs, etc.
So while in general, I'd love some clear delineations just to make life easier, I worry that not many folks will use them.
And where they do get used -- say, for gating products at a big wirehouse -- they could have unintended consequences.
Not to harp on it, but these recent Innovator defined outcome ETFs would get the "exchange-traded instrument" designation, I believe, and I could see that getting them pushed off of certain platforms, when in fact, their outcome pattern is LOWER risk than the underlying equity markets.
So -- pros and cons there. But if it adds SOME level of clarity, that's a good thing.
Here's the letter, FWIW:


J. Gross: Given that Fidelity now has index mutual funds at zero bps and Schwab, iShares, and Vanguard have not responded, do you think these other firms are thinking "decreasing expense ratios by 1 or 2 bps is no longer going to cut it; we have to come up with something bigger"? Do you expect iShares, Schwab, or Vanguard to announce something big in response?
Dave Nadig: The big reason Fidelity can/wants to do the "zero" thing is because you can only access those funds from your Fidelity account.
That means Fidelity knows who you are, and can sell you other things.
This isn't how ETFs work. You can't make your ETF "not available" to certain venues. That's the whole point of trading openly on an exchange.
And in fact, it's basically impossible for, say, BlackRock, to know with certainty if I happen to own any of their shares in my Schwab account.
So I don't expect a rash of zero-priced ETFs.
I think there's a point of diminishing returns. Cutting from 5 to 4 basis points verges on irrelevance, even if you have a $1 million position.
We'll continue to see compression, but I think the floor remains the floor, essentially.
One or two? Maybe, but not a flood.


Fran Thompsen: Hi Dave, Would you ever want to hold office, like Fed Chair? :)
Dave Nadig: Hilarious question Fran. And NOPE! There simply HAVE to be better qualified people!!!


Marvin: Is there a difference beweeen defined-maturity ETFs and target-date ETFs?
Dave Nadig: Well, sort of.
A defined maturity ETF -- like a Bulletshare bond ETF -- simply goes away on a given date (like a bond does). Technically, that's what a target-date fund does too (there are no target-date ETFs left anymore, to my recollection).
But a target-date fund -- traditionally used in retirement accounts -- owns a mix of assets and then changes the mix on a glidepath, getting less risky as the target date approaches.
The idea is to automate what most investors should do with their retirement accounts -- get more risky up front, less risky as you get close to retirement.
A target maturity bond ETF is designed to replace individual bonds, so you can do bond laddering or liability matching. Great question though.


Bhuvan: Hi Dave, have a really rudimentary question. How is the issue price of an ETF decided when it is being launched. Any links where I can understand more about this? Thank you.
Dave Nadig: This is actually entirely up to the issuer.
If a fund comes to market with, say, $10 million in seed funding, they could choose to price that at $10 a share, and thus issue 100,000 shares.
Or they could price it at $20 a share, and issue 50,000 shares.
Generally, you see most funds come to market around $25 -- it's small enough for a mom-and-pop investor to get in, but big enough that institutions don't get scared off.
Exchanges have rules about small values - like sub-dollar -- and too big, you end up scaring off little folks.
But it's essentially a marketing decision.


Sadie T.: Hi Dave, Of the 6 factors, is there one that seems to take greater precedence, or does it just depend on, e.g., what you most want exposure to, or how you want to position your portfolio?
Dave Nadig: Great question: the six generally accepted factors being size, momentum, value, growth, quality, volatility -- although people sometimes swap in all sorts of things, like liquidity, and so on.
Research would suggest (and Rob Arnott would argue!) that value is kind of the "ur factor"
But they're all quite cyclical.
The reason we tend to look at these is they seem to be less correlated than the 4,000 other factors academics have tried to identify.


RC: Which oil tracker product do you like: oilx,oilb, oilk, nothing else?
Dave Nadig: So, not going to pick a hard favorite here -- there are real pros and cons. THe things to consider though are:
ETNS - like OILB - can give you a better tax treatment if you hold them for a while.
Optimized funds - like DBO - are trying to profit from the structure of the market itself.
And traditional funds - like USO - are just raw plays on the futures contracts; in USO's case, front month.
I think all of them should be treated as speculative, honestly. I don't think a long-term allocation to ANY individual commodity is a super good idea.
But these ETFs (or ETCs, if you want to call them that now!) all do what they say on the tin. You just need to read up to make sure you know which one is doing what you want.
With that, I'm afraid, I'm going to have to wrap up. My apologies if I didn't get to your question. Don't take it personally!

One quick plug: our next webinar coming up is on fixed income in the current rate environment. Should be a great one:

Next week I'll be at Inside ETFs Asia in Hong Kong, so we'll be skipping, but I'll see you all the week following!
Have a great day everyone.

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