Live Chat: Inverse ETFs & Self-Indexing

December 06, 2018

[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 enter your questions in the box below, and I'll get to as many as I can before my fingers cramp up (about half an hour).
At the end of this, we'll post a transcript at this same URL, in case you missed anything.
And with that, let's get rolling!


Todd Rosenbluth - CFRA Research: Hi Dave. ETFs often hold stocks investors would not expect. For example, despite sharp dividend cutm GE is owned by SDOG, DHS, DIV. Any other favorite examples?
Dave Nadig: Hi Todd, welcome back.
The dividend example is a good one, but I also always find it somewhat hillarious when you end up with growth/value funds owning the same thing.
That tends to happen with the non-pure-play versions like iShares' IVE/IVW, but it can catch stocks like AT&T or Wells in the crosshairs.
I think the MOST interesting one, which I frankly still don't quite get, is Autodesk.
I love Autodesk, I think it's a great company, they make software like Autocad, and it features heavily in logical places like the 3D printing ETFs.
But it is also, for reasons that baffle me, prominent in cleantech ETF PZD.
Some of these more thematic areas can get you some pretty surprising exposures. You really do need to look under the hood.
Some themes are just so narrow, the definitions have to be pretty broad to get an investable portfolio.


Spike: What is an "inverted yield curve" and what's its significance?
Dave Nadig: Hi Spike, so, briefly, it's when the 10-year yield is lower than, say, the 2-year yield. Or when the 20 is lower than the 10.
Why does it happen? Two theories. One is that investors think that the future is awful, which is why you read all the headlines about an inverted curve predicting recessions.
The other explanation is that many firms (like insurance companies or some endowment funds or pensions) have mandates to own certain kinds of things - like Treasuys of a certain duration.
That creates a kind of "forced buying" that drives down yields. But short paper - particularly under a year - is often skipped over in those mandates.
So you end up with more buyers for long paper, even though it pays worse than short paper.
This is, incidently, also how we got negative interest rates on German bonds. Mandatory buyers.


Guest: Seems like now's a perfect time to use inverse ETFs. Any tips or caveats you'd suggest?
Dave Nadig: Hoooh boy.
So, in general, you should consider levered or inverse ETFs to be that scary ceramic knife you have carefully protected in your knife drawer.
It will do what it's designed to do, very well, and very aggressively, and if you're not careful, it will also cut off your finger before you even realize it.
More than ANY corner of the ETF universe, you REALLY need to understand both the math and how your funds will perform over time.
As day-trading vehicles, have at it - if you think you can win as a day trader (which, mathematically, the average person won't).
But over more than a day, your returns will deviate - perhaps substantially - from the naive "2X" or "-3X" it says on the label.
Here's a piece on why, from our education section:


Jen F.: It seems like finance "gurus" are always making market predictions. I'm guessing more of those don't come true than do. Is there ever any type of "accounting," so to speak, on those?
Dave Nadig: Hi jen.
Well, the "accounting" is all of our collective memory.
You are correct that the majority of predictions are wrong, and that's not that surprising. It's also true that the most dire or aggressive predictions tend to make the most headlines.
Vanguard, for instance, just published its 2019 guidance, and it's pretty ... boring. It calls for a modest market uptick, with a lot of caution. That doesn't make for good headlines.
So what you tend to see are the +/-50% predictions, which are RARELY right, in either direction.
But as investors, it's on us to keep folks accountable - mostly by ignoring them.


Anonymous: When can we start nominating issuers for the yearly ETF Awards?
Dave Nadig: EASY one. Here's the link!
And by all means, if you're an ETF watcher, we'd love your thoughts. You don't have to nominate in every category - you can just nominate on the ones you have a real opinion about.
Nominations are open through the end of the year.


Bill Donahue: Hi Dave... The SEC examiners are currently performing a sweep of ETF shops which have self-indexed ETFs (there's a lot of them). The inherent conflicts of interest and model risk are probably two areas of focus... Anything else concern you about self-indexed ETFs?
Dave Nadig: I'm generally not too worried about "self-indexing" any more than I'm worried about active management.
I do think that the big index firms - MSCI, S&P, FTSE, Bloomberg, Solactive, etc.-- have real value-ad.
Sometimes it's in intellectual property, like with a factor methodology. Sometimes it's just having a really good international corporate actions team.
So when an issuer takes an index in-house, the question to ask is, "why"?
if its JUST to save a few basis points, well, how complex is the strategy? If its really simple, it may be fine.
If it's multimarket, or in a complex asset class, maybe be a bit skeptical.
But ultimately, the line between self-indexed and active is very small, in my opinion.


Martha Tyndale: SEC Commissioner Hester Peirce recently (delightfully) said she is "not as charming as other people" re trying to convince her colleagues to approve a bitcoin ETF. When do you imagine this inevitable vehicle will finally be approved?
Dave Nadig: Well, who am I to challenge Hester Peirce and her comment that a bitcoin could be any day, or 20 years from now?
That's a pretty wide swath. I think it's hardly imminent, but I would put the over/under bet in the next year or two - maybe 18 months.
The motivators to be longer are many - just the SEC's inevitable caution.


Chad: Seems like asset classes go through random cycles in terms of being favorable. Are emerging markets and gold making comebacks?
Dave Nadig: Well, almost all asset classes display some level of cyclicality. Some of that is just following the business cycle; some of it may be what a tech would call just oscillation from overbought to oversold and back again.
I am personally pretty bullish on emerging markets from a fundamentals perspective, relative to U.S. equities, but I don't really make market calls.
Gold is just a psychological commodity, so there's no "reason" for it to really go up or down other than "people are nervous, so they're buying" or "people are liquidating for other opportunities."
So any bet on gold at a particular price is a bet on "people are going to get more nervous before they get less nervous."


HotDoggity: There are so many niches in ETFs now; are there any foodie ETFs?
Dave Nadig: We've had two restaurant ETFs, but really all that's standing are two broad food and beverage ETFs: PBJ and FTXG
All the assets are in PBJ, and it's a bit of a long time theme.
It's been around forever, but is (IMHO) a bit expensive for a pretty simple portfolio.


HotDoggity: Or hipster ones?
Dave Nadig: LOL. Someone should launch "HIPS" just for that.
We have a LOT of new-tech, social media, millenial targeting ETFs.
Everything from iShares' XT, to the social media ETF, SOCL - literally dozens at this point, depending on your perspective of what "hipster" means.
Nothing just targeting vinyl records and fedoras that I know, however.


Moving Avg: Hi Dave, what are you thoughts on something like the Pacer TrendPilot ETFs, especially during volatile markets like we are currently seeing?
Dave Nadig: Boy the action around the S&P dropping below the 200-day MA the other day was interesting, wasn't it? Clearly a lot of money following that strategy.
As for the TrendPilot, I noted that PTLC went to cash at the end of October. Whether that was smart or not is a super-narrow timing call.
TODAY that looks a little smart. Three days ago, it didn't.
I think the strategies are interesting, because they remove the human element of "pulling the trigger," but they have just as much opportunity to be wrong as everything else out there.


Lebowski: US-listed ETFs saw $50 billion in new assets in Nov. when the market was sliding down a ski slope. What's up with that?
Dave Nadig: Well, my dude, you have a couple of things going on.
First, a lot of that money came in toward the end and it came into equity. U.S. and int'l equity pulled in $33B, which is a BIG month.
So that's clearly people calling the bottom. We saw, especially earlier in the month and in October, a lot of flows into very-short-term bond ETFs. That's people parking cash.
We've been saying for some time that market hiccups tend to actually be GOOD for ETF flows. I am quite sure ETFs picked up some new money from people finally selling out of some underperforming active mutual funds, which is what we've seen in pretty much every downturn since the dot-com boom.


Jamie C.: Which currently holds more assets: mutual funds or ETFs?
Dave Nadig: So both in the U.S. and globally, mutual funds still dwarf ETFs.
U.S. ETFs have about $3.5 trillion right now.
Mutual funds are something like $20 trillion.
That holds globally too - about $50T in mutual funds, about $5T in ETFs.
Slowly but surely, that's changing.
Right now, ETFs in the U.S. are something like 15% of share. It was 8% just a decade ago.
Mutual funds will hold on to 401(k) plans and similar uses for the long term, but even there, low-cost index-based funds will continue to take money from high-cost active - even there.


Bill Donahue: Dave... Two-for Thursday... While I agree with your premise that there is no such thing as too many ETFs, there is only so much liquidity in the marketplace, and only so much capital that authorized participants are willing to commit. Are you at all concerned that there are fewer authorized participants and thus there could be increased liquidity risks in a market correction period like many expect will occur over the next few years?
Dave Nadig: Back for more!
So, I do think that market maker consolidation is an issue. If you reduce it to absurdity - where only one market maker is left - then of course there are real problems.
Lack of competition means no incentive to keep spreads tight.
But I think that as long as we have 3-4 large players competing, the market can function just fine.
OK, last question here:


Laura W.: If there's one thing you'd like to see improved about the ETF industry, what would that be?
Dave Nadig: Well, it's hard not to say education. I think it's very easy for issuers - and folks like too! - to think "OK, we've done the investor education; we can move on."
And the reality is, it only gets MORE important the more ETFs go mainstream.
Every single day, a whole pile of folks discover ETFs for the first time. And because they're now so commonplace, there's a real risk people assume they get them.
And heck, even *I* don't get them and I've been doing this forever. It's always new, and it's always evolving, and the education can never, ever stop. It's super important.


OK folks, that's it for today. We'll clean up (and reorder!) this for a transcript and get it up shortly.

For folks interested in emerging markets and China, I'm hosting a webinar on the topic next Wednesday. You can register here:

Thanks, and have a great rest of the day!

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