Live Chat: Playing World Events With ETFs

March 15, 2019

[Editor's note: Join us for a weekly Live Chat! with Managing Director Dave Nadig.]


Dave Nadig: Good afternoon folks. Thanks for joining the special Friday edition of Live!
As always, you can ask questions in the window below, and I'll answer what I can in the next 30 minutes or so.
We'll have a transcript up shortly, in case you miss something.
With that, let's get started: I'll fend off the weekly question on soundtrack.
Mellow acoustic mix from Spotify today, nothing radical:

Macey  Hi Dave, How important/accurate is SPIVA as a measurement?
Dave Nadig: Hi Macey. So, the S&P Index vs. Active scorecard is what SPIVA stands for.
And you can find it here:
What it does is measure how the community of actively managed funds does against a naive benchmark in each of a dozen or so categories.
So right now, for instance, it would tell you that on a five-year basis, 82% of large-cap U.S. equity managers have underperformed the S&P 500.
Unsurprisingly, it shows year after year that active managers -- as a class -- don't beat the market.
Occasionally, you get a bright spot like "aha! International small-cap managers had a good year," but over long time periods, it's been pretty consistent.
As for importance -- high -- everyone reads the report and it gets a TON of media coverage (we tend to cover it here quarterly or so).
Accuracy: The methodology is very good, and corrects for all sorts of biases. The biggest problem is the benchmarking.
Because it really uses a handful of buckets, I would argue there are pockets where you need to take it with a grain of salt.
This is particularly true in fixed income. The FI funds are put up against benchmarks that often aren't really relevant to the funds' stated strategies.
So what I'd love to see is like 5X as many buckets.
But in general, I'm a big fan, and it's always good reading.

Princess SparklePony: Is there any way to exploit what's going on with the China trade war via ETFs? Or will there actually be a resolution soon?
Dave Nadig: Plenty of ways to play the China thing: Certainly you could simply go long (or short!) China ETFs, of which there are dozens.
But honestly, with anything THIS well-covered, you have to ask yourself, what's not priced in?
Whatever the value of a given Chinese stock is right now, it represents the culmination of all investors' thoughts about the situation.
So, much like Fed watching, you have to ask, is the market pricing this because they think things will drag on, or because they will resolve?
And then ask if your opinion is different.
I tend to think (and have thought for some time) that this trade war is actually going to be a long-term benefit for China, because they're using it as cover to make reforms internally (shadow banking, overinvestment, etc.)
So I'm actually personally quite bullish on China/Asia right now.

Hermione Grainger: Will Brexit happen? Why doesn't the U.K. just hold another referendum and roll this back?
Dave Nadig: Boy, this is the bar-bet of the century, isn't it?
There are, as I see it, a few potential outcomes.
The least likely to me is that the EU grants a delay until the elections in May, and the U.K. negotiates and approves a deal by then.
That seems VERY unlikely
The other option is the EU gives the U.K. LOTS of time. This strikes me also as very unlikely.
Or, they could use a delay to do a new referendum. I don't believe there's the political will to do this, and it would be a huge lift.
So the unthinkable option is the EU tells the U.K. to pound sand, and doesn't grant an extension, and that leads to a hard no-deal exit in two weeks.
While that's somewhat terrifying, I personally believe it's the most likely outcome. Not like 90% this is what happens, but I think it's more likely than any other single outcome.
I got asked this morning ,"so what do you do with that?" My short answer would be "short the pound." But I don't have the conviction to actually put the money there. So take that for the namby-pamby answer it is.

Todd Rosenbluth- CFRA Research: Hi Dave. Do you think the asset managers that focus on active or smart beta will bring pricing down in response to recent cap-weighted moves, or focus more on what exposure makes them unique?
Dave Nadig: Welcome back, Todd!
That ship has sailed. It didn't get much coverage, but John Hancock did an across-the-board 0.10% fee cut on their Dimmensional-based smart-beta ETFs just a month ago.
I think anyone charging in the 0.60%-and-higher range is frankly going to have to either drop down into the 30s/low 40s, or they better have a really amazing story.
In talking to advisors, 0.30% seems like a magic number. That seems like about the premium people are willing to pay over "dumb cheap beta" -- with so much of that now available for less than 0.10%.
Couple of bitcoin questions i'll squish together here.

Jameson: You don’t own any ETFs; do you own any bitcoin?
Danna: Is this the first month Cboe hasn't added a new bitcoin futures contract?
Dave Nadig: So no, I don't own any bitcoin futures, and yes, this is the first month Cboe declined to launch a new contract (disclosure: is owned by Cboe Global Markets, but we're independent, so I don't really know much from that side of things).
In general, I feel like crypto remains a bit wild west for most folks to think of as an asset class. I think the process various issuers are going through with the SEC is actually super, super healthy.
It's forcing everyone to really dig in and think about the issues. So whatever the outcome, I think the ETF process is great for advancing the maturity of the crypto ecosystem.

Anonymous: When you're looking at a sector or thematic ETF, what weighting scheme do you think makes the most sense? Market cap, equal weight, fundamental, etc.?
Dave Nadig: All else being equal, I actually think cap-weighting can do you more harm than good once you've decided NOT to buy the whole market.
So for instance, if you're buying a tech fund, do you really want to be 25% in Apple? Or do you want to get some more exposure to smaller names?
After all, if you're buying a tech ETF, you clearly believe tech is undervalued vs. the broader market. Otherwise you'd be shorting it.
So when things are undervalued (whether because growth isn't priced in enough, or because you believe something exogenous is going to change), what goes up?
Well sure, the big guys go up, but often it's further down the cap spectrum where interesting things happen -- acquisitions, patents, FDA approvals, etc.
So at a minimum, I like something that breaks the cap-weighted link. Whether that's fundamental, equal, etc., depends on the index methodology and the investment thesis, and I don't think there's a universal "best" once you've broken the link.
Let me bundle two mutual fund ones together here too:

Newb: What's the real difference between an ETF, and just a regular old index mutual fund?
Sammy P.: Hi Dave, With ETFs experiencing such ongoing popularity/success, you don't think they'll ever literally replace mutual funds, do you?
Dave Nadig: Great question.
In many cases, there's effectively very little difference between an index mutual fund and an index ETF.
So for instance, the difference between a Schwab large-cap ETF and a Schwab large-cap mutual fund is negligible. They charge the same fee, they track the same index, the performance will likely be nearly identical.
BUT, the ETF, because of creation/redemption activity, will most likely not make any capital gains distributions.
If you're invested in a tax-deferred account, that's mostly irrelevant, of course. But if you're a taxable investor, the ETF will give you better control at minimum, and likely better after-tax performance.
So do mutual funds go away? Nope. Mutual funds have a few advantages. If you're dollar cost averaging into your portfolio, say $300 a week from your paycheck, ETFs can be awful. You can't buy half a share of something, so that $300 is going to be spread around unevenly, and with transaction costs possibly.
Mutual funds do fractional shares though, so you can buy $14 of a mutual fund easily.
That makes them ideal for things like 401(k) plans.
So while I think we've reached peak mutual fund -- i don't see anything to drive much inflow in the next decade -- they don't actually disappear. They just become a situational vehicle, largely for defined contribution plans.

Biff McDickie: Everywhere I look, I see experts saying that emerging markets are due for a turnaround. But the EM space isn't a monolith. Should I be looking at something like IEMG or VWO or digging down into individual regions/countries?
Dave Nadig: Hi Biff, so I was at the Research Affiliates conference this week, and Rob Arnott confided that 50% of his portfolio (fifty!) was in emerging markets, deep value and small-cap stocks.
For most investors, that sounds bananas of course, but the point he was making was sound: On a valuation basis (almost however you measure it), the forward expected returns for emerging markets, adjusted for risk, are much better than the U.S., and much better than most of the developed markets.
I don't think 50% is the right number, but certainly most investors have enormous home bias, so even making a small adjustment -- say, from 5% to 10% of your portfolio -- is probably warranted just on a relative valuation basis.
Recognize this is a long-term thing, however. The U.S. could still have a great year, and EM could still have a bad year. But over the next 5? I think Rob's right.

RAFI Fan: Saw you at the Research Affiliates event this week. You talked a little bit about proxy voting. Is there a way to find out easily how a fund voted a particular company's proxy?
Dave Nadig: Honestly - no. Sometimes folks like State Street or BlackRock will discuss governance, but I don't know of an easy way to specifically look and see how BlackRock voted on a specific issue on a specific company without wading into each company's individual reporting.
I actually think there's probably a market for someone consolidating/analyzing these voting patterns (and I wouldn't be surprised if there's a quasi-institutional service that does this and I just don't know about it right now).
But personally, I'd love to see a report from issuers on an regular basis about what positions they've taken on various issues.
After all, they're voting OUR money!
OK, time for one more questoin, and I'll just do this one because it's fun:

Tucker Arnesson: You do webinars, podcasts, videos, interview, blogs, conferences … what’s your favorite part of your job?
Dave Nadig: Honestly, the thing I love MOST is talking to actual advisors and investors one-on-one, usually in situations like this, or at conferences and events, or on webinars.
I learn SO much from that part of things.

OK folks, thanks for joining today,

A quick plug: I'm hosting a webinar on Tuesday on dividend investing, which should be super interesting. Honestly. I have a lot of questions for our guests from S&P and ProShares, so if you've ever been curious about it, hop on:

Have a great weekend everyone!

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