Live Chat: Why Do ETNs Expire?

January 31, 2019

[Editor's note: Live Chat! with Managing Director Dave Nadig happens weekly at 3:00 p.m. ET, with the question window available in the morning.]


Dave Nadig: Good afternoon everyone! Welcome to Live!
You can enter questions below at any time. I'll get to as many as I can in the next 30 minutes or so, and we'll also have a transcript up shortly after we're done.
Let's get to the questions!


Anon: Soundtrack?
Dave Nadig: Love it. Vampire Weekend just dropped a new track, so that's the order of the day.
But on to the real stuff.


Roger-Dodger: I read today's story "New Volatility ETN In Demand" How does $450 million remain in VXX at expiration, or paid back to holders, happen? Is that deliberate to leave money there at expiration?
Dave Nadig:
I'm guessing that's the story you're talking about.
As an ETN, it's basically just a piece of corporate debt.
So just like a bond, if you hold till maturity, your investment simply becomes cash, paid out just like a bond.
So why would anyone leave it in? Well, I suppose SOMEONE out there doesn't actually realize that VXX is expiring and has been replaced by VXXB.
So they could theoretically just get the cash in their account.
But more likely: There are no transaction fees or spreads associated with just holding it.
So why would you sell it and pay the bottom half of the spread when you can just get the actual fair value for free?
If you're insensitive to the timing, it could save you real money.
So it's probably some combo of folks who don't realize it's happening, and folks who don't care about EXACTLY when they sell out, but are happy to save some cash.


Todd Rosenbluth - CFRA Research: Hi Dave. You’ve been coming for years. What’s an underappreciated session or part of Inside ETFs in your opinion? What’s a must-see/do?
Dave Nadig: So, Todd is of course referring to the big Inside ETFs conference hapenning in Hollywood, Florida a week from Sunday.
Obviously I love all the big-name keynotes.
But I would say the very best part of the event is getting to meet advisors and investors and find out what's on their mind.
So I tend to think the cocktail events and lunches and so on are actually the most interesting.
If I was coming as an advisor or investor, however, I'd go to the most random side sessions I could find. Or things like the "hidden gems" presentations.
I think what goes on at the edges of the business is often much more interesting than whatever the latest products from the top 3 issuers are.
That doesn't mean those are necessarily GOOD investments, of course; it just means they're INTERESTING. That's just the start of the due diligence process.


Don Bascomb: Do all ETNs necessarily have a maturation date, like a target-maturity ETF?
Dave Nadig: Hi Don. To my knowledge, every ETN has a maturity date, because they are ultimately just pieces of corporate debt.
And we don't really have perpetual bonds in the U.S. They get used in some other countries.
So consequently, we get effectively "long paper" for these ETNs.
Interestingly, some ETFs expire too. I'd have to double check, but the QQQs I believe expire on the death of the last-named board member or something. Very odd.
(But there's a lot odd about the QQQs.)


Doug: When it’s said, e.g., "no two factor ETFs are exactly alike," I’m assuming that applies to ETFs of every type (e.g., smart beta).
Dave Nadig: For the most part, it's true that any given two ETFs likely have differences, no matter how small.
Even SPY/IVV/VOO have differences, even though they all track the exact same index (the S&P 500).
Now, these differences can be quite small, a basis point here and there.
But if you go to something like "growth," things open WAY up.
You can't get two CFAs over coffee to agree on what a correct growth methodology is, much less two independent companies trying to figure out what works and what sells.
So the less vanilla something is, the more likely there are real, substantial exposure differences. And thus, the more work you'll need to do to make an informed decision.


Taylor: What specific attributes make for a superior robo advisor?
Dave Nadig: GREAT question.
If I were evaluating robos for my personal use, I would probably focus on:
1: Customer service. It may be automated, but I still want to be able to get someone on the phone.
2: Cost. This varies pretty widely. Not suggesting "cheaper = always better," but I'd want to know what I'm paying for.
3: Investments. While there's a lot of similarity between ETF-based robos, there are also a lot of differences. Schwab/Vanguard lean heavily on house brands, for instance. I'd want to kick those tires.
4: Unique bells and whistles. Things like tax lost harvesting and direct indexing.
Probably in that order for me, but maybe in a different order for you. I can hear Todd Rosenbluth screaming "exposure" into his computer through the internet from here.


Roger F.: Are trading spreads more important than expense ratios when evaluating ETFs?
Dave Nadig: This is a great question, and entirely dependent on holding periods and how much you believe the spreads.
If your time horizon is infinite, then spreads don't matter at all, because you're making two trades: one in, one out. And you're making those trades so far apart, that even a 1% spread fades into nothingness.
If your time horizon is today, then the expense ratio is irrelevant, because you're only paying a tiny fraction of the expense ratio. Spreads are everything, because you're going to pay both sides of that today.
Of course, most of us are in the middle. So I'd advocate doing personal math here. Just put the potential funds in a spreadsheet, and run a simple calc of your actual dollar cost for your holding period.
As for "believing the spread": With smaller ETFs (especially if you're a larger customer), you can often do substantially better than the advertised on-screen spread if you work with a trading desk, or call the issuer's capital markets desk and ask for advice.


Nemo: Are you aware of any rebalancing research that covers variations in asset correlation or rebalancing of smaller portfolio allocations? Almost everything I've seen is 2-3 asset classes with any allocation rarely below 20%
Dave Nadig: Hi Nemo, there's actually surprisingly little work that's been done around this.
I did read some intersting stuff on the risk implications of fixed rebals a while ago. One sec:
(Thank god I'm a link hoarder!)
And if you hit up the Research Affiliates website, I believe Rob Arnott and his team have done some work around this area as well, but not at the small level you're talking about. I'd love to see that work though. If you find something, send it to me!


TomTom: Are smart beta and factor investing the same animal?
Dave Nadig: Given that nobody will even agree what "smart beta" is ... probably not. In my personal definition, factor investing is a subset of smart beta.
But I'd also put things like sector rotation strategies, or market-timing strategies into the "smart beta" circle of the Venn diagram.
So all factor investing equals smart beta, but all smart beta does not equal factor investing.


Anonymous: What would you say to someone who has an ETF-only portfolio? That that's too narrow; they should also include, e.g., mutual funds, stocks …?
Dave Nadig: For most investors saving for retirement, future spending, college, houses and so on, you can absolutely have an ETF-only portfolio. In fact, tons and tons of advisors do just this.
Even the relatively "dumb" portfolios we often highlight here as examples are massively diversified, well run, tax efficient and incredibly cheap.
So there's nothing you'll get from mutual funds or single stocks that's really helpful.
The caveat is that if you believe in active management, or more specifically, a SPECIFIC active manager, you may need to include mutual funds as well.
Of course, you can also build a low-cost, indexed mutual fund portfolio that's basically as good as an ETF portfolio.
Single stocks (or single securities of any kind) introduce large, large vectors for risk, however.
Single-stock blowup risk is a real issue. Imagine you were the stereotypical older investor leaning on your utilities stocks for dividend checks, and you had a giant position in PG&E.
Even the safest "safety" stocks have blow-up risk. Diversification is a superpower.


TokeN: Seriously, AdvisorShares wants its potential marijuana ETF to be called “YOLO”?
Dave Nadig: First, two points for the name. And yeah, I kind of snickered at that too. But is it really much less funny than "MJ" or, "PBJ" ...?
But really, I just see it as a way to get an extra headline or two. Proof is always, always in the pudding.
So I would give them a bit of a pass for having fun with the ticker. I mean, the pet-care ETF is called PAWZ for Pete's sake. And it's a perfectly solid investment thesis and portfolio if you're a buyer in the theme.


Jenna Robideaux: Will direct indexing make ETFs obsolete? If this is the trajectory, how soon do you think it will happen?
Dave Nadig: Hi Jenna, I'll be talking a bit about this in Florida, and wrote a bit about it earlier this week.
But to recap: I think we're headed for a mass-customization world, which implies a new business model built on direct indexing (or whatever we end up calling it).
But just like I don't think mutual funds go away, I don't think ETFs go away.
Mutual funds have a solid use case (nontransparent strategies, fractional shares for DC plans).
ETFs have a solid use case (easy trading of massive portfolios, tax efficiency, etc.)
Those use cases don't go away.
I just think direct indexing competes with both for a certain portion of the wealth market.
I think it WILL be big, but it's not "killing" anything. Just competing.
OK, time for a last question:


Bob: On ETF Edge, you seem to talk a lot about "how to avoid XYZ earnings surprise." Is this a smart way to think about long term investing?
Dave Nadig: First, thanks for watching! I love what CNBC is doing with ETF Edge (Mondays around 12:30) and I'm honored to be a part of it.
By nature of being CNBC, we have to respond to news, which has been earnings-driven these last few weeks.
But in general (see above), I do think building portfolios to minimize idiosyncratic risk is just smart.
Do you really want 15% of your portfolio in Apple? Or 50% of your portfolio in 10 names? Personally, I don't, and I'm willing to sacrifice a few good days when those few stocks explode, to avoid those days when they fall apart.
So I think, to reword your question, "how to avoid single-event risk" is a great way to think about a portfolio. Doesn't just have to be earnings. It could mean asking dozens of questions about what you own.
What happens if oil goes to $100? How exposed am I?
What happens if interest rates go up another 1%?
What happens if we have another shutdown?
What happens if EM collapses?
Those are good questions to ask. And diversification usually answers them.

That's going do it for today. I'll be skipping next week to get ready for the Florida conference (and hope to see many of you there. Don't be a stranger! Come say hi!)
And we'll pick this up again two weeks from today.
Have a great afternoon.

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