Next Hot ETF Theme & How Fee Wars Can End

May 03, 2018

[Editor's note: Live Chat! with Managing Director Dave Nadig happens Thursdays at 3:00 p.m. ET, with the question window available two hours before and during.]


Dave Nadig: Howdy folks!
Welcome to the Live Chat for today. As usual, you can post your questions in the box below, anonymously if you like.
I'll try to cram as many answers as I can into the next half hour or so.
We'll post a transcript soon. And for future reference, you can always hop on Thursday morning and get your questions in if the 3 PM time slot doesn't work out for you.
With that, let's get rolling.

P. Northfield: Would there be a benefit to putting an ETF (or a mutual fund, or a futures contract, or any investment) on a blockchain?
Dave Nadig: While I'm a bit of a cryptocurrency skeptic, I'm a big fan of the underlying blockchain mechanics.
Blockchain is a super interesting way of keeping track of transactions in a distributed way, so you could imagine a world where equity share ownership moved (somehow) to a blockchain.
Right now it's up to the DTCC to keep track of who owns what, and further down the chain, the accounting and transfer agency functions of large brokerages.
(The DTCC doesn't know you exist, they know Schwab exists).
Blockchain could potentially allow for a very tidy and efficient way of processing transactions.
Nothing particularly ETF-ish about it. It's more just any financial transaction.
Of course, these are regulated markets, so I imagine such a move would take a long, long time.
It's more likely you see it in things like distribution of index data, which I believe Vanguard is using it for.


Mickey: What are your thoughts on the best interest rule?
Dave Nadig: So, we're talking here about the SEC's new proposal, which essentially replaces the Fiduciary Rule.
Jay Clayton is currently on a bit of a media tour talking about it. I saw a good Barron's piece on it just like 20 minutes ago: hold for link: 
While there's nothing BAD about it, my concern is it's not GOOD enough. The comment Marcia Wagner makes in that article is the nut of the problem (and she may be one of the smartest people I've ever met), which is that, at the end of the day, it just tosses everything back on FINRA arbitration.
And there's no clean legal definition of what "Best Interest" means the way there is for a fiduciary.
So A for effort, but I don't think it's as far as I'd personally like it to go.


Jerry D.: I saw on your site this week that, for example, Aberdeen Standard Investments bought ETF Securities’ U.S. operations. Do you foresee consolidation, or should I say, fewer ETF issuers -- or, conversely, more? Either way, is there a benefit to investors?
Dave Nadig: Hi Jerry -- so, Aberdeen is just the latest - there have been a string of these "old-school investment company buys upstart ETF company" transactions in recent years.
The reasoning is obvious - it's a jumpstart that gets you some regulatory head start, and more importantly, some expertise. That's why Janus bought VelocityShares, for instance.
I think we'll continue to see what we're seeing -- huge concentration in the top 3-5 firms, and lots of small firms wading in.
So the 80-20 rule on flows may end being a 90-10 rule.
But the flows, in general, continue to be so strong, that there's actually a fair amount of room at the midtier for folks who have either a unique proposition, or embedded distribution.
Is it good for investors? Well, competition is in general good (pricing, choice, etc.) but it makes the challenge of ETF selection even harder.
It can encourage "rule of thumbing" your investments (just buy things I've heard of, just buy things everyone else is buying).
And that's usually a bad idea.
So it makes investors'/advisors' lives harder, but the end results probably better.


Anonymous: Everyone says to "look under the hood" of ETFs and better understand them. What are some tools to help me do so?
Dave Nadig: (Note: funny "anonymous" names are funny, but don't make me edit your name please!!! I did this one, because it's a great question)
So, your first stop should of course be right here, at (so, for instance) ... but you you already know that, because you're here.
But even if you ignore us, you should ask yourself the same questions, wherever you get the data: does the fund do what it says, well (efficiency), can I get access to it reasonably easily (tradability), and is the exposure what I really want (fit)?
You can wade into most issuer websites and actually construct that opinion yourself from the ground up -- it just makes apples-apples across issuers a little bit tough.
Almost all issuers post their holdings daily, however, and you can always mess with that holdings list. You can use your own brokerage account, or dump the stocks into Yahoo Finance, or whatever tool you're comfortable with.
You can also of course get other folks' takes -- Morningstar, ETFDB, ETFTrends, Bloomberg, wherever -- sure, they're sort of competitors, but it's a big market, and there are a lot of different points of view.


Todd Rosenbluth - CFRA research: In your 2018 bold predictions piece, you highlighted boring defensive ETFs having a chance to shine in market pullbacks. What are some examples to you that are well constructed, easy to understand and cheap given recent and expected volatility?
Dave Nadig: Hey Todd!
So, first, I don't think we can really call this much of a market pullback. What we have here is just a little return of volatility.
So "what works" in markets like this are actually strategies that thrive on a little uncertainty. Like the WisdomTree Cboe S&P 500 PutWrite Strategy Fund (PUTW), which has done really well so far this year. (Disclosure: it tracks an index developed by our parent company, Cboe Global Markets).
But what I meant by "defensive" were really things like DEF or QUAL -- I probably used those exact examples, which are more classically defensive equity strategies.
I don't think any of that ilk is particularly beating their bogies right now. We'd need a sustained long-term pullback for their low-betas to really shine.
Right now, you're just missing the dips and the rallys, but we've actually had some really strong rallies these last 6 months.
So i think they're mostly trailing.


J. Gross: Hello Dave. My question relates to the ETF "fee wars" and whether or not you think they may be coming to an end (obviously ,zero being the end game). Recently, Vanguard lowered the expense ratios on their large/mid/small cap ETFs to 5 basis points (from 6). They now match those at Schwab. For the first time in Schwab's ETF history, they have not responded with a fee cut. Your thoughts?
Dave Nadig: So a few points.
Unless I missed a press release (which I totally could have), I don't think Vanguard explicitly said "we're cutting to match." Vanguard changes their ETF fees almost quarterly -- and sometimes they go up!
On those big funds, a lot of it's just rounding up or down from a fraction of a fraction of a percent.
And I think we could all probably agree, for any retail investor -- even a HUGE one -- 1 basis point isn't going to matter.
Especially when you consider that Schwab and Vanguard track quite different indexes, even in things as simple as US equities.
Something as simple as Vanguard/CRSPs "banding" methodology for when something gets moved from mid to small cap, for example, will DWARF the performance difference between it and a competitive Schwab fund.
But to your other question -- the end state certainly CAN be zero. There's enough "vig" in the securities lending business that you could conceive of a world where core equity beta is basically free (if 5bps isn't already basically free).
I don't think we get there, though. I think we're reaching a point of no return.
Someone will, inevitably, launch the free series as a gimmick.
But i don't think it will make THAT much difference for investors.
Where it really matters is in places where we have BIG gaps -- say, gold funds, where GraniteShares is now 10s of basis points lower than some competitors. That actually can move the needle, and of course, it's great for investors.


Nate Geraci: Thoughts on why more active mutual fund shops don't launch flagship equity strategies in ETF wrapper (e.g., Fidelity ContraFund)? Many experiencing outflows even if outperforming. Perhaps moving to an ETF wrapper could help. Are concerns over front-running/giving away secret sauce (given daily transparency in ETFs) legit?
Dave Nadig: So, it's a free country - there's no reason Fidelity has to launch a Magellan or ContraFund ETF, ever.
If the portfolio managers genuinely believe it will cost them performance -- they're obligated, as fiduciaries, not to make their portfolios transparent.
Are they right? Well, I'm crazy skeptical about that.
I understand the logic -- if I broadcast my moves, my alpha will disappear. And to some extent, to be a traditional stock picker, you have to have the kind of belief that your sausage is made better than everyone else's.
But as a class, of course, they're wrong, because traditional active -- as a class -- fails. So while some fraction of active managers indeed do have protectable secret sauce, most don't.
The devil is in which one.
But yeah, I think it's the transparency issue that's the big bugaboo for almost all of them.
Which is why it's so entertaining to watch Chris Davis at Davis Advisors on stage defending their decision to go full monte.


Anonymous: I was looking at DIVY's intraday NAV, and it never moves, even when the ETF itself does. Is its fair value really that stable?
Dave Nadig: Super-nerd alert!
So, DIVY is the fund that basically uses swaps to extract dividend growth as a unique pattern of returns (it's from RealityShares).
The problem is, those swaps they enter into, even though they have a theoretical value that should be moving all the time, actually only get "marked" once a day.
Structurally, there's no way to directly say "this swap is worth .25% less at 10:30 AM then it was at 10 AM"
So in the case of most funds with weird underlyings, they just punt (I'm guessing) and they only reprice the things there are live prices for (like the short-term Treasuries or whatever they hold as collateral).
So the iNAV ends up being essentially worthless.
The APs have their own algos to keep track of what "fair" is on pricing, but we don't get to see those (and each AP will have their own model (some good, some bad!).
INAV in general, is ONLY really useful when the underlying of an ETF is trading liquidly at the same time as the ETF itself. Even in something like bonds, you need to take it with a grain of salt, as it can take a LONG time for iNAV to react to new information (days, sometimes!).


Ronna Crostwait: Seems like marijuana and ESG ETFs have really taken off out of the gate. Besides bitcoin ETFs, which seem like they're next, any areas you see as new hot spots that will thrive out of the gate in this industry?
Dave Nadig: So, last week I talked about about some of the "defined outcome" ETFs coming to market, and I dismissed them a bit out of hand because they weren't solving the retirement decumulation problem.
I've had some time to really think about it though, and I may be wrong. I think there are markets where investors might genuinely want to have, for instance, 5% downside risk, but a 10% upside cap.
That's the whole (enormous) structured products market.
That's basically what folks like Innovator are doing, and I could see some of those types of products gaining some surprising traction. Probably takes some real market chaos to show they do what they promise, but I could see that.
As for "new hotness" thematics like marijuana -- maybe it's a failure of creativity on my part, but honestly no. I don't see the big gaping hole ready for the industry to jump in and fill to make billions.


Michael T. Kennedy: S&P 500 Bond ETF just launched today ... what is your outlook on this fund performance and flow wise?
Dave Nadig: Yeah, interesting launch.
Esp at an interesting time, when there are starting to be these undercurrents about "is corp debt over" from things like the Milken conference.
At the core, it's mostly a branding play. THere's nothing magical about the S&P 500 that should make the issuers inside it better credit than, say, company 501. So I think it's a shorthand way for investors to feel good about their corp bond investments.
That's not a bad thing at all, honestly. Most investors are pretty monolithic in their thinking about bonds: they buy a single big bond fund, whether it's something like AGG or Pimco's BOND.
Getting folks to think about the corp bonds as a distinct slice of the pie is actually probably healthy, and if it takes slapping "S&P"on the label to get people there, more power too them.
But I can't think of a reason it should perform notably differently than competitors in the investment-grade bond space, like LQD.

Phew, ok, I think I'll wrap it up there. Great questions as always folks.

Transcript will be up shortly, and hey, if you hadn't seen, is now a weekly part of the ETF Prime podcast.

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Thanks, and we'll see you next week, same time, same place!

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