Live Chat! Transcript 3.22.18

March 22, 2018

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


Dave Nadig: Hi there! Welcome to Live.

Ed Slamme: Are fixed term defined maturity bond ETF's like Bulletshares an effective way to guarantee the "return of principle" in a rising rate environment?  How good are these products at actually returning the NAV at the point of distribution when the products mature?
Dave Nadig: Hi Ed.  Love this question.
So the short answer is, the Bulletshares so far have done exactly what you'd expect.  They've moved into cash as they approach maturity, then distribute it all out on the last day.
They've matured these since 2011, so there are a dozen or so examples of these funds basically just doing what they promise to do as they reach maturity.  I'm actually a big fan of the approach;  I think it solves a real problem.
Does it "solve" rising rates?  Well, not really, in the sense that the day you buy, you're still buying securities that lock in a certain payout.  They will mature at par, of course, so if you hold till the end, it really doesn't matter if rates spike -- you'll get your coupons, and you'll get your coverage on maturity -- pretty much just like owning the paper yourself.


Mark in OH: When deciding between 2 ETFs, do volume and AUM matter? Vanguard Total Mkt has a lot more vol and AUM vs Schwab Total Mkt. Thank you!
Dave Nadig: So this is another version of the rule-of-thumb question.
And my short answer is -- well, not really.  That is, the exposure matters SO much more.
AUM can be quite misleading.  I suppose it's natural to be a LITTLE skeptical of an ETF that has the same 5mm it launched with a year ago ...
But if you can trade it, the larger asset base isn't inherently better.
Scale does matter for the issuer -- a larger fund increases the chances you're covering your fixed costs and so on.  But if the expenses are capped on a small fund (which they usually are), then that's mostly irrelevant.
Volume -- same thing.  What matters is whether you can trade it, and volume can be a shorthand -- but nothing beats looking at the actual bids and offers on screen, and putting in smart limit orders.
But truly, exposure matters the most.


Todd Rosenbluth - CFRA Research: With the PowerShares/Guggenheim deal soon to close, do you think it more likely there are more smart beta strategies (size plus low vol, etc.) from them or a consolidation of existing ones?
Dave Nadig: Hi Todd!  So, consolidations are always super interesting.
For the most part, we really haven't seen any "consolidations" in ETF M&A activity, meaning where, say, 2-3 funds get collapsed down into one.  That's actually a pretty thorny thing to manage, and it's really rare even in traditional mutual funds.
It's much more likely you just see a little pruning around the edges, I think.
As for "more or fewer," well, there should be some product rationalization, and when they squish the product lines together, I imagine they'll find a few holes, and launch to fill them, along with a few overlaps.
But I doubt we'll see anything dramatic -- like a huge new suite launching, or 15 funds with real assets getting wiped.
(And perhaps it goes without saying, but I wouldn't expect there to be really any investor impact, except as a result of a closure, and even there, it's mostly just timing.)


Danny: Dave, why don't we have a high-yield bond spread ETF yet (short HY-long Treasury, something opposite of interest-rate-hedged HY bond ETFs)?
Dave Nadig: Hi Danny, I'll consolidate this and your other question into one "why not more curve/spread based fixed income!?"
I'll point out that there are two ETFs that bet on whether the curve will get steeper or flatter (STPP and FLAT).  Importantly, they're ETNs, so you're not literally going long or short anything, you're just betting directionally with the issuer (Barclays) about which way the curve moves.
But we don't have explicitly a credit-spread ETF or ETN.  I think it's an interesting idea, and again, one that would probably be cleanest in an ETN wrapper.
My suspicion is that this has been floated, but that institutions that want to make this trade are big/sophisticated enough to either put it on themselves (using ETPs, futures, or bonds), or just get a swap contract for it.


Stefania Perrucci: Good day! Do you ever see ETFs using multiple Cayman subs in a single ETF in order to get around diversification rules?
Dave Nadig: (Rubs hands together, a nice nerdy question)
So, for those not familiar, there are a few commodities products that get around the K-1 commodity pool structure by investing in a Cayman Islands subsidiary, which in turn owns all the futures contracts.
Because most futures contracts have HUGE inherent leverage, this means they can put just a small amount of money in the subsidiary, but get notionally full exposure to whatever commodities they are tracking.
These funds actually end up (I believe) passing the basic IRS diversification rules, because they don't put a large percentage in the sub, and the rest is just sitting in cash collateral.
So I'm not sure why you'd need a second Cayman subsidiary, unless you were explicitly trying to access all the leverage inherent in the futures; for instance, if you were launching a 3X GSCI fund.


Bill Donahue: Dave, Hester Peirce, SEC Commissioner and Dalia Blass, SEC Director Investment Management, both gave speeches earlier this week which included discussion about a proposed ETF Rule.  What are some areas that you think should be addressed in a proposed ETF Rule?
Dave Nadig: Ah, the much-discussed "ETF Rule!"
I'm a big proponent of an ETF Rule.  To me, the No. 1 thing is leveling the playing field. Right now, firms that "got in early" have a different set of rules to work under in terms of all sorts of nuances, from what they can hold to how they structure to how they manage creation and redemption baskets.
Getting that sorted out will be more explicitly "fair" but it will also make it easier for new entrants to get products to market.
Now, it's not like we're at a huge lack of new products, but still, I like the idea of a cleaner set of rules.


Lois Gregson - FactSet Research:
We know the ETF structure exists via a number of exemptions.  In your opinion, what is the biggest exemption or aspect of ETFs that need to be revised?
Dave Nadig: A follow-up (Hi Lois!).
So, the BIGGEST issue is custom baskets, I would say.  Older ERs let issuers take in, for instance, a different bunch of bonds from one AP than they do from another.
This allows for a lot of flexibility in tough-to-manage portfolios (like, say, junk bonds).  If an ETF Rule fixes one thing, it should be that.  The question is, can they do it retroactively?
(I don't actually know the answer to that.)


Art: Is this Cayman Island thing a tax dodge? Seems shady.
Dave Nadig: A reasonable question -- it's a "tax dodge" only in the sense that it's using a completely legal structure to change the tax status of an investment.
That's precisely what ETFs themselves do, of course.
The REAL impact is: instead of getting a K-1 partnership form at the end of the year (which is a huge pain), and having to pay 60/40 Long/Short capital gains on a mark-to-market basis, you get to treat it just like any other equity-like security.
I'd argue that since most ETP buyers aren't actual securities dealers, taxing them like they are isn't really fair, so the Cayman structure makes a lot of sense.
And it's not like this stuff hasn't been reviewed -- it's pretty clean, and fully transparent.


Erik Hagar: One of the benefits of mutual funds is the ability to receive NAV at the close of the day, no matter the size of the order. Do you envision Cboe, Nasdaq, NYSE or other sources being able to offer NAV at the close for trades less than 50,000 shares?
Dave Nadig: NAV-based trading is a bit of a holy grail, for sure.
But if you go through the motions of it, NAV-based trading for less than creation unit size requires someone to take some level of risk -- and generally folks will only do that when compensated.
To get NAV at the end of the day, some sort of hedge has to happen, whether it's making a creation basket to get new shares from the issuer at NAV, or just a counterparty "promising" the NAV price, but working the other side of the trade in some non-NAV way.
That latter scenario has risk, so it will always have cost (my opinion).
So in short, I don't see it anytime in the near future, unless it's through some sort of matching system, where traders match at NAV instead of in a market-on-close auction -- but even there, someone will want to get paid for providing that match.


Michael T. Kennedy: Good morning and thank you for your time. With technology becoming more and more efficient and becoming able to replicate most of the portfolio management/administrative/operational aspects of running an ETF business, do you anticipate more technology firms acquiring or taking stakes in ETF providers? It seems there may be some strong synergies between the two. Your thoughts?
Dave Nadig: Since I've been poking the ETF bear for about 25 years, I'm constantly trying to figure out where it all goes next, and technology is definitely the driving factor going forward, I think.
I do think you'll see a major tech firm wade into financial services, but more because of their audience than  because of their technological chops.
So think more Google/Amazon/Facebook rather than, say Microsoft or Apple.  Increasingly the plumbing of ETFs isn't hard; it's the distribution that's a challenge.
Also, side note - a lot of the existing big financial services tech providers -- custodians, banks, recordkeeping firms and the like -- have BIG, established infrastructures.  Those are a real pain to update and move into modern standards.
There are still people out there making fat salaries on their COBOL skills for just that reason.


pete: Has the closure threat of the marijuana ETF (MJ) subsided since some of the first coverage reported when launched? It does have $400 million in AUM.
Dave Nadig: Well, the chat has for sure died down.
Whether that means the threat is gone ...?  It seems unlikely the SEC just shows up and says, "hey wait a minute" on a big existing fund like this.
But there could be some side discussion we all never hear about. It's possible someone in the value chain gets cold feet and pulls out.
But the rumor mill is a bit silent at the moment.


Barry Z: My iShares wholesaler told me that it is risky to buy an ETFfrom an issuer that doesn't have several billion in overall assets under management or to buy an ETF that is small unless it is from BlackRock or Vanguard. This seems suspicious to me - is he right?
Dave Nadig: Well, I always ask the "what if" question on things like this.
What if your ETF issuer only has $700mm under management?  What's the worst case scenario?
I suppose in this case, you could imagine said small issuer just isn't making enough money to keep the lights on, and the fund board isn't paying attention, and so one day you wake up and the issuer is just overnight bankrupt.
That seems super far fetched, but what would happen?  Well, the assets in the funds are unaffected.  They just exist, on behalf of the shareholders.
The board (which is paid by the fund, not the issuer) immediately meets and appoints a new advisor.
Theoretically, in a completely botched situation, you could imagine a day or two of index drift while things get sorted out.
That's really about the worst thing I can imagine.  And it would be truly unprecedented.
OK, one or two more questions and I'll wrap it up...


Tom Sawyer, CFP: What's the difference between an ETF market maker and an authorized participant?
Dave Nadig: Market makers are in the business of buying and selling securities -- making markets.
They make money by buying something low, and selling something high.  That can be simply buying and selling AAPL stock and counting on making money on the difference between buys and sells.
But ETFs give them the option of also being an AP.
The AP functionality lets them buy low or sell high in and out of the ETF, not just in the open market.
Technically (legally) I don't believe any AP *has* to also be a listed market maker, but it would be pretty much impossible to make a living at it if they weren't.
And of course, not every market maker has to be an authorized participant -- each AP contract with an issuer -- with an individual fund -- is a separate legal contract.
(Now I'm trying to think if I've ever heard of an AP not being a MM, and I can't come up with one.)


P. Lacroix: Are you planning to open a website or specific section to talk about the European ETF Market in the future? is a very good source of information for the US market, I wish we would have the same in Europe. Thanks.
Dave Nadig: I'll make this the last question --
So, we used to run an EU website, but the reality is that the market in EU/UK is so fragmented it makes it difficult for a firm like ours to really cover it completely.
The UK advisor market, for instance, is just SO different than, say, how German insititutions use ETFs.
And much of the data is (even post-MIFID II) still very hard to get/verify. is a pretty data-driven world, and it's hard to see how we could take our model, there, successfully.
On the data side, Debbie Fuhr does a great job at ETFGI (if you're looking for resources), and is pretty cool as well. has the closest to our screener functionality, I'd say.

OK folks, going to wrap it up there.  Thanks for everyone's questions.  We do our live chats here on Thursdays, and you can always begin entering questions Thursday morning.
Also, check out coverage of the Awards Dinner, which will be up tomorrow morning on (or late, late tonight).

Have a great afternoon.

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