ETF Expert Corner
ETF.com CEO Dave Nadig Recaps ETFs in 2016, Looks Ahead to 2017
January 10th, 2017 by ETF Store Staff
You can listen to our interview with Dave Nadig by using the above media player or enjoy a full transcription of the interview below.
Nate Geraci: I'm now very pleased to welcome to the program Dave Nadig, CEO of ETF.com. ETF.com is considered one of the world's leading independent authorities on ETFs, and Dave himself is simply one of the best ETF resources around. As a matter of fact, I'm not sure there's anything Dave doesn't know about ETFs. Dave, as always, great to have you on the program, and Happy New Year to you.
Dave Nadig: Happy New Year to you and thanks for having me back.
Nate Geraci: Dave, in our first segment, Jason and I highlighted the record-setting year for ETFs in 2016. 287 billion dollars in new money flowed into ETFs. Obviously, we continue to see this shift towards lower cost investments. I think both ETFs and index-based mutual funds. I'm curious, did anything else catch your attention in terms of these flows? Was there anything noteworthy besides this continued low-cost migration?
Dave Nadig: You know, I think the way that low-cost migration happened I find interesting. We spent a lot of 2014 and 2015 talking about the rise of smart beta, alternatively-weighted index products that were really designed to compete against active. Of those 280 billion dollars we had in flows, only about 50 billion went into those smart beta type products. It wasn't just that low-cost was winning, it was really plain vanilla low-cost that was winning. I mean, we had 180 billion into funds that charged less than 15 basis points. The super, super cheap funds. 20% of the flows just went into the S&P 500. It's a remarkably rational investor ... set of investor behaviors. Despite all of the hoopla we heard about smart beta, while they continue to grow, they're not really setting the world on fire.
Nate Geraci: Now also in 2016, there were 246 new ETFs launched, which wasn't a record. The record was 284 back in 2015. That still works out to about a new ETF every business day. However, a record that was set last year was ETF closures with 128. I know you said recently that these closures, "Aren't a sign of weakness, they're a sign of health, that the ETF industry is still in the throes of creative destruction." Can you expand on that a bit for us? How do you view the number of ETF launches and closures that we've seen?
Dave Nadig: I think the main thing is you have to ask what the alternative is, right? I mean, we've reached a point now where we've got effectively 2,000 ETFs. Not every new ETF is going to be successful out of the gate. They're not free to run. With all these new entrants, it's natural to expect that some of these funds are just not going to catch on with investors. That being the real world, what would you rather have happen? That these funds get closed? Or, that these funds sit around year after year, being poorly traded with no assets in them, actually acting as a kind of landmine for unsuspecting investors? Historically, that is what's happened. We have a lot of these so-called zombie ETFs and ETNs that are still out there that are frankly a little dangerous because they trade so far off of fair value, they trade so infrequently, it's hard to actually know what you're looking at when you look at something like a price return chart or something like that. I, and I think a lot of people in the industry, would rather have these products that don't catch on close than sit around. That being said, we had a couple of very large funds close and de-list this year. That was, I think, surprising to some people. We expect tiny little funds that nobody wants to close. We don't expect big ones.
Nate Geraci: Dave, given that there does continue to be a healthy number of both new ETF launches and closures, what advice can you offer to investors in terms of evaluating new ETFs, or steering clear of, as you said, the landmines, these ETFs that may ultimately close up shop?
Dave Nadig: A lot of advisors and investors have rules of thumb. I'm always a little skeptical about rules of thumb because there are always exceptions. It is the case that if you look at a relatively recently launched ETF, and it has very few assets, and it really doesn't trade, you should be very skeptical about that ETF. It doesn't mean it's unownable. It doesn't mean it may not be the right exposure that you're looking for, but your level of skepticism should go up as those two metrics, trading volume and assets, go down. On the flip side, I do think you can lean into the issuer a little bit. If one of the big ETF issuers launches a brand new series of funds tackling a new space, for instance, the chances are they're going to be committed to that for some period of time. I think it's a little harder to wade in with a brand new issuer, who's never come to the space, who maybe launches one or two funds. Taking a wait and see approach to those kinds of funds may make sense.
Jason Lank: Dave, this is Jason Lank. Wonderful to have you here. Avoiding landmines for investors, I think, is a function of investor education. I'd hope you'd speak to a little bit of the educational opportunities at ETF.com. Maybe give us an example for the first time ETF investor who's just getting started, maybe a tool or a trick, something on the website? Then, for the seasoned investor, someone who's taking their game to the next level, what do you have to offer those folks?
Dave Nadig: I think we see ourselves really as the hub of ETF information out there. Obviously, there are a lot of other great resources. One of the first things a new investor might see when they come to our website, right on the main menu, is something called ETF University. If you go to ETF University, you'll find effectively a whole course to get you up to speed on what ETFs are, how they work, how to approach using them in your portfolio, some of the trickier corners of the markets that you're interested in, commodities, or leverage and inverse products. We have guides to walk you through the do's and don'ts of those kinds of products. I think that's a great starting resource, both for a new investor, and for maybe a seasoned investor who's looking for something a little trickier or more interesting. Then, the other major piece of the site would be tools and data. That's another major feature right off the main menu. We have a fund screener there that will help you sort and pick ETFs that meet a particular need, whether that's small cap China or 20 year treasuries. We help you get to that through the tool. Last, if there's an ETF you've heard about and you just want some quick information on it, you can always type in ETF.com/ whatever the ticker is. SPY, AGG. That'll take you right to a fund page.
Nate Geraci: Again, we're visiting with Dave Nadig, CEO of ETF.com. All right Dave, let's look ahead to ETFs in 2017. Last month on our show, we actually walked through several of ETF.com's 2017 ETF predictions. I did want to ask you about a few of these in particular, the first of which is the prediction that 2017 is the year ESG explodes. For our listeners, ESG stands for Environmental, Social, and Governance. These are socially responsible ETFs. Why do you think this could be an area to watch?
Dave Nadig: You know, it's a question of whether it's going to be an area to watch from an assets perspective or a launches perspective. I think, from a launches perspective, it's nearly guaranteed. We know what's coming in the pipeline. We've seen launches already from major firms like Nuveen and Oppenheimer, who are coming into the space with ESG type products. It's easy if you're not somebody focused on ESG investing to dismiss this as, I don't know, the vagaries of a bunch of millennials who want to make sure that their investing along a certain belief system. The reality is this is driven from the institutional market. If you look at the major launches we've seen in the space so far, a fund like maybe SHE, SHE from State Street, which looks at women in governance positions, that's got hundreds of millions of dollars in it not because mom and pop investors think it's a great idea, but because California Retirement System thinks it's a great idea and wanted to wade into an ETF as opposed to a separately managed account. Increasingly, you're seeing major endowments, major pension funds, look for some level of ESG exposure in their portfolios. ETFs are a natural way to do that. It's what really started the smart beta movement a couple years ago. I think we're going to see the same thing in ESG.
Nate Geraci: When you look at these institutional investors, do you think they're looking at this area seeking better performance, or do they just want to feel better about the types of investments they're making, or have perhaps some mandates in place? Or, is it a combination of the two?
Dave Nadig: You know, it depends who you ask. I think that's one of the most interesting things about ESG because certainly any individual investor who says, for instance, "I don't want to own tobacco stocks." Well, that's obviously their prerogative. They can own whatever they want to own. That's not necessarily an investment return seeking decision. It's a social decision. It's a moral decision, if you will. That's certainly a valid screen with which to approach your investing. There is, however, another whole school of thought that suggests, for instance, focusing on stocks with low exposure to carbon may in fact be a better long term play because of global warming. Those types of factors, if you will, the way we think about factors in smart beta, some of the research suggests it can in fact generate some long term out-performance or risk reduction. You actually get people coming at it from both angles. The institutional side, certainly on a retirement system, tends to come less from the performance chasing perspective and more from the wanting to represent the values of the investor base they're representing. You're seeing products that target both angles.
Jason Lank: Dave, really your answer there dovetails into my question. When you compare institutional demand, ESG and other types of ETFs, versus the individual investor demand, do they both drive innovation? Does the institutional channel have the bucks and so they call the shots? Or, is it the other way around? Is there any metric out there on that?
Dave Nadig: I think it's anecdotal, but if we look at the major innovations that have happened over the course of the ETF industry, going back all the way to SPY and then the country baskets inside WEBS, and then things like GLD giving us exposure to gold, and then recently thinks like QUAL from iShares giving exposure to quality and other sorts of smart beta factors, they've really all been driven by institutional demand. As you suggested, the folks with the bucks tend to call the shots there. Now, that being said, some of the recent innovations we've seen, things like say robo-advisors, or some of the bespoke suites at firms like Charles Schwab that are super cheap. Those are really targeted at a smaller investor, at a more retail investor. I have a hard time calling those innovations, because for the most part, what they are is well-packaged, well-run, very cheap vanilla.
Nate Geraci: All right Dave, another 2017 prediction from ETF.com is that bond ETF growth will outpace stock ETFs. Your colleague, Matt Hogan, over at Inside ETFs, he had a great quote recently. He said, "The problem with the underlying fixed income market is that it's built on 1800's era technology." He said, "ETFs are transformational to the fixed income market." Why is that and why might 2017 be the year of bond ETFs?
Dave Nadig: What he means by that 18th century technology is the telephone. The bond market is still largely a relationship driven market. The Bloomberg terminal may have replaced the telephone in terms of how you actually call up your buddy and ask him if he's got inventory, but it is still very much that sort of dealer to dealer market, as opposed to say any of our equity, or ETF, or options markets, which are now highly automated matching systems. The bond markets never quite caught up. Putting bonds into an ETF actually makes them vastly easier to trade in a modern way. It gives you access to things like the futures and options markets. Trading options around something like AGG, the Barclay's aggregate, opens up a whole new world of risk management for people. That's very tough to do without the ETF structure being there. While I may be a little less bullish than Matt Hogan is on maybe the volume of assets we're going to see, I do think it's the case that fixed income ETFs are going to be the dominant way people get exposure to fixed income in advised portfolios.
Nate Geraci: One last prediction for 2017 at ETF.com was that ETF fee wars are changing shape. You made the point that ETF providers are looking to knock down sales barriers. They don't want cost to be a reason investors don't use their ETFs. You gave a stat earlier. I know Jason and I noted earlier that half of the 287 billion in ETF flows last year went into products with fees of .09% or less. I'm just curious, how do you see this fee war ending? Because there is a limit here. These fund companies still need to make money.
Dave Nadig: You know they can go to zero. If the securities lending revenue's good enough, you can theoretically run these products at zero. I actually don't think that that's where we're headed. I think there's a point of diminishing returns when you start getting below 9 basis points where it's very difficult to argue to any investor that the difference between 9 and 4 basis points is having a meaningful impact on their returns, especially when at that level you start ... It's almost like quantum physics. When you start looking at that level, that small of difference, minor differences in portfolio management, even in an index fund, make more of a difference than those few basis points in returns. What it actually does is shine a light on the science and the art of running low cost beta. I think what investors will start focusing on is not so much the headline expense ratio, but what your actual experience is versus the index, tracking differences, the term we use for that, and I think that's a much more realistic way to think about your real experience as an investor. I think that's where the next piece of education has to happen is looking beyond expense ratio towards how these portfolios are actually run.
Nate Geraci: Dave, any thoughts on the potential impact of the DOL fiduciary rule on ETFs? I know there's still some question about whether or not this will get delayed. Right now, it's set to go into effect in early April. We'll see what happens. Any thoughts, I guess, on the rule and then perhaps its impact on ETFs?
Dave Nadig: My personal opinion about the rule, not that anybody really cares, is that pieces of it are definitely needed and well-intentioned, and pieces of it are perhaps a little overly complex. I think you could say that about pretty much every piece of financial regulation in history though. It's no question that the DOL rule is a benefit to the ETF industry because putting people who perhaps weren't in a fiduciary role into one makes them focus on things like cost. The transparency that's implied by the DOL rule around how advisors get paid will drive folks towards lower cost products. If you have to charge an explicit fee, what you're going to put your money in is going to have to be lower in order to make that customer feel whole. I think that's very positive. As far as how it gets implemented, most firms have already done all of the hard work. They're all on target to hit those April or end of year deadlines, depending which kind of firm they are. Even if an incoming administration delays some portion of it, or even upends it, I think the ship has already sailed.
Nate Geraci: All right, we have about two minutes left here. Before we let you go, I did want to quickly ask you about the upcoming Inside ETFs conference. I know we're looking forward to being down in Florida here in a couple of weeks. Give us a quick preview. Who are some of the speakers and what's on the agenda?
Dave Nadig: I think there's obviously the traditional stuff that's there. There's going to be a lot of very smart investors talking about their calls for the year. The ETF University Live program will be running all day Sunday, which is a great opportunity for individual investors or advisors who really want to get up to speed on ETFs and have some interaction with real human beings. I think thematically, I see this conference as being really a lot about investor behavior. We've got some great speakers talking about investor behavior, whether that's Barry Ritholtz from Ritholtz Asset Management who's going to be there talking about sort of how to keep clients from doing dumb things. You've got Denise Shull, who's a neuro economist, I want that title that sounds like a great job, who focuses on why people make the decisions they do. We've got Tim Urban, who is mostly known as a Ted Talk speaker. He's very funny and he talks a lot about things like procrastination, and again, why investors do the things they do, sometimes against their own interest. I think those are really important topics, not just for advisors, but for all investors.
Nate Geraci: Well Dave, with that, we'll have to leave it there. As always, we greatly appreciate you joining us on the program, and we look forward to seeing you down at the conference here in a couple of weeks. Thank you.
Dave Nadig: Looking forward to it. See you there.
Nate Geraci: That was Dave Nadig, CEO of ETF.com and I want to mention a new feature at ETF.com. They now have a daily ETF hot reads, where they put together a really nice summary of ETF-related articles from all around the web. Certainly worth checking out. I think this is sort of a one-stop shop for the day's big ETF news. Again, you can find that at ETF.com.