ETF Expert Corner

Bloomberg’s Eric Balchunas Recaps Year in ETFs

December 12th, 2017 by ETF Store Staff

Eric Balchunas, Senior ETF Analyst at Bloomberg, recaps the year that was in ETFs and looks ahead to 2018.


You can listen to our interview with Eric Balchunas by using the above media player or enjoy a full transcription of the interview below.

Nate: Our first guest today is Eric Balchunas, Senior ETF Analyst at Bloomberg. Eric spearheads all of Bloomberg's ETF coverage. He's on Bloomberg radio, Bloomberg TV. As I mentioned earlier, he recently helped launch the first and only TV show focused on ETFs, Bloomberg's ETF IQ. He just launched an ETF podcast on Bloomberg called Trillions. You would be hard pressed to find someone more plugged in to the ETF space than Eric, who's now joining us via phone from Philadelphia. Eric, as always, it's a pleasure having you on the program.

Eric: Pleasure to be here and let me just say, I love the transition music, Tom Petty. But even better is your intro, The Who, Won't Get Fooled Again. So you always have the best music.

Nate: I appreciate that. I know you're a music connoisseur.

Eric: Yeah, that's also a very symbolic song. I get it.

Nate: Well, Eric, let's start with ETF flows today. It has already been a record breaking year for ETFs. Give us some of the highlights here. What are two or three things that have stood out to you in 2017?

Eric: Sure. So one thing that I found pretty interesting was ETF flows in general. There's 443 billion as of today into ETFs this year. Now, we know that's a big deal because the old record was 286 billion, so we're talking about almost 60% above the record with two weeks left. What's interesting about that number is if you look at mutual funds, and this includes index funds by the way, as a structure, the best they ever did was 393 billion in 2009 - right after the financial crisis when everybody came back in. ETFs are breaking the record of any structure ever, so I think that's interesting just to put some perspective on how big half a trillion is in flows. Another one I would point out is a phrase I've been using: the power of one ... basis point. This cost migration and this cost obsession from investors has shown up in the flows. IVV cut its fee to .04%. That's one of three S&P 500 ETFs. It's only one basis point cheaper than VOO, which is a Vanguard product. That alone redirected about $20 billion this year, one basis point. And when it comes to plain vanilla side, it is amazing how cost-obsessed investors are. And then I'd also talk about this BYOA thing, which is what I call bring your own assets. You see a lot of big, gigantic companies coming in. This year it was insurance companies like USAA, Nationwide, Transamerica. And they've done pretty well, pretty quickly largely because a lot of what they're doing is saving assets that would have gone. So I think that's an unforeseen pipeline for new flows as well is big companies just rather take the hit and have someone in a cheaper product that I'm offering than lose them to Vanguard or BlackRock. And so I think those are three mega-trends that sort of pop out to me.

Nate: Eric, you mentioned Vanguard and BlackRock. I saw last week Morningstar's Ben Johnson provided some data that through the end of November, iShares and Vanguard took in over 75% of the net new money into ETFs this year, and then Schwab and State Street were a distant third and fourth respectively. If we continue to play this forward, where does this end? Do you think the larger ETF providers just continue consolidating assets at the top and, if so, is that a good thing or a bad thing?

Eric: Yeah, so I see the asset management business looking like the airlines in 10 or 20 years, where there's just a couple gigantic companies that compete on cost, and then you have a lot of niche players. Alaska Air, right? Or private jets. And so they'll be a home for some small boutique shops, but it's possible three or four companies manage 80% of America's assets because I just don't think we're ever going to come to a point - and this is what active managers seem be hoping for, and I don't think a bear market is going to do it, I don't think anything's going to do it - where someone goes, "Wow, what I just saw happen, I actually want to go back and pay 1% in an active mutual fund that gives me capital gains. Let me go do that." So I don't think that's ever happening and, therefore, you are going to have to scale up to get cheap and basically survive in what I call the Vanguardian future.

Nate: Yeah, and you know there's no doubt that cost has been a big driver for both iShares and Vanguard, and really the movement into ETFs overall. But one thing that has been noticeable to me recently is that there almost seems to be a backlash against the focus on low cost. I think the idea being that since ETF costs have come down so much - we're talking four or five basis points, what's the difference of a basis point here or there? We should be focusing much more on exposure and tracking error and liquidity and how the ETF is taxed. The question is, are we at a point now where maybe cost is a bit of a tired story?

Eric: Yeah, I think so. You should talk to Todd Rosenbluth. This drives him crazy. I don't get as crazy over it because I see this as ... You know the phrase I use is ... About five or six years ago, it just seemed like the retail host organism that the whole industry was living off of woke up. But now it's not just awake, it's PO'd. So it's almost like I don't trust the charts anymore. I don't trust the star system. I don't trust performance. But I can trust the fee. And when that's all you trust, I think that's why you see them going there. So I understand it for sure. But I do agree it's short-sighted because you could have an exposure difference where you pick the cheaper one, but the exposure is significantly different and you could have performance that's not as good. And the second thing is behavior. I see us in an investor enlightenment era right now. And the first phase, or the latest phase was low cost. And I think people got that. It's now swept the nation. Everybody thinks low cost is good. Fine. The next, the baton is going to be passed to behavior, because in a sell-off or a correction or a panic, if you behave badly and don't hang in there and learn the art of doing nothing, you will completely kill and destroy all the cost savings. So I think that there's two reasons that cost isn't everything: A, the exposure matters, and B, behavior matters. And so there's a lot of legs to this stool per se when it comes to being a good investor and making the most of the market gains.

Jason: Eric, this is Jason Lank. I'd like to follow up on this discussion about really the investor obsession with low costs. Any good shop, you have to pay the light bill. There are good people that need to be paid. Can innovation be stifled because there just aren't the resources available in this environment for new ideas to come to market? Are we just going to stumble around in a five basis point world where we're just plain vanilla products are there?

Eric: I mean, well okay, so I see the ETF and passive in general having two evolutionary lines. One line is racing towards zero. That's this sort of Vanguardian future we speak of where yeah, it's going to be a rough environment. It's like a desert. There's no food, nothing. You get to survive on scraps. And I think you're going to see the portfolio for using ETFs could be one or two basis points all in. Right now, it's six for the world's cheapest portfolio. That's great. I mean, it's a rough environment for issuers, but it's a paradise for investors. That's going to be a rough place to exist. That's why there could be only three companies doing it. The other evolutionary line though is where we have some fun, and where I as an analyst enjoy myself a little more, because you're going to see active repackaged - that's smart beta. You're going to see themes. You're going to see ideas. And out there, if you're producing something that's high active share, has a lot of unique exposure, or is thematic, you can charge more. And I think that boutique area and that area is where you'll be able to make a living if you're active. I think it will be harder if you go against Vanguard or Schwab or BlackRock if you're trying to do what they do for 30 basis points or 1%. You're just ... That's impossible. But on the other side, I think there's some room. Like I said, that's why the other side is where I see the equivalent of private jet companies or Alaska Air. People doing very specific things, alternative things, and I think they're going to package those things into ETFs and you can charge more. And ROBO is a good example. That took in 1.5 billion this year. It charges 95 basis points, but who cares because it's beat the market by three fold.

Nate: Well Eric, on that note, if we do look outside of the top ETF providers, the iShares and the Vanguards of the world, you mentioned ROBO. Who are some of the other ETF providers or what are some of the other ETF launches that have stood out to you this year based on their success and what do you ultimately attribute that success to?

Eric: So I think two things. One is ROBO. I think that's been out for a couple years. But in order to really get some assets quickly as an indie issuer, you've got to outperform. I've really yet to see a case where people just go, "Oh that's a great idea. Let me put money into it." I mean, even ESG can't get money, and that gets the best press attention in the world. ROBO outperformed. It just had its moment. The stars aligned, sort of like currency hedging a couple years ago, or TAN a couple years before that. Once the thing outperforms, people think to themselves, "Oh, of course that would outperform, robotics is a big deal. Let me buy it." So you have the outperformance and then you have the brain cells clicking, that's a good story, and then boom, that is how an ETF goes from oblivion into the mainstream. We also saw it happen with Ark, the active fund shop. They're fighting two battles. They're indie and active, and that's two big hurdles. They saw their assets grow by a thousand percent this year because of killer returns. I call it Babe Ruth returns. Because they're only investing in innovation and disruption. And, again, when you see those returns and you look at the holdings, you're like, "Oh yeah. It would make sense for me to hold Tesla, Amazon, Bitcoin" and therefore people buy it. And I think MAGA is another one. Even though this is controversial, this is the GOP stock tracker. It's got $30 million. That's not bad. And this one hasn't outperformed per se, so that's why that 30 million is really interesting. This is partisan investing, and I think the world, the stock market is going to be the next thing thrown into this just brutal, divisive, political world we live in. And the market will be divided Democrat, Republican. And MAGA I think is first to see that and seize that opportunity.

Nate: Our guest is Eric Balchunas, Senior ETF Analyst at Bloomberg. Eric, switching gears here a bit, what about the fear mongering surrounding ETFs? I feel like 2017 was noteworthy in that the attacks on ETFs did seem to ramp up, probably in proportion to the inflows into ETFs. Have we peaked here? Do you think with ETF education, the market is now beginning to outweigh the naysayers?

Eric: Good question. Probably not because remember, ETFs threaten the establishment. They're like Bernie Sanders, right? But even Bernie Sanders was eventually taken in by the establishment and adopted. And I think that's what you're starting to see, because if you have all these big active managers - Fidelity, JP Morgan - sooner or later, every company is going to offer ETFs, and therefore the active managers who are lashing out against them have ETFs too. So they would probably stop lashing out against the product they already offer. But a lot of the fear mongering I think came from threatened parties, whether that's an ETF manager, or somebody on CNBC who has a stock picking show. I mean, these are the people who would rather ETFs not exist because it's taken away from their attention and their flows. So almost all of it can be dismissed as histrionics. But I get it. I mean, it's a new thing, and passive in general I think concerns people. But at the end of the day, we're still only 15% of the stock market owned by passive funds. So until that gets up to 50, I don't think I'd be too worried about it.

Nate: Alright, we have a few minutes left here, and I've got to apologize in advance. You know I have to ask you about Bitcoin ETFs today. You're probably tired of answering questions on this. But handicap the Bitcoin ETF race for us. You've dubbed this the Cannonball Run after the old Burt Reynolds movie. Where do we stand?

Eric: Is that the greatest metaphor? I'm really proud of that one.

Nate: I love it.

Eric: I need to make a graphic with the different issuers’ faces. So who do I think the Lamborghini girls are? That's who won the Cannonball Run in the movie. I have to go with VanEck or Rex. These are the two that were first into bitcoin futures ETFs. Based on Kathleen Moriarty's feedback on what the SEC might do, and she's the lawyer who worked on a lot of ETFs, including Winklevoss ones. She says that they're going to look to the fact that futures are now regulated by the CFTC, and the ETF is now tracking something regulated, therefore it'd be just like USO, the oil futures ETF, and they'll probably approve one of those. So I would give those two as my favorites. The Winklevoss I would still give a lot of attention to because, even if it comes after those, we all know people want the real thing if they can get it as opposed to derivatives, just like GLD has $40 billion and gold futures ETFs have almost nothing. When the Winklevoss one does launch, I think that's going to be a big deal, even if the futures ones steal a little thunder from them.

Nate: Any thoughts on the blockchain ETF filings? These have been compared to sort of a pick and axe play on bitcoin?

Eric: Yeah, these are just thematic stock ETFs. So ultimately they're like the GDX to GLD I guess. But I don't ... Look, the first one out is going to get a hundred million. It's a great quick idea to get some cash. But this is not the holy grail. This will be not nearly as big as ... Because when you put a bunch of stocks that are related to bitcoin, it's only going to go up a certain amount. Bitcoin futures and bitcoin, man that is the action. That's a whole ‘nother ball game. But they should do okay. I just don't see them on the same level as the bitcoin ones.

Nate: Alright, lastly here, I don't want to steal Dave Nadig's thunder - he's going to join us next week to talk 2018 ETF predictions - but besides bitcoin ETFs, maybe just give us one or two things you'll be watching for next year as it relates to ETFs.

Eric: Sure. I'm going to go out on a limb. Most people take what happened this year and they extrapolate it and they call that their outlook. And that's boring. I'm going to get exciting for you guys. And again, this is half tongue in cheek, but I'm going to say flows are going to be less next year. This is a big year with the Trump trade and everything just fell in the right place for ETFs. I think the market goes sideways. I think the VIX comes back to life and I think commodities start shining. They have been neglected for forever. And now, if you look at the commodity area, there's now dirt cheap commodity ETFs. And I think you'll see this whole fee thing and cost migration hit commodities. Commodities just need a little bit of a catalyst to get some performance going. The other thing I'm looking for is smart beta and fixed income. The Agg, the Barclays Agg and Bloomberg Barclays Agg has been like the Washington Generals - the Harlem Globetrotters team that just beat the you know what out of every game. It's such an easy benchmark to beat compared to the S&P 500. So credit managers have had it easy. I see smart beta fixed income becoming more of a presence because, after all, this is taking some of those tricks and moves by active credit managers and putting it into an ETF. It's almost like the way factors did for the equity side. So I'm looking for smart beta fixed income to maybe get a foothold and gain some assets. I think it could do better next year.

Nate: Eric, do your Philadelphia Eagles still have a shot at the Super Bowl after the Wentz injury?

Eric: Yeah, that's a sore topic. I do. You know, Nick Foles used to be the starter. He's not that bad, even though he kind of looks like Napoleon Dynamite. He's better than he looks, and the rest of the team is solid. So I see them making a deep run at the playoffs still, but the Saints are the team that scares me.

Nate: Well, Eric, thank you so much for joining us on the program today. Always a fun discussion and I hope you and your family have a wonderful holiday season.

Eric: You too. Always a pleasure, guys. Love the show.

Nate: That was Bloomberg's Eric Balchunas, a highly recommended follow on Twitter. His Twitter handle is @EricBalchunas. And again, as I mentioned earlier, Eric recently launched his own ETF podcast on Bloomberg. It's called Trillions - would certainly recommend checking that out. He co-hosts the first and only ETF focused TV show. It's called ETF IQ. You can find that on Bloomberg TV. And Eric also published a book last year. It's titled The Institutional ETF Toolbox. You can find that on Amazon. Perhaps a good stocking stuffer for anyone interested in ETFs.