ETF Industry Has Reached Maturation Without Maturing
We are seeing the sorts of excesses you see at the top of a market.
ETF Industry Has Reached Maturation Without MaturingBy
Blackrock Inc., the top issuer of exchange-traded funds in terms of assets under management, will close 16 ETFs this month. Even though ETFs get shuttered all the time these days, I was mildly amused by the names of some of these funds, such as the iShares Edge MSCI Min Vol EM Currency Hedged ETF. The closing of that the one will surely upset those who are a sucker for a good Venn diagram of emerging markets, factor investing and currency hedging.
A lot of the good real estate in ETF-land is currently occupied, so what you get now are fringe ideas. As Bloomberg Intelligence ETF analyst Eric Balchunas observed recently, the new funds that have generally succeeded are those that either have exceptionally low fees or are “shiny object” funds that invest in things like marijuana or blockchain. The ETF industry likes to think of itself as a legitimate competitor to the open-end mutual fund industry, but with offerings such as the now-delisted Whiskey & Spirits ETF you can be forgiven for thinking the business is a bit unserious.
Despite increasingly bizarre product launches and blowups (who could forget the saga of the VelocityShares Daily Inverse VIX Short-Term ETN?), the ETF business has still managed to claim the moral high ground from actively managed funds, which have been vilified as money-grubbing rent-seekers who add zero value. I’m a fan of the ETF structure (having traded them institutionally), but I often wonder whether there’s any real difference in investor behavior between an exchange-listed product and the open-end product. Vanguard founder Jack Bogle was concerned ETFs would induce investors to trade more and churn their portfolios, eating into their returns. There is definitely some truth in that. Investors I speak to usually tell me how they trade ETFs, not invest in them.
Also, the ETF business is an asset-gathering game — much like the open-end mutual fund business — but there are key differences. An open-end mutual fund spends money on marketing and distribution, but the No. 1 advertising strategy is performance. If a fund puts up excellent one-, three-, five- and 10-year numbers, and, as a bonus, outperforms an index, it is generally successful in attracting assets. The interests of the portfolio managers and the investors are aligned. Put up good numbers, get rewarded with more assets.
ETFs, on the other hand, are a pure asset-gathering game, and it often comes down to the selection of a cool ticker, a clever fund name, the timing of a launch or sheer advertising muscle in order to induce trading activity in the ETF. It is a bit like hanging up flypaper. There is a paradox of sorts in that ETF managers are mostly indifferent as to whether their investors make or lose money, but of course they have mostly been pretty successful in delivering good returns — assuming their investors do actually buy and hold.
Still, the ETF industry remains a Wild West in a way that the stodgy mutual fund industry never was at a similar phase in its development. Mutual funds aren’t tripping over themselves to hold Bitcoin despite the potential rewards. Mutual fund folks are some of the most boring people I have ever met, but in a nice way, of course. The ETF business gets many more colorful personalities, as in Kevin O’Leary, who is one of the stars of ABC’s “Shark Tank.”
It’s easy to poke fun at these imagination-free, pinstriped mutual fund drones behind their mahogany desks analyzing securities, especially since they are supposedly getting it all wrong, but as Oaktree Capital Group cofounder Howard Marks recently pointed out, “Active investors do the heavy lifting of security analysis and pricing, and passive investors freeload by holding portfolios determined entirely by the active investors’ decisions.” To put is simply, you need people doing the unglamorous work of security analysis in order for ETFs to be successful.
At every ETF conference there is a diagram of assets under management that looks like a hockey stick with lots of projections about how investors are just beginning to adopt ETFs, translating into a sky’s-the-limit mentality. But, the industry is reaching maturation without really maturing. For every SPDR S&P 500 ETF, iShares 20+ Year Treasury Bond ETF or SPDR Gold Shares, there is an ETF that looks little more than a get-rich-quick scheme. These are the sorts of excesses you see at the top of a market, not at the bottom.
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Robert Burgess at email@example.com