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Ep 16: Dave Nadig on the extraordinary growth of ETFs
276 Plays1 year ago
Even those with only a passing interest in investing can’t have failed to notice the extraordinary rise in recent years of ETFs.
Exchange traded funds now account for around $4.3 trillion of global assets under management — up $1 trillion on this time last year. And although the pace of new product launches has slowed, there are now around 6,300 exchange-traded products worldwide.
There are several reasons why investors should consider them, not least because they’re very cheap compared to conventional mutual funds.
For the latest episode of the TEBI Podcast, John Swolfs from Inside ETFs has been interviewing Dave Nadig, CEO of ETF.com about this remarkable phenomenon.
Among the questions they tackle are these:
Are ETFs growing too fast?
Are there too many products available?
When will start seeing cryptocurrency ETFs? and
When eventually a downturn comes, what will be the impact on the ETF market?
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Transcript
Introduction to the Impact of ETFs
00:00:04
Speaker
Hello and welcome to another episode of the TEBI podcast from The Evidence-Based Investor. My name's Robin Powell.
00:00:12
Speaker
In this programme, we're going to be discussing exchange traded funds. It's no exaggeration to say that ETFs are transforming the investment landscape. And few people understand that better than Dave Nadig.
Dave Nadig's Role and Upcoming Event
00:00:26
Speaker
Dave is CEO of ETF.com. Previously, he was director of ETFs at Factset Research Systems.
00:00:35
Speaker
Later this month, he's a keynote speaker at Inside ETFs, Europe's largest ETF event. At the end of this podcast, we're going to tell you how you can attend Inside ETFs as a VIP guest free of charge.
Rapid Growth and Risks in the ETF Market
00:00:51
Speaker
But before that, let's listen to Dave Natick being interviewed by Inside ETFs, John Swelfs.
00:00:58
Speaker
Dave, good afternoon and thank you for joining us. We're hugely excited to have you as part of the Speaking Faculty at the Inside ETFs Europe's Conference this October in London. But I did want to jump right into a question with you here. Year over year, we've seen ETFs continue to gather assets at a record pace. I was wondering if you're still continuing to see that trend in 2017 and just how healthy is the ETF universe? It's growing faster than we can even keep up, honestly, John.
00:01:25
Speaker
We've got, globally, we're looking at something like $420 billion in dollars. It flows through the end of August. About 300 of that's been in the U.S., about 120 of it's been elsewhere from most of that in Europe in sort of usage-style products.
00:01:42
Speaker
We've got 4.3 trillion in the overall market. That's up basically a trillion since this time last year when you add in the incredible growth we've seen in, frankly, all the risk markets around the world. It's hard to find a market that's been down over the last 12 months. On top of that, we've seen just huge product launches. Now, the pace of launches has slowed down a little bit.
00:02:08
Speaker
We're at about 6,300 ETPs globally, which seems like an awful lot to me. And so you haven't seen a tremendous number of new products, but boy, the assets really do keep flowing in. Great. Thanks for that, Dave. That sounds like a really, really rosy picture there, but we all know every industry faces potential risks and threats. What do you see right now as probably the biggest threat to the ETF industry?
00:02:31
Speaker
Well, I mean, it's hard to look back at the last either year to date of the last 12 months and not wonder whether or not we're looking a little frothy in global risk markets, particularly, I think, global equities. You know, I mean, people focus a lot on things like the S&P 500, which is up about 15 percent over the last year. You look globally, though, it's even higher. Emerging markets, depending on which ones you look at, are 18, 19, 20 percent up over the last year. We're at the end of almost no matter how you measure it, we're at the
00:03:01
Speaker
the tail end of what's just been this incredible bull market for almost all risk assets. You have to wonder how long that can continue. I know many economists are looking for pullbacks. The question is, when we do inevitably have a pullback, because it's never going to be like this forever, what does that mean for the ETF industry? If you look back at how the ETF industry reacted, say, in 2008,
00:03:25
Speaker
The last time we had a big shock to the system, while it was not great and fun for anyone, it did actually turn out to be a positive for the ETF industry overall. What we saw was some investors did take money off the table, but when they came back in, they tended to come back in looking for low-cost
00:03:45
Speaker
beta exposures that drove them to ETF. So when we have those moments of turmoil, I actually think it ends up being positive for the ETF market. You see folks who might have been in an expensive, actively managed product reconsider when they come back in.
00:04:00
Speaker
So even in the downturn, it sounds like ETFs
Complexity of Smart Beta Products
00:04:03
Speaker
do have kind of a leg up, an opportunity to grow. But with that, I know you mentioned earlier, there was something like 6,300 products globally, which does sound like a lot. Are we just starting to slice and dice the investable universe too much? Have the ETFs moved on past the point of a viable solution for investors to some extent? If you look at traditional funds, whether in the US or in Europe or in UK or in Hong Kong, they're far more than 6,300.
00:04:30
Speaker
funds of the traditional variety too, particularly when you start counting multiple listings, et cetera. So while it seems like an awful large number of funds, when you actually sort of roll them up into categories, uh, the reality is that it's a fairly small number of those that have the bulk of the assets and which continue to get the assets. If you look at the new products that have been launching, it is true. You're not seeing a lot of folks launching a cheap vanilla, low cost beta products anymore. I mean, there's only so many.
00:04:59
Speaker
you know, stocks funds that you need out there. There are only so many DAX funds that you need. You know, there are real economies of scale there and the big tend to get bigger there. Now, we have seen the case where people will launch new products for a captive distribution channel, whether it's new banks entering the space,
00:05:16
Speaker
In the U.S., we've had traditional mutual fund folks entering the space, and they will sometimes launch MeToo product. But to your point, a lot of the new product has been really slicing the market very thin, emerging markets growth funds or emerging market sector funds or
00:05:34
Speaker
different spins on narrow slices of the fixed income market. I think it's reasonable to think a lot of those funds will have problems gathering assets. Those are not going to be bread and butter funds for the average punter who's just trying to get investment exposure. Where we do see innovation is in and around things that we call smart beta or strategic beta, quantitative approaches to try to either minimize risk or
00:06:00
Speaker
get a little extra return out of things. I think you'll continue to see growth there, but that's going to be
Bitcoin Speculation and Future ETF Products
00:06:05
Speaker
a long tail. Those products will need to prove themselves. People will need to see that performance over a period of years before I think you're going to see billions and billions flow in.
00:06:14
Speaker
Absolutely. And I do want to get to the smart beta in just a minute. But before we do, ETFs built their reputation as being kind of disruptors. And we're starting to see that now with things like Bitcoin and blockchain. Do you see them having a big impact on the ETF space? And if so, do you think issuers will be able to get products to market in time for investors to take advantage of these, you know, quick growing trends? Yeah. So anytime you have a fast moving speculative asset, which for sake of argument, let's call Bitcoin a
00:06:43
Speaker
a speculative asset. I think there's reasonable people can disagree what Bitcoin even is. But there's no question people are interested in it as a speculation vehicle, potentially as an investment vehicle.
00:06:54
Speaker
If you look around the world, different regulatory regimes are looking at Bitcoin very differently. There are actually a few ways to get access to Bitcoin in European notes products right now. You really can't get access to it in the US. You really can't get access to it in Asia. So different markets are approaching the question of Bitcoin differently. I think we will see derivatives on Bitcoin's launch fairly soon. I think there'll be an active futures market for Bitcoin. That'll help.
00:07:23
Speaker
All right, once we have a regulated futures market for these things, it will make it much easier to start wrapping products around it. So I think it's almost inevitable. Now, does that make it a great investment? I'm pretty skeptical about that personally, but I think structurally, it's just a matter of time, maybe the next six months before we actually see some globally listed cryptocurrency based products.
Long-Term Strategy for Smart Beta Returns
00:07:48
Speaker
Yeah, it's all interesting stuff, absolutely. And we'll hear more about that at the conference. But I did want to move into Smart Beta because you did see that we're starting to see some great launches there and new approaches within that space. So one, I guess, as you said, they need to be proved out. What did you really mean by that? And how can investors find out if the Smart Beta is delivering on its promise?
00:08:08
Speaker
Well, I think the challenge for ETF-focused investors is that if they're coming at a new product, a smart beta product, from the lens of a long-term investment portfolio, they have their home equity allocation, they have some international diversification, maybe they have a fixed income fund or some commodities exposure, and then they look at a smart beta product. It's inevitable that they're going to say,
00:08:32
Speaker
Well, if I'm going to spend, say, 90 basis points or 60 basis points for this newfangled thing, what's it going to do that my 15 basis point core exposure isn't? They're going to be looking for something. Right. And the challenge is most of these smart beta products are based on a pretty nerdy academic finance, looking at factor exposures, looking at multi-factor combination exposures.
00:08:56
Speaker
And the math would tell us that a lot of times you have to wait for those products to deliver their returns or their risk reduction over a period of years. MSCI has some great research out where they suggest that a good multi-factor strategy would work over seven years, that that's a core cycle where you'll get that risk adjusted outperformance.
00:09:17
Speaker
Seven years means that you have to be willing to sit through three years of underperformance to capture the next four years of good performance. Personally, I don't have that kind of patience, and I worry a little bit that some investors won't have that kind of patience. These are not quick fix products, but we live in a pretty quick fix world, and so I think investors really have to recalibrate their expectations. They really need to believe in these strategies in a way that they wouldn't necessarily just believe in a sector rotation strategy, for instance.
Innovations in Fixed Income ETFs
00:09:46
Speaker
Yeah, it makes sense. Now, one of the areas that when you look at kind of across the board that I think is ripe for disruption is the fixed income space. It's been a good old boys network for a long, long time. And we're starting to kind of see that that crack a little bit. But we're also starting to see some launches in the smart beta fixed income space. How is that impacting that market? And how is that changing the approach typical bond investors take?
00:10:08
Speaker
It's really early days in the fixed income market for smart beta. The problem with fixed income is that indexing bonds is fundamentally different than indexing stocks. Most bond indexes don't make a lot of sense intuitively. They tend to give more weight to more indebted issuers. They give more weight to a company that's issued tons of debt, which is the opposite of how you and I might approach personally loaning money to people. You generally loan money to people. You think
00:10:38
Speaker
are going to be solvent no matter what. And so that counterintuitive weighting, I think, creates this idea that there should be better ways of doing this. The reality is it's hard to come up with. There are not a lot of factors to play with in fixed income. You've got interest rate risk measured by duration. You've got credit risk. You have sort of idiosyncratic issuer risk, particularly when you start thinking about individual countries, for instance.
00:11:05
Speaker
And that's about it. You don't have a lot else to work with. It's not quite as refined as what we've seen in factor analysis in stocks. And that makes it tricky to come up with products that really work, that actually either deliver that extra return or actually deliver risk reduction. Now, we have seen some.
00:11:24
Speaker
Deutsche Bank has some interesting ideas around how to think about sovereign debt from emerging markets. We've seen folks like Research Affiliates put out some interesting stuff around corporate bonds and how to think about the issuers there. But I think it's very early days. I think it's exciting. I think it's interesting. But I would be very skeptical as an investor. And again, you have to really make sure you understand these products before
Growth of Actively Managed ETFs
00:11:46
Speaker
you wait in. You can't just trust it.
00:11:48
Speaker
So when we talk about early days of products, one of the things that you're starting to hear some buzz about is the active ETF. Just if you could give us kind of the quick down and dirty on your thoughts on active ETFs. I think it's inevitable. We've seen significant growth in actively managed ETFs. ETFs fundamentally, they're just a wrapper. And you can kind of stick any kind of investment strategy you want inside that wrapper.
00:12:12
Speaker
Historically, traditionally, active managers have been reluctant to use the ETF wrapper because part of being an ETF is showing what you own so that the creation and redemption mechanism will work so that it will trade near fair value. That seems to be eroding. We've seen more and more managers willing to
00:12:32
Speaker
disclose their full portfolio, their actively managed portfolio, and just let that be part of the process. In fixed income in particular, we saw huge international managers like PIMCO and DoubleLine come to market with product that is just straight up actively managed bond funds. You're starting to see that crack on the equity side too. It's taking time. Most of the regulatory hurdles are non-existent around the world.
00:12:58
Speaker
It's, I think, really just a matter of time until we see what will eventually be a flood of active management coming to the ETF space.
Preview of Keynote on ETF Misconceptions
00:13:07
Speaker
Yeah, fantastic. I look forward to it. I do think that active ETFs are certainly an opportunity for ETFs to take that next leg up as they continue to grow and they're used throughout the world. But Dave, we're just about out of time. 30 seconds here. I know that you're delivering a keynote with Matt Hogan at the Inside ETFs Europe Conference. What can people expect to learn from your talk?
00:13:25
Speaker
Well, we'll cover some of what we see globally from the trend perspective. I think what we really want to address is some of the hyperbole we see in the headlines around the ETF market, around how ETFs are driving prices, or they're going to cause the next giant flash crash, or they're fundamentally changing how capital gets allocated in the global economy. We want to hit some of those issues head on, debunk some myths, and maybe leave people with a couple of new ideas.
Invitation to Inside ETFs Europe
00:13:52
Speaker
Awesome. Love it. Thanks for the time and I look forward to seeing you in London, Dave. You've been listening to John Swalfs interviewing Dave Nadig, CEO of ETF.com. As you heard, Dave is a keynote speaker at Inside ETFs Europe, which this year is being staged at Hilton Park Lane in London from the 23rd to the 25th of October.
00:14:13
Speaker
Ember Regis Group, which produces the evidence-based investor, is one of the sponsors and has a number of complimentary VIP passes to give away. I'm certainly going to be there. Would you like to be as well? If so, all you need to do is search for Inside ETFs Europe. Click on the green Book Now button
00:14:35
Speaker
enter your details and use the VIP code Regis. That's Regis, R-E-G-I-S at checkout. It would be great to see you. That's all for this time. Thanks for listening. From me, Robin Powell and our producer, Wahida Rahman, goodbye.