Bogleheads® on Investing Podcast 015 – Eric Balchunas, host Rick Ferri (audio only)

00:00:00.000 | [MUSIC]

00:00:10.000 | Welcome to Mogul Heads-On Investing Podcast #15.

00:00:14.000 | My name is Rick Ferry,

00:00:16.000 | and today we have a special guest,

00:00:18.000 | Eric Balchunas,

00:00:20.000 | Senior ETF Analyst

00:00:22.000 | at Bloomberg Intelligence,

00:00:24.000 | and the author of a book,

00:00:26.000 | The Institutional ETF Toolbox.

00:00:29.000 | [MUSIC]

00:00:38.000 | Welcome again to Bogul Heads-On Investing

00:00:40.000 | Podcast #15.

00:00:42.000 | This podcast, like all podcasts,

00:00:45.000 | is brought to you by the John C. Bogul

00:00:47.000 | Center for Financial Literacy,

00:00:49.000 | a 501(c)(3) corporation.

00:00:52.000 | In this episode of Bogul Heads-On Investing,

00:00:55.000 | I am happy to have with us

00:00:57.000 | Eric Balchunas, the Senior ETF Analyst

00:00:59.000 | at Bloomberg Intelligence.

00:01:01.000 | I've known Eric for many years,

00:01:04.000 | since he started doing this research.

00:01:06.000 | He is also now on the air

00:01:08.000 | at Bloomberg Radio and TV,

00:01:11.000 | a weekly television show,

00:01:12.000 | where he discusses different ETFs

00:01:14.000 | and the way investors can utilize them.

00:01:17.000 | He has a book,

00:01:18.000 | The Institutional ETF Toolbox,

00:01:21.000 | published by Wiley.

00:01:23.000 | So with no further ado,

00:01:25.000 | let me bring in Eric Balchunas.

00:01:28.000 | Welcome, Eric.

00:01:29.000 | Great to be here, Rick.

00:01:31.000 | I'm so glad to have you on the show.

00:01:32.000 | I get so many questions

00:01:34.000 | about exchange-traded funds

00:01:36.000 | versus mutual funds.

00:01:38.000 | What should I buy?

00:01:39.000 | Should I buy an ETF?

00:01:40.000 | Should I buy a mutual fund?

00:01:42.000 | And I'm hopefully going to be able to answer

00:01:44.000 | a lot of those questions today.

00:01:46.000 | But let's start out with you.

00:01:48.000 | How did you get involved in the ETF business?

00:01:51.000 | Yeah, good question.

00:01:52.000 | I was an economics major

00:01:53.000 | and a journalism major.

00:01:55.000 | So I did a couple of things out of college.

00:01:57.000 | One was I worked at Institutional Investor,

00:01:59.000 | the magazine.

00:02:00.000 | I was in the newsletter division.

00:02:02.000 | I first covered derivatives,

00:02:03.000 | but then I got moved over to covering funds

00:02:04.000 | at a newsletter called Fund Action,

00:02:06.000 | which is still around today, actually.

00:02:08.000 | Ironically, now they'll call me to get a quote,

00:02:11.000 | so come full circle.

00:02:13.000 | So I wrote for them.

00:02:15.000 | When was that?

00:02:16.000 | When did you start?

00:02:17.000 | Mid to late '90s.

00:02:18.000 | I remember the Vanguard PR guy, John Wirth,

00:02:22.000 | he actually sent me recently an email.

00:02:24.000 | I wrote him in like '97,

00:02:26.000 | asking him for information on some Vanguard fund,

00:02:29.000 | which I didn't recall.

00:02:30.000 | But at the time, the big companies

00:02:32.000 | were T. Rowe Price, Fidelity.

00:02:33.000 | Like Vanguard was a little more down the list.

00:02:36.000 | Indexing was still a minor player

00:02:39.000 | in the funds business,

00:02:40.000 | but I certainly remember covering them a little bit.

00:02:42.000 | So then I went off, worked at,

00:02:44.000 | did some third-party marketing,

00:02:45.000 | a couple of different jobs.

00:02:46.000 | But I found a job at Bloomberg in year 2000,

00:02:49.000 | and I instantly loved it.

00:02:51.000 | So I was working in the public relations department

00:02:53.000 | for about two years,

00:02:55.000 | but then right around 9/11,

00:02:57.000 | a few months after that,

00:02:58.000 | I moved back out of Manhattan to South Jersey,

00:03:01.000 | and I didn't want to make that commute to New York.

00:03:03.000 | So I transferred to the data office,

00:03:05.000 | and I took a job there.

00:03:07.000 | And the closest thing that would be applicable for me

00:03:10.000 | was fund data.

00:03:11.000 | So I worked in the data,

00:03:13.000 | at the funds data area of Bloomberg for 14 years.

00:03:18.000 | And right in the middle of that time,

00:03:20.000 | I got assigned to ETFs in about 2006.

00:03:23.000 | I immediately saw they were going to be a big deal.

00:03:25.000 | And, you know, after you talk to some people,

00:03:28.000 | go to a conference or two,

00:03:29.000 | you're like, yeah, this is actually,

00:03:30.000 | this product makes a lot of sense.

00:03:31.000 | And you sort of see that

00:03:33.000 | if you know mutual funds and close-end funds,

00:03:35.000 | you sort of see the ETFs

00:03:36.000 | as taking a few evolutionary steps forward at once,

00:03:38.000 | not just one little step, but a few.

00:03:41.000 | And so I just sort of made myself

00:03:43.000 | the expert on ETFs around that time,

00:03:45.000 | started going to conferences,

00:03:46.000 | and at the same time,

00:03:47.000 | building out the DEF page for ETFs

00:03:49.000 | to make them more ETF-ish,

00:03:51.000 | add fields like index rating methodology and so forth.

00:03:54.000 | So I was like the ETF data guy for many years.

00:03:56.000 | And then I started writing a little bit

00:03:58.000 | because I had that background.

00:03:59.000 | And the research group just took a notice

00:04:01.000 | in some of the posts I would do for our website

00:04:04.000 | and asked me to join research

00:04:05.000 | and head up the ETF research for Bloomberg Intelligence,

00:04:08.000 | which is the research wing of Bloomberg.

00:04:10.000 | And I've been doing that for about three years now

00:04:12.000 | and manage a team of four people

00:04:15.000 | who now write ETF research,

00:04:17.000 | although we'll do mutual funds a little bit,

00:04:19.000 | we'll do hedge funds even,

00:04:20.000 | and we'll work in some of the global scene as well.

00:04:23.000 | But largely we stick to US ETFs.

00:04:25.000 | - And you also do a television program once a week.

00:04:28.000 | - Yeah, so when I was trying to become the ETF guy

00:04:31.000 | within Bloomberg in the late 2010, 2012, 2014,

00:04:35.000 | like around that time,

00:04:36.000 | I felt there was vacuums in ETF coverage

00:04:39.000 | all over the company,

00:04:40.000 | whether it's sales, television, radio.

00:04:43.000 | And so I just sort of tried to forge through

00:04:46.000 | and make myself available

00:04:47.000 | and started doing a couple of hits here and there

00:04:50.000 | for television.

00:04:51.000 | Found myself a weekly segment on Friday at 4.30 PM,

00:04:54.000 | which is like three in the morning

00:04:56.000 | for financial television,

00:04:57.000 | but still I was beggars can't be choosers.

00:05:00.000 | But that was a segment that got me some reps.

00:05:03.000 | Yeah, then a TV show formed,

00:05:05.000 | it's called ETF IQ,

00:05:06.000 | it's about two years old.

00:05:07.000 | It's with Scarlett Fu

00:05:08.000 | and I'm sort of,

00:05:09.000 | I come on and give color commentary,

00:05:11.000 | play a good hand in sort of getting some of the guests

00:05:14.000 | and writing the script each week.

00:05:15.000 | And then I have a podcast called Trillions

00:05:17.000 | that formed about two years ago.

00:05:18.000 | So I think ETFs kind of went mainstream

00:05:21.000 | inside Bloomberg for sure,

00:05:23.000 | and in the general market about three or four years ago.

00:05:25.000 | So I think the show and podcast

00:05:27.000 | and a lot of the great news coverage

00:05:30.000 | you see out of Bloomberg

00:05:31.000 | is all part of the sort of mainstreaming of ETFs,

00:05:34.000 | even at a big company like Bloomberg,

00:05:36.000 | although they were covered heavily for a long time

00:05:39.000 | in the trade publications, obviously.

00:05:41.000 | Like I just looked today,

00:05:42.000 | Financial Times and Wall Street Journal

00:05:44.000 | both had multiple ETF articles out.

00:05:46.000 | I guess every month or so

00:05:47.000 | they put out like a special report.

00:05:49.000 | So they've definitely gone mainstream.

00:05:50.000 | And I think the show and the podcast

00:05:52.000 | are just a sort of symbolic of that,

00:05:55.000 | how big they've gotten.

00:05:56.000 | - And there's a few things

00:05:57.000 | that have occurred here in the last year

00:06:00.000 | that is going to even cause that to accelerate,

00:06:03.000 | which we'll get to in a few minutes.

00:06:05.000 | But before then,

00:06:06.000 | I want to sort of walk down a memory lane

00:06:10.000 | and go back to the beginning.

00:06:13.000 | And I know you did a couple of shows on this

00:06:15.000 | where you researched the beginning of ETFs

00:06:18.000 | and why they were created

00:06:19.000 | and who was involved

00:06:20.000 | and talk about why these products

00:06:23.000 | even came into existence

00:06:24.000 | and what they were originally for

00:06:26.000 | and how they've changed and evolved over the years.

00:06:30.000 | - You know, it really goes back

00:06:31.000 | to the '87 crash Black Monday.

00:06:33.000 | That was a monster event.

00:06:36.000 | There still has not been

00:06:37.000 | a percentage decline day in the market

00:06:39.000 | that has even come close to that.

00:06:41.000 | What happened was the SEC went

00:06:43.000 | and wrote a postmortem on what happened.

00:06:45.000 | And in that report,

00:06:48.000 | you know, they sort of,

00:06:49.000 | there's a lot of things going on,

00:06:50.000 | but it was portfolio insurance

00:06:52.000 | which used futures contracts.

00:06:55.000 | And that was the key.

00:06:56.000 | I think they thought

00:06:57.000 | that there was a downward spiral created

00:06:58.000 | between stocks and futures.

00:07:00.000 | And the futures were not managed by the SEC.

00:07:02.000 | And I, in that report,

00:07:04.000 | SEC kind of hinted that

00:07:06.000 | if there was something like a futures contract

00:07:08.000 | that were like under our supervision,

00:07:10.000 | that was like basket trading

00:07:12.000 | could be done on the exchange,

00:07:14.000 | this big event might not have happened

00:07:16.000 | because the futures market

00:07:17.000 | had different rules and regulations.

00:07:19.000 | And they thought some of that

00:07:20.000 | kind of contaminated the stock market in New York.

00:07:24.000 | And that was part of, I believe,

00:07:26.000 | the motive for writing that report

00:07:28.000 | and sort of suggesting that

00:07:30.000 | if people wanted to do basket trading and hedge

00:07:32.000 | and there might be a better way to do it.

00:07:34.000 | So this report was read

00:07:37.000 | by Nate Most and Steve Bloom

00:07:39.000 | who were at the American Stock Exchange.

00:07:41.000 | Now, Amex was in third place in trading.

00:07:43.000 | So they were hungry

00:07:44.000 | to try to find a new product

00:07:46.000 | that would increase volume.

00:07:47.000 | And so when they read this report,

00:07:49.000 | they sort of took this little sketch

00:07:51.000 | of a basket trading product

00:07:54.000 | and ran with it.

00:07:55.000 | And they sort of kicked around a few ideas

00:07:57.000 | and this is where the story gets interesting

00:08:00.000 | for Bogleheads.

00:08:01.000 | Nate Most had this idea

00:08:03.000 | to have the Vanguard 500 be traded on an exchange.

00:08:07.000 | And that would be this new ETF idea.

00:08:09.000 | He goes to Bogle's office

00:08:11.000 | and Bogle basically says,

00:08:14.000 | "No way on hell would I ever do anything like this

00:08:17.000 | to my precious Vanguard 500.

00:08:19.000 | I'm anti-trading, yada, yada."

00:08:20.000 | But Bogle, and when I interviewed him about this,

00:08:23.000 | said Nate Most was a great guy.

00:08:25.000 | You know, we remained friends

00:08:27.000 | and Bogle says he gave Nate Most

00:08:29.000 | three problems with the product

00:08:31.000 | that would help separate the trading

00:08:34.000 | and the cost inside the fund.

00:08:36.000 | And Bogle said, "No, thank you,

00:08:38.000 | but here's some suggestions."

00:08:39.000 | So Nate Most went

00:08:41.000 | and reworked the product at that point.

00:08:44.000 | And I think a key part

00:08:45.000 | to what made the product work so well

00:08:47.000 | was in order to separate the trading

00:08:50.000 | that goes on an ETF every day

00:08:52.000 | from the long-term investors

00:08:54.000 | 'cause they don't wanna incur the cost of the trading.

00:08:56.000 | That's part of the problem with the mutual fund

00:08:58.000 | is the trading costs.

00:08:59.000 | What they did was Nate Most used his background

00:09:02.000 | of working at a commodities warehouse.

00:09:05.000 | He ran the Pacific Commodities Exchange

00:09:07.000 | for a number of years.

00:09:08.000 | And in a commodities warehouse,

00:09:10.000 | instead of trading soybean oil back and forth

00:09:12.000 | and moving a lot of product around,

00:09:13.000 | you store the soybean oil in this warehouse

00:09:16.000 | and you get a receipt.

00:09:17.000 | And then you can just trade the receipt with people.

00:09:19.000 | And if you get enough receipts

00:09:20.000 | where you actually want your soybeans,

00:09:22.000 | you just go to the warehouse, give them all the receipts.

00:09:24.000 | They get you the soybean oil back in your possession.

00:09:28.000 | And vice versa,

00:09:29.000 | if you're sitting on a lot of soybean oil

00:09:30.000 | and you'd rather not,

00:09:31.000 | you can go into the warehouse,

00:09:32.000 | get the receipts and then sell those.

00:09:34.000 | And he just took that concept

00:09:36.000 | and applied it to the 500 stocks in the S&P.

00:09:39.000 | So that's where the word spider actually comes from,

00:09:42.000 | S&P Depository Receipt.

00:09:44.000 | So try to tell people ETFs are like a receipt

00:09:47.000 | to the 500 stocks sitting in a warehouse,

00:09:50.000 | except instead of a warehouse, it's a custodian.

00:09:52.000 | So that concept is where Nate Most

00:09:56.000 | really took that SEC sketch

00:09:58.000 | and took it to the next level,

00:09:59.000 | added in Bogle's suggestions.

00:10:01.000 | And what they did is they submitted to the SEC this idea,

00:10:05.000 | which is the ETF.

00:10:07.000 | And it sat there for four years.

00:10:09.000 | The SEC had a lot of internal back and forth and issues,

00:10:13.000 | but the weight was worth it

00:10:15.000 | because a lot of other types of derivative products

00:10:18.000 | that were based on indexes were coming out,

00:10:20.000 | but nothing had the sort of fiduciary

00:10:23.000 | long-term ability as SPY.

00:10:26.000 | So when SPY came out,

00:10:27.000 | what made it I think so powerful for many

00:10:30.000 | is that a lot of people could see

00:10:31.000 | the long-term investor potential for it,

00:10:33.000 | not just the trading aspect,

00:10:34.000 | but of course, Amex really designed it

00:10:37.000 | to increase trading on the exchange

00:10:39.000 | and it definitely worked.

00:10:40.000 | That thing traded, although it took a couple of years,

00:10:43.000 | it wasn't like a hit right off the bat.

00:10:44.000 | The '90s market helped,

00:10:46.000 | got some true believers,

00:10:48.000 | had a couple of big investors early on.

00:10:49.000 | People liked to use it to hedge options on it,

00:10:53.000 | help people.

00:10:54.000 | So it took a little while,

00:10:56.000 | but towards the late '90s,

00:10:57.000 | the assets and the volume started to double.

00:11:00.000 | - I was in the brokerage industry at the time in the 1990s

00:11:03.000 | and I had had my epiphany about index funds

00:11:05.000 | and I was really limited to what I could use.

00:11:08.000 | I was over at Smith Barney and active management

00:11:11.000 | was just not doing well relative to markets.

00:11:14.000 | And, you know, SPDRs had come along

00:11:17.000 | and then I think it was '96 MIDIs,

00:11:20.000 | which are the mid-cap, S&P 400 mid-cap came along.

00:11:24.000 | And I was able to swap out actively managed funds

00:11:27.000 | and individual managed accounts of equities

00:11:31.000 | for SPDRs and MIDIs.

00:11:33.000 | And they weren't ETFs at the time.

00:11:35.000 | The acronym ETF didn't exist.

00:11:38.000 | They were SPDRs.

00:11:40.000 | That's what they were called.

00:11:41.000 | So I began using these ETFs as a broker

00:11:45.000 | and I had to be one of the first brokers

00:11:47.000 | to actually use them in retail accounts,

00:11:49.000 | but I thought they were great and they were very low cost.

00:11:52.000 | So since the popularity of SPDR,

00:11:56.000 | which was a State Street product,

00:11:58.000 | Vanguard also came out with a S&P ETF, VOO,

00:12:03.000 | and iShare has an S&P product, IVV,

00:12:08.000 | and they're both lower cost versus SPY.

00:12:12.000 | SPY has higher fees and yet it's so much bigger

00:12:17.000 | and has more volume.

00:12:20.000 | And so why would money flow into the higher cost S&P product

00:12:26.000 | when there are lower cost S&P products available?

00:12:29.000 | Well, liquidity.

00:12:31.000 | It's got what I call oceanic liquidity.

00:12:34.000 | And if you look at the investors in SPY,

00:12:36.000 | there are some big giant fish using this thing.

00:12:40.000 | Everybody from Bridgewater, right?

00:12:42.000 | That's the world's biggest hedge fund.

00:12:43.000 | You've got Bank of America, Goldman Sachs, J.P. Morgan.

00:12:47.000 | There's pensions in there, there's endowments.

00:12:49.000 | So a lot of people like the liquidity

00:12:51.000 | and a lot of people use SPY as a liquidity sleeve.

00:12:54.000 | Like if they're active or doing something else,

00:12:56.000 | SPY could be something that they just use

00:12:58.000 | to tweak up or down their beta exposure

00:13:00.000 | or their equity exposure on their portfolio.

00:13:02.000 | This might not be their core equity exposure.

00:13:04.000 | I think also that SPY's assets have been hurt by the fee

00:13:09.000 | because if you look at SPY over the last three years,

00:13:12.000 | it's I think seen a little bit of outflows

00:13:15.000 | or it's at least flat.

00:13:16.000 | All the new money is going to the net new flows

00:13:19.000 | are going to IVV and VOOC.

00:13:21.000 | But what's interesting is we study volume market share

00:13:25.000 | and asset market share for ETFs.

00:13:28.000 | And what's fascinating is while SPY's asset market share

00:13:32.000 | has been going down pretty steadily for a number of years,

00:13:35.000 | it's volume market share is almost unmoved.

00:13:38.000 | I think it still is about 95% of all the volume

00:13:40.000 | in the S&P 500 ETFs.

00:13:42.000 | And this is where we come to our conclusion,

00:13:44.000 | which is that in the sea war,

00:13:47.000 | it's much easier to steal land than sea.

00:13:49.000 | Vanguard has an amazing army.

00:13:52.000 | They're going to steal your land because they're cheaper.

00:13:55.000 | The assets can be moved pretty easily.

00:13:58.000 | But when it comes to liquidity,

00:14:00.000 | it's a lot harder to peel off people who seek liquidity

00:14:04.000 | like institutions and traders.

00:14:06.000 | And so SPY, MDY, the ones we mentioned earlier,

00:14:09.000 | they're going to be around and big for a long time

00:14:11.000 | because it will be quite a while before IVV

00:14:14.000 | hits that tipping point where it becomes actually more liquid.

00:14:18.000 | Could be 10 years from now.

00:14:19.000 | We used to think it would happen quicker

00:14:21.000 | and that those older, more liquid ones

00:14:24.000 | that cost more would just go away.

00:14:26.000 | But it could take a long, long time for that to happen.

00:14:29.000 | It probably will at some point,

00:14:31.000 | but SPY at this point is sort of like a sun

00:14:34.000 | and there's a whole solar system connected to it.

00:14:37.000 | The options on SPY have a volume

00:14:39.000 | that is about half of all equities.

00:14:41.000 | It's enormous.

00:14:42.000 | And that takes a long time to eat into.

00:14:44.000 | - So Eric, where could I find more information

00:14:46.000 | about the history of ETFs?

00:14:48.000 | - If you go to Google and you type in the ETF story,

00:14:52.000 | you will find a site called the ETF story.

00:14:56.000 | And me and my podcast colleague, Joel Weber,

00:14:59.000 | did a Ken Burns style audio documentary,

00:15:02.000 | a six part series on the history of ETF.

00:15:04.000 | Starts on Black Monday and goes right through

00:15:06.000 | to the invention of smart beta basically.

00:15:08.000 | And it really is fascinating.

00:15:11.000 | We interview people who were there

00:15:13.000 | and Vogel is also in the interview,

00:15:16.000 | that part about him being involved.

00:15:18.000 | He talks about the ETF and it's just fascinating.

00:15:20.000 | So if anybody finds this somewhat interesting,

00:15:23.000 | you will love this documentary.

00:15:24.000 | I highly recommend it.

00:15:25.000 | - Let's get into the whole concept

00:15:27.000 | of how these things work

00:15:28.000 | and really why they could be a better mousetrap.

00:15:32.000 | They certainly are from a tax perspective

00:15:35.000 | for taxable clients.

00:15:37.000 | How do I know when I put my order in

00:15:39.000 | that I'm gonna get a decent price?

00:15:41.000 | These funds also have an iNav

00:15:44.000 | that shows what the value was up to 15 seconds ago.

00:15:50.000 | You know, but still, I mean,

00:15:52.000 | the market moves faster than that.

00:15:54.000 | So let's get into the whole mechanics

00:15:56.000 | of how ETFs got created,

00:15:59.000 | how they're redeemed, how they're traded.

00:16:01.000 | Start out with the creation.

00:16:03.000 | I mean, how do you get an ETF into the marketplace?

00:16:06.000 | - So if you think about a creation,

00:16:08.000 | go back to that commodities warehouse receipt, right?

00:16:10.000 | Where in order to create new shares of an ETF,

00:16:13.000 | an authorized participant, which is, you know,

00:16:16.000 | really just a gigantic bank

00:16:17.000 | that is hooked up to the whole system.

00:16:19.000 | In fact, when Spyder was being designed,

00:16:22.000 | when the original ETF was being designed,

00:16:24.000 | here's a quote from Kathleen Moriarty,

00:16:26.000 | who was a lawyer working on it at the time.

00:16:28.000 | "In order to create all 500 stocks,

00:16:30.000 | "you'd have a portfolio basket

00:16:31.000 | "that was worth about 1 million.

00:16:32.000 | "The average person was never gonna come in

00:16:34.000 | "and out for a million,

00:16:35.000 | "so we need to deal with companies

00:16:37.000 | "who were dealing with the DTC and the NSCC."

00:16:40.000 | So people who were broker-dealers,

00:16:41.000 | it had to be somebody hooked up to the system.

00:16:43.000 | So that's why it's like a Goldman or a Credit Suisse.

00:16:46.000 | These are the APs,

00:16:47.000 | and each ETF is assigned a couple APs

00:16:49.000 | who do this creation redemption.

00:16:51.000 | And so they'll take the 500 stocks in the S&P,

00:16:54.000 | go to that proverbial warehouse,

00:16:56.000 | hand it in in a certain size,

00:16:58.000 | and get shares of the ETF or receipts.

00:17:02.000 | Those receipts then trade on the open market.

00:17:04.000 | So if there's a lot of demand for a product,

00:17:07.000 | let's say the solar energy ETF,

00:17:09.000 | it has a good month and everybody starts to want it,

00:17:12.000 | the demand on the exchange will start to get so high

00:17:15.000 | that market makers and the AP will say,

00:17:18.000 | "Hey, why don't we arbitrage this?

00:17:19.000 | "We'll put new shares on the market

00:17:22.000 | "and sell the stocks and pocket the difference."

00:17:25.000 | And that arbitrage is really what creates

00:17:29.000 | creations of redemptions in a normal market.

00:17:31.000 | So the fact that you can take the underlying basket,

00:17:35.000 | hand it in, is really wonderful

00:17:37.000 | because it does utilize arbitrage.

00:17:40.000 | And arbitrage is a nasty sounding word,

00:17:43.000 | but it's actually very useful in this case

00:17:45.000 | because arbitrage is what keeps the price of the ETF

00:17:48.000 | very, very close to the net asset value,

00:17:51.000 | which is what the portfolio is worth.

00:17:53.000 | In my book, I call that the flux capacitor.

00:17:56.000 | In "Back to the Future," that's how time travel works.

00:17:59.000 | The creation redemption process is ETF's flux capacitor.

00:18:02.000 | That's the brilliant part of it that really makes it work

00:18:06.000 | and survive and work well in nasty days,

00:18:10.000 | up days, down sideways days.

00:18:12.000 | It makes it very robust.

00:18:14.000 | - The way it works for an individual investor

00:18:16.000 | when they put their order in to buy 100 shares of VTI,

00:18:21.000 | the Vanguard Total Stock Market Index Fund,

00:18:24.000 | they're going to the exchange.

00:18:26.000 | They're getting their 100 shares from somebody else.

00:18:30.000 | They're not getting it from the fund company.

00:18:33.000 | - Yes.

00:18:34.000 | Yes, so if somebody puts in...

00:18:35.000 | Sorry, go ahead.

00:18:37.000 | - No, and then they...

00:18:39.000 | So it's an exchange between two people

00:18:41.000 | as opposed to opened-end mutual funds

00:18:43.000 | where you would go to Vanguard directly

00:18:46.000 | and buy the Total Stock Market Mutual Fund

00:18:48.000 | directly from Vanguard with cash.

00:18:50.000 | Here, you're going to the exchange with the same cash,

00:18:53.000 | and you're buying somebody else's shares

00:18:55.000 | that is trading them on the exchange.

00:18:57.000 | - Correct, and I think that's an important difference.

00:19:00.000 | Most people who are buying their ETF

00:19:03.000 | are probably just going to buy it

00:19:04.000 | from somebody else who's selling that day,

00:19:06.000 | just like a stock.

00:19:07.000 | About 90% of ETF volume is that.

00:19:10.000 | 10%, give or take the asset class,

00:19:13.000 | will be creation/redemption activity

00:19:15.000 | where there's just a bigger order

00:19:17.000 | that there's not enough shares on the exchange,

00:19:19.000 | so somebody has to go and do a creation

00:19:22.000 | to satisfy that big order,

00:19:23.000 | or there's just a frenzy of excitement for an area,

00:19:26.000 | and they need more supply.

00:19:28.000 | So that market maker will then go ahead

00:19:31.000 | and make creations in order to feed that demand.

00:19:35.000 | But again, that's only a small portion of the time.

00:19:38.000 | Most of the time, the market just is buyers and sellers

00:19:41.000 | going back and forth like stocks.

00:19:43.000 | - Now, there's a lot of benefits

00:19:45.000 | to an individual investor for using ETF.

00:19:47.000 | There's some drawbacks,

00:19:48.000 | but there's some benefits as well.

00:19:50.000 | I'll hit a couple of drawbacks first.

00:19:52.000 | So when you go to the exchange

00:19:53.000 | and you're going to buy or sell something,

00:19:55.000 | you really don't know what the price is.

00:19:57.000 | You can look on your computer screen,

00:19:59.000 | but the information we get as an investor

00:20:03.000 | trading down here in Texas

00:20:06.000 | using my app on my custodian

00:20:10.000 | is light years behind

00:20:13.000 | what is actually going on in the marketplace.

00:20:15.000 | So I put my order in to buy.

00:20:17.000 | I really don't know what I'm going to get,

00:20:19.000 | but I try to put in a limit order of some sort

00:20:22.000 | so I don't overpay,

00:20:24.000 | but again, I don't know what the price should be.

00:20:26.000 | And I put the order in, and I get an execution,

00:20:29.000 | but I don't know whether or not that's good or bad.

00:20:31.000 | So that's kind of a disadvantage.

00:20:33.000 | I'm in the dark trading,

00:20:34.000 | whereas if I was going to go directly to say Vanguard,

00:20:38.000 | and there are other companies out there,

00:20:40.000 | Schwab and so forth,

00:20:41.000 | but I'm just using Vanguard as an example.

00:20:43.000 | If I was going to go to Vanguard directly

00:20:44.000 | and buy their open-end fund,

00:20:46.000 | I know I'm going to get NAV at the end of the day.

00:20:48.000 | No question.

00:20:49.000 | So how close really is my trade

00:20:54.000 | as a retail small investor doing ETF trading,

00:20:58.000 | how close am I to actually getting NAV

00:21:01.000 | on a big fund like VTI?

00:21:04.000 | It's going to be very close.

00:21:06.000 | VTI, I mean, I have a chart here,

00:21:08.000 | and I'm pulling up of the percent premiums.

00:21:10.000 | I mean, if you look at it on any given day,

00:21:13.000 | it's one basis point, one basis point,

00:21:16.000 | two basis points.

00:21:18.000 | So we're talking two basis points,

00:21:20.000 | and let's just say the bid-ask spread is another BIP.

00:21:22.000 | And by the way,

00:21:23.000 | sometimes you could actually pay a little less than the NAV

00:21:25.000 | if you're lucky,

00:21:26.000 | so it doesn't always work against you,

00:21:27.000 | but let's just assume

00:21:28.000 | you're going to pay two BIPs of a premium.

00:21:32.000 | Worst case scenario,

00:21:33.000 | you could put a market order in,

00:21:35.000 | maybe three, right?

00:21:37.000 | You add a BIP to that, there's four.

00:21:39.000 | So yeah, that's a real extra cost.

00:21:42.000 | How much is a BIP?

00:21:44.000 | If I'm investing $10,000, what's a BIP?

00:21:48.000 | $10,000, that'd be a dollar.

00:21:50.000 | Oh, okay.

00:21:51.000 | Well, it's not like $100 or anything like that.

00:21:54.000 | No, no.

00:21:55.000 | I mean, so VTI, let's see.

00:21:57.000 | Here's how, in fact,

00:21:58.000 | this is a great excuse to do a total cost of VTI.

00:22:01.000 | VTI charges you three BIPs,

00:22:03.000 | so that'd be $3 on an annual fee.

00:22:06.000 | Let's say the premium,

00:22:08.000 | let's say there's two there,

00:22:09.000 | and your spread is one,

00:22:11.000 | so there's three, that's six.

00:22:12.000 | The good news is Vanguard will do

00:22:14.000 | a little securities lending in this thing.

00:22:16.000 | And if I look over the past year,

00:22:18.000 | it's put in two basis points

00:22:21.000 | worth of securities lending revenue,

00:22:23.000 | so that takes two away.

00:22:24.000 | So you're looking at maybe four,

00:22:26.000 | four BIPs.

00:22:27.000 | But again, you have to remember that

00:22:29.000 | the trading costs that we just mentioned

00:22:31.000 | are just a one-time fee.

00:22:33.000 | It's the expense ratio that comes

00:22:35.000 | day after day, rain or shine.

00:22:38.000 | So that's really, if you're long-term,

00:22:39.000 | the more important fee.

00:22:41.000 | And the trading cost becomes less.

00:22:43.000 | If you're trading all day

00:22:44.000 | and you're like a maniacal day trader,

00:22:47.000 | that is why SPY is so popular

00:22:49.000 | because it is just going to be,

00:22:52.000 | the more liquid it is,

00:22:53.000 | the more it's going to just

00:22:55.000 | completely digest all these orders

00:22:57.000 | right at NAV.

00:22:58.000 | And the arbitrage will be almost,

00:23:00.000 | the arbitrage is so good

00:23:02.000 | that you're paying the NAV

00:23:04.000 | virtually almost all the time.

00:23:05.000 | So that's why as you get further out,

00:23:09.000 | in terms of your investment horizon,

00:23:11.000 | it's probably better to go to the cheaper funds.

00:23:14.000 | Even if that does mean an extra BIP

00:23:16.000 | and a spread or something,

00:23:18.000 | it's worth it because it goes away

00:23:20.000 | as time goes on.

00:23:21.000 | But I'd go even further to say

00:23:22.000 | if you're long-term

00:23:23.000 | and you're a bogey head type,

00:23:25.000 | there may not be a reason

00:23:26.000 | to buy the ETF at all.

00:23:29.000 | Unless you trade or have a portfolio

00:23:32.000 | where you just want to use ETFs

00:23:34.000 | because you want to move it around a little bit.

00:23:37.000 | In index mutual funds,

00:23:39.000 | especially Vanguard,

00:23:40.000 | you can get the same fee virtually

00:23:42.000 | or if not cheaper.

00:23:44.000 | And they do the same exact thing.

00:23:46.000 | And they benefit from that

00:23:47.000 | securities lending revenue I talked about.

00:23:49.000 | So I don't really see any reason

00:23:52.000 | to use the ETF

00:23:54.000 | if you're a buy and hold bogey head.

00:23:58.000 | There's really no...

00:23:59.000 | You don't have to mess with all this.

00:24:01.000 | So I'm not thinking ETFs

00:24:04.000 | should do really much

00:24:05.000 | to replace the index mutual fund

00:24:07.000 | if you're long-term.

00:24:09.000 | It does make a difference

00:24:10.000 | if you're holding your account

00:24:13.000 | at Schwab or TD Ameritrade

00:24:17.000 | or Fidelity

00:24:19.000 | where if I wanted to buy

00:24:22.000 | the Vanguard Total Stock Market Index Fund

00:24:24.000 | and I did it through Fidelity

00:24:27.000 | or if I can even buy it through Fidelity,

00:24:29.000 | I don't even know if I can,

00:24:30.000 | just at the mutual fund,

00:24:32.000 | they would charge a commission, 25.

00:24:36.000 | I mean, I think if Schwab,

00:24:37.000 | if you bought a Vanguard mutual fund,

00:24:39.000 | they're going to charge a lot of commission dollars.

00:24:41.000 | But they don't charge anything to do an ETF trade.

00:24:44.000 | So if I'm holding my assets at Schwab

00:24:46.000 | and I wanted to buy a Vanguard fund,

00:24:49.000 | if I can do it with an ETF,

00:24:51.000 | it seems like a better deal.

00:24:53.000 | Absolutely.

00:24:54.000 | And this is part of why Vanguard launched ETFs,

00:24:57.000 | to be able to distribute better

00:24:58.000 | because of that reason.

00:24:59.000 | So if that's the case,

00:25:01.000 | then obviously that scenario with VTI

00:25:03.000 | becomes the better deal.

00:25:05.000 | And it's one other thing too

00:25:06.000 | that I want to talk about

00:25:08.000 | is Vanguard has a unique structure

00:25:11.000 | where their ETFs are a share class

00:25:16.000 | of the open-ended mutual fund.

00:25:18.000 | And they're the only ones who have this.

00:25:20.000 | They have a patent on it.

00:25:22.000 | And so when it talks about tax efficiency,

00:25:26.000 | their mutual funds have the same tax efficiency

00:25:29.000 | as their ETFs within the same fund.

00:25:32.000 | It's spread across all classes of shares equally.

00:25:37.000 | Now, the fee might not be exactly the same.

00:25:39.000 | I mean, actually Vanguard now

00:25:40.000 | is actually lowering the fees on their ETFs

00:25:42.000 | because administrative costs

00:25:44.000 | are actually less expensive to them.

00:25:46.000 | For holding shares away at Schwab or Fidelity,

00:25:50.000 | the cost to hold shares there is less.

00:25:54.000 | So they're actually now passing that savings

00:25:56.000 | on to the ETF shareholders.

00:25:58.000 | So if you look at the VTI

00:26:00.000 | or some of the other funds,

00:26:02.000 | the ETF share class

00:26:03.000 | is actually starting to trickle down

00:26:05.000 | even below the Admiral share class.

00:26:08.000 | But the question is taxation.

00:26:10.000 | I was talking with a client a few weeks ago

00:26:13.000 | who said they made the mistake last year

00:26:17.000 | of buying a Schwab S&P 500 mutual fund

00:26:24.000 | in their taxable account last year.

00:26:26.000 | And they got a tax distribution

00:26:28.000 | at the end of the year.

00:26:29.000 | Pretty big one, apparently.

00:26:31.000 | Enough to make them upset about it.

00:26:33.000 | Rather than buying an ETF like IVV

00:26:38.000 | in their account

00:26:40.000 | where they would not have gotten a tax distribution.

00:26:42.000 | So from a investor standpoint,

00:26:45.000 | an individual investor standpoint,

00:26:47.000 | can you tell me why an ETF

00:26:50.000 | would not make capital gain distributions

00:26:53.000 | while a mutual fund

00:26:55.000 | that's following the same index might?

00:26:57.000 | Not including Vanguard

00:26:58.000 | because as we just talked about,

00:27:00.000 | they're the same.

00:27:02.000 | Right. Vanguard is a special case.

00:27:04.000 | And if you're using Vanguard's index funds,

00:27:06.000 | you don't have to worry about this.

00:27:08.000 | I am looking at the Schwab.

00:27:09.000 | You're right.

00:27:10.000 | This mutual fund put out capital gains

00:27:12.000 | almost religiously every year.

00:27:15.000 | Yeah, I hear you. That's annoying.

00:27:16.000 | And look, this tax efficiency of the ETFs

00:27:19.000 | that you hear about is fascinating

00:27:21.000 | because for some people,

00:27:23.000 | it's the number one benefit.

00:27:24.000 | ETFs probably have 10 features like a smartphone,

00:27:28.000 | but some people use two or three

00:27:30.000 | or hardly anybody use all 10.

00:27:32.000 | But tax efficiency might be the most important thing

00:27:34.000 | for certain people

00:27:35.000 | because of those taxable counts.

00:27:37.000 | Now, the reason this happens

00:27:38.000 | is that creation redemption process,

00:27:40.000 | the portfolio manager is able to sort of

00:27:43.000 | wash out gains if there are some

00:27:45.000 | in that process of the creation redemption.

00:27:47.000 | All that's happening in the primary market.

00:27:49.000 | It doesn't affect the investors.

00:27:51.000 | The mutual fund, you just don't have that.

00:27:53.000 | So the mutual fund's a lot easier to understand.

00:27:55.000 | Somebody's running a fund.

00:27:57.000 | They have to,

00:27:58.000 | let's say somebody wants to get out of the fund.

00:28:00.000 | They're going to have to sell some equities

00:28:02.000 | or they have a lot of cash,

00:28:03.000 | which in case you have cash drag.

00:28:05.000 | But let's just say they don't,

00:28:06.000 | they have equities.

00:28:07.000 | You got to sell something to meet those redemptions.

00:28:09.000 | And so that's going to trigger a gain.

00:28:12.000 | And the people who sat there get it,

00:28:14.000 | which is annoying because all you did was sit there.

00:28:17.000 | And that is what ETFs don't have.

00:28:20.000 | So you rarely get a capital gains distribution.

00:28:23.000 | There are a couple of cases when you will see them,

00:28:26.000 | but they're usually in special situations

00:28:28.000 | and more exotic products.

00:28:30.000 | But the big general ones don't really, really do that.

00:28:33.000 | And I think that that track record

00:28:35.000 | of not having capital gains is very valuable.

00:28:38.000 | They didn't design the ETF to sidestep the tax rules.

00:28:41.000 | It was a happy accident

00:28:43.000 | when they made the creation redemption,

00:28:45.000 | which was really largely to keep the costs

00:28:47.000 | of trading separate from the investors.

00:28:49.000 | And by doing that,

00:28:50.000 | they kind of made the taxes separate too.

00:28:53.000 | And that is a big win for ETFs.

00:28:56.000 | And frankly, I think that's more fair.

00:28:58.000 | I think mutual funds,

00:28:59.000 | when you look at them side to side,

00:29:00.000 | have the unfair way.

00:29:02.000 | I'd almost, you know,

00:29:03.000 | obviously ETFs have a lot of advantages.

00:29:05.000 | This is one where I almost feel bad for mutual funds

00:29:08.000 | because it is an unfortunate way.

00:29:10.000 | It's almost like you just get taxed

00:29:12.000 | when you make the action as the investor.

00:29:14.000 | If you sell, that's on you.

00:29:15.000 | And that you do get the capital gains distribution

00:29:18.000 | if you sell your ETF,

00:29:20.000 | but you don't get one just sitting there.

00:29:21.000 | And I think that's a more fair way to get taxed.

00:29:24.000 | - Gene Fama won the Nobel Prize

00:29:26.000 | in economics a few years ago.

00:29:28.000 | He and his research partner, Ken French,

00:29:32.000 | they wrote an op-ed Wall Street Journal article,

00:29:35.000 | I want to say 13, 15 years ago,

00:29:38.000 | where they talked about this problem

00:29:41.000 | with mutual funds, not with ETFs.

00:29:44.000 | They said that ETFs were doing it the right way.

00:29:46.000 | And it's the way that mutual funds

00:29:48.000 | are not tax-efficient.

00:29:51.000 | And the Congress needs to change the way

00:29:54.000 | mutual funds work so that they become

00:29:57.000 | on a level playing field with exchange-traded funds.

00:30:00.000 | So it was clear a long time ago

00:30:03.000 | that this was a better mousetrap

00:30:04.000 | from a tax perspective.

00:30:06.000 | - Yeah, and I think some people say,

00:30:08.000 | why doesn't the ICI lobby Congress?

00:30:12.000 | First of all, I'm not sure they'd want to, you know,

00:30:16.000 | mess with what's obviously good tax revenue.

00:30:19.000 | Number two, I'm not sure they fully understand it.

00:30:21.000 | And number three, the ICI, nowadays,

00:30:24.000 | is filled with people who have ETFs and mutual funds.

00:30:26.000 | Like these companies all have both, mostly.

00:30:28.000 | Back in the day, I might've been smarter

00:30:31.000 | if the ICI was more full of just active mutual funds.

00:30:34.000 | But now it's, ETFs are kind of part

00:30:36.000 | of all these big companies' lineups.

00:30:39.000 | And so it would be hurting, you know,

00:30:40.000 | a lot of their own members.

00:30:41.000 | So, you know, that's why I don't think

00:30:44.000 | you'll see any pushing to undo it.

00:30:46.000 | But I could be wrong.

00:30:48.000 | It's possible that somebody decides to change rules.

00:30:51.000 | - Hasn't happened.

00:30:52.000 | And by the way, ICI is the Investment Company Institute,

00:30:55.000 | which kind of is a trade group of fund providers.

00:31:01.000 | - Yes, ICI is like the big trade group.

00:31:04.000 | And as we know how Washington works,

00:31:05.000 | usually you need some group like that

00:31:07.000 | to sort of get the ball rolling

00:31:08.000 | on what would be otherwise pretty complicated tax issue.

00:31:11.000 | And I just don't see them taking that initiative.

00:31:13.000 | - We said Vanguard doesn't make any difference

00:31:16.000 | because everything's treated the same

00:31:18.000 | and it's all tax efficient.

00:31:19.000 | In fact, Vanguard is really super tax efficient.

00:31:21.000 | And we can get into why this sort of double structure

00:31:24.000 | of having it as a share class of a mutual fund

00:31:28.000 | is actually even more tax efficient

00:31:30.000 | 'cause when there are cash redemptions

00:31:32.000 | in the mutual fund side,

00:31:33.000 | you can get rid of stocks that are at a high cost

00:31:37.000 | and are at a loss

00:31:38.000 | and therefore gather losses in the fund.

00:31:40.000 | And then when there's a redemption on the ETF side,

00:31:44.000 | you can get rid of low cost basis stocks.

00:31:46.000 | So it really is a super efficient model

00:31:49.000 | that I always wondered why other fund companies

00:31:52.000 | didn't just go to Vanguard and pay them a fee

00:31:55.000 | to use that invention that they have a patent on

00:32:00.000 | because it is so tax efficient.

00:32:02.000 | I mean, it would make your open to a mutual fund

00:32:04.000 | so much more tax efficient

00:32:05.000 | if you had an ETF share class of it

00:32:08.000 | and you could get rid of the low cost basis stocks

00:32:11.000 | so you don't have these distributions

00:32:13.000 | at the end of the year.

00:32:14.000 | But I've not heard of any company

00:32:16.000 | that has successfully gone to Vanguard

00:32:18.000 | and gotten them to let them use the patent.

00:32:22.000 | I've heard that companies have tried

00:32:23.000 | but that Vanguard wasn't listening.

00:32:26.000 | - This comes up sometimes when we talk about

00:32:28.000 | this new structure coming out next year

00:32:30.000 | called non-transparent actives

00:32:32.000 | where they have a way to have an active ETF

00:32:37.000 | not have to show its holdings to the public every day.

00:32:40.000 | It almost seems like licensing Vanguard's patent

00:32:43.000 | would make more sense.

00:32:44.000 | I agree with you.

00:32:45.000 | I'm not totally sure why more people haven't thought of that.

00:32:48.000 | And the patent runs out, I believe it's 2022.

00:32:51.000 | - I think that's what I've heard, yeah.

00:32:54.000 | - So you can either wait it out.

00:32:56.000 | They might not be, I mean,

00:32:58.000 | the flows are getting pretty rough out there.

00:33:01.000 | And I think a lot of active firms

00:33:03.000 | don't wanna wait that long.

00:33:04.000 | So maybe they just don't wanna have to pay Vanguard

00:33:07.000 | which they see as like the Amazon of this industry.

00:33:09.000 | - I have heard that as well.

00:33:11.000 | - Yeah, I mean, there could be some pride involved here.

00:33:14.000 | I just don't wanna, I just can't do it.

00:33:16.000 | I can't bring myself to pay Vanguard.

00:33:18.000 | They're doing enough damage to me.

00:33:20.000 | So, but yeah, I don't know.

00:33:22.000 | I think maybe they want more control, who knows.

00:33:24.000 | But I would think that might work better

00:33:27.000 | than what they're gonna do,

00:33:28.000 | which is if they come out with these sister ETFs

00:33:31.000 | or something close to their,

00:33:33.000 | where do they price them to not alienate

00:33:35.000 | the existing mutual fund investors

00:33:37.000 | yet appeal to the low cost obsessed ETF type investors?

00:33:40.000 | So this is a real puzzle they're gonna have to deal with.

00:33:42.000 | I'm curious to see what they do.

00:33:44.000 | - Well, speaking of the future,

00:33:46.000 | first off, how many ETFs are there now in the US alone?

00:33:51.000 | I mean, how many do we have?

00:33:53.000 | - Okay, well, I can give you an exact figure.

00:33:56.000 | It's gonna be around 2,200.

00:33:58.000 | Well, I'm here with my steady terminal, 2,369 in the US.

00:34:03.000 | - And do you-- - Worldwide?

00:34:08.000 | - Well, sure, worldwide, sounds good, go ahead.

00:34:11.000 | - I'm gonna guess 8,000, let's see what the survey says here.

00:34:14.000 | Probably gonna be, 'cause it's interesting,

00:34:17.000 | the US only has about a quarter of all the global ETFs,

00:34:20.000 | but we have about 70% of the assets.

00:34:23.000 | It's a huge market in terms of assets.

00:34:27.000 | And we have about 85% of the volume.

00:34:29.000 | So a lot of the action is here,

00:34:31.000 | but there's products galore in other countries.

00:34:35.000 | - So I've heard that the number of--

00:34:39.000 | - The answer is 8529. - Oh, okay.

00:34:41.000 | - So 8,529 worldwide.

00:34:43.000 | - So screening these things could be a real issue.

00:34:46.000 | I've heard that with index mutual funds

00:34:51.000 | and ETFs that are tracking indexes now,

00:34:54.000 | equity indexes, that there are more equity index mutual funds

00:34:59.000 | and more equity index ETFs than there are stocks

00:35:04.000 | on the US Stock Exchange, is that true?

00:35:06.000 | - Oh, yeah, this chart, I put this in a bit once.

00:35:12.000 | I took the number from Sanford Bernstein

00:35:14.000 | that there was, I don't know, something like 7,000 indexes,

00:35:18.000 | and it was a huge spike up.

00:35:20.000 | You can imagine almost like a hockey stick growth

00:35:22.000 | in the number of indexes.

00:35:23.000 | So what we did is we took that chart, referenced them,

00:35:26.000 | and we put the number of stocks on top of it.

00:35:29.000 | And you can see the number of indexes

00:35:30.000 | just fly right past the number of stocks.

00:35:32.000 | Everybody went wild.

00:35:34.000 | Even Gunlock commented on this on Twitter.

00:35:36.000 | It was just a chart that just struck a nerve

00:35:41.000 | or a cord with people.

00:35:43.000 | I think a nerve is better,

00:35:45.000 | in terms of indexes taking over.

00:35:46.000 | A couple things.

00:35:47.000 | A, according to that number of 7,000,

00:35:50.000 | there's more mutual funds than stocks, too,

00:35:53.000 | and nobody cares.

00:35:54.000 | And to quote Meb Faber,

00:35:55.000 | there's also more words than letters.

00:35:58.000 | And for some reason, nobody has a problem with that.

00:36:01.000 | In other words, there's so many stocks,

00:36:03.000 | there's so many combinations you can make,

00:36:05.000 | it doesn't matter.

00:36:06.000 | And there's an index association group,

00:36:08.000 | I forget the exact name,

00:36:09.000 | but they claim there's 2.7 million indexes.

00:36:12.000 | So that number from Sanford Bernstein

00:36:14.000 | was actually way underdoing it.

00:36:16.000 | A lot of indexes have many versions,

00:36:18.000 | but largely you could have a billion indexes.

00:36:21.000 | Most of the money is going to be connected

00:36:23.000 | to a small, tiny portion of those anyway.

00:36:25.000 | Most of them are just meaningless.

00:36:28.000 | So you could go ahead and design,

00:36:30.000 | if a statistician or a mathematician

00:36:33.000 | were to take the number of stocks

00:36:35.000 | and figure out how many different combinations

00:36:37.000 | you could have,

00:36:38.000 | I bet the number is infinity.

00:36:39.000 | So, you know, it doesn't really matter.

00:36:42.000 | It's just more, look, it's a sign of the times.

00:36:44.000 | It strikes to the fears people have

00:36:46.000 | of passive sort of like taking over.

00:36:48.000 | And that's what that chart did,

00:36:49.000 | but it was much more optic than reality.

00:36:52.000 | - Now, you said that a lot of these funds

00:36:55.000 | don't have a lot of money in them.

00:36:57.000 | And I think somebody once referred to them

00:36:59.000 | as zombie funds, where they're the walking dead.

00:37:02.000 | So what happens when one of these funds

00:37:04.000 | doesn't make it and it closes?

00:37:05.000 | I mean, how do people get their money out?

00:37:07.000 | Is it a taxable event?

00:37:08.000 | How does that work?

00:37:10.000 | - Yeah, that's the problem is you will,

00:37:12.000 | if it went up, you'll get hit with a tax bill on that.

00:37:15.000 | You don't lose your money.

00:37:16.000 | I mean, and yeah, you're right.

00:37:17.000 | There's a lot of ETFs to close.

00:37:18.000 | In fact, if you look at all the ETFs

00:37:20.000 | in the US ever launched,

00:37:21.000 | about a quarter of them have closed.

00:37:24.000 | That's a pretty high number.

00:37:25.000 | You know, this year we're looking at closers

00:37:27.000 | that may rival a record.

00:37:29.000 | It could be close,

00:37:30.000 | but a lot of issuers will just close them

00:37:33.000 | if they don't work.

00:37:34.000 | The good news is hardly anybody's in them

00:37:35.000 | if they close them.

00:37:36.000 | So you're probably not owning the ones that close,

00:37:38.000 | but let's say you do.

00:37:39.000 | The problem isn't that you lose your money.

00:37:41.000 | The problem is you would get hit with a tax bill.

00:37:43.000 | Either you sell it and it's at a gain.

00:37:46.000 | So there you go.

00:37:47.000 | Or if you just forget,

00:37:48.000 | they'll cash everybody out at the NAV that day.

00:37:51.000 | So the tax consequence is the reason

00:37:55.000 | that there's a "closure risk" in ETFs,

00:37:57.000 | but it's not credit risk per se.

00:38:00.000 | And it's important to distinguish the two.

00:38:04.000 | But this is part of the reason

00:38:06.000 | why there's people are nervous,

00:38:07.000 | advisors in particular,

00:38:08.000 | about going into ETFs that don't have a lot of assets.

00:38:11.000 | And so welcome to the plight of the small issuer,

00:38:14.000 | especially the indie issuer

00:38:15.000 | that doesn't have a big distribution.

00:38:17.000 | That's why you see some of them going to zero fee

00:38:19.000 | and trying to lure you in in other ways

00:38:22.000 | because they know how hesitant people are

00:38:24.000 | to buy ETFs that don't have, say,

00:38:26.000 | like over 50 million in assets or 100 million.

00:38:29.000 | It's hard out there.

00:38:30.000 | And there's currently, I don't know,

00:38:32.000 | about half of all ETFs are probably under 100 million.

00:38:36.000 | - Is that the breakeven point, do you think,

00:38:38.000 | for a new ETF, 100 million?

00:38:42.000 | - I've heard 50, 30 to 50 is like the breakeven.

00:38:45.000 | We consider 50 probably like you won't close.

00:38:48.000 | If you look at the average closure size,

00:38:50.000 | it's about 30 million.

00:38:51.000 | So we think, okay, if you're at 50,

00:38:53.000 | you're probably not going anywhere

00:38:54.000 | 'cause you're probably like breakeven at least.

00:38:56.000 | If you're 100, you're officially in the middle class.

00:38:59.000 | We consider the middle class to be 100 to a billion.

00:39:03.000 | And then once you're over a billion,

00:39:05.000 | you're rich, you're elite.

00:39:07.000 | You're the top 10%.

00:39:08.000 | - Okay.

00:39:09.000 | - And so about half of the ETFs

00:39:12.000 | are below that middle class line.

00:39:14.000 | And about half of those are in the danger zone,

00:39:18.000 | which is 30 million or less,

00:39:20.000 | which are the most at risk of closing.

00:39:22.000 | Yeah, there's a ton of them.

00:39:23.000 | Like 500 are probably in that danger zone.

00:39:26.000 | - As an investor, if I am looking at an ETF,

00:39:30.000 | do you think that that should be one of my criteria,

00:39:34.000 | that it has at least 50 million?

00:39:37.000 | Or if it doesn't,

00:39:38.000 | I know that I'm taking more risks somewhere.

00:39:40.000 | - I don't want to ever say

00:39:41.000 | you should never look at small ETFs

00:39:43.000 | because some people think

00:39:44.000 | that if there's not a lot of volume or assets,

00:39:47.000 | then you can't actually even trade it.

00:39:49.000 | But the fact is you could put a limit order

00:39:51.000 | and probably get a decent price

00:39:52.000 | because there's never a liquidity risk

00:39:55.000 | to being in a small ETF.

00:39:56.000 | Again, a market maker

00:39:57.000 | or somebody could always do a creation.

00:39:59.000 | Like, but there is the closure risk.

00:40:01.000 | If getting that tax bill is that annoying to you,

00:40:05.000 | and it's, you just say,

00:40:07.000 | how much is this strategy interesting to me?

00:40:09.000 | 'Cause keep in mind,

00:40:10.000 | a lot of the innovation in the financial world

00:40:13.000 | is in the ETF market.

00:40:14.000 | I call it the Silicon Valley of investments

00:40:16.000 | because a lot of PhDs,

00:40:18.000 | a lot of smart people are putting products out.

00:40:20.000 | They may not have 50 million for a couple of years,

00:40:23.000 | but you may love the product.

00:40:24.000 | I would say, okay, well, how much do I love it?

00:40:27.000 | Is it worth the potential of this tax bill?

00:40:29.000 | There's a percentage chance that it could close

00:40:32.000 | and you have to weigh that.

00:40:33.000 | But I wouldn't necessarily not go into a small product

00:40:36.000 | because you feel like in like an equity,

00:40:39.000 | you could get stuck.

00:40:40.000 | I don't really see that

00:40:41.000 | as the spread could be a little wider.

00:40:43.000 | But again, as long as you use a limit order

00:40:46.000 | in trading these smaller ETFs, you're probably fine.

00:40:48.000 | So I also have a soft spot for the indie smaller issuers.

00:40:52.000 | I think a lot of them are so overwhelmed

00:40:55.000 | by BlackRock and Vanguard.

00:40:56.000 | It's tough, but there's a lot of good ideas.

00:40:58.000 | A lot of the innovation happens with smaller issuers

00:41:02.000 | that are closer to their markets.

00:41:04.000 | And so some of the best products are coming out

00:41:06.000 | from the small guys

00:41:07.000 | and it takes them a couple of years to get to 50 million.

00:41:09.000 | So I don't wanna say make that a hard rule,

00:41:11.000 | but just understand that closure risk tax bill possibility.

00:41:16.000 | - Just wanna remind listeners

00:41:17.000 | that Eric's book is called "The Institutional ETF Toolbox."

00:41:22.000 | And it has a lot of this screening, due diligence,

00:41:26.000 | explanation of cost and spreads and when to trade

00:41:30.000 | and a lot of good information in the book.

00:41:32.000 | So let's talk about the future.

00:41:35.000 | A lot of things have happened.

00:41:36.000 | It used to be a lot harder to issue an ETF,

00:41:39.000 | let's say if I decided Rick Ferry wanted

00:41:41.000 | to issue some balanced ETFs.

00:41:44.000 | I bring that up because there are so few balanced ETFs

00:41:48.000 | out on the marketplace

00:41:49.000 | that are just a basket of balanced funds.

00:41:52.000 | - Let's go into this a minute.

00:41:54.000 | This is a fascinating question.

00:41:56.000 | - Okay.

00:41:57.000 | - 'Cause my podcast host, Joel Weber always says,

00:42:00.000 | why isn't there an ETF with the ticker easy

00:42:03.000 | that just holds everything?

00:42:05.000 | And I'm like, they exist.

00:42:07.000 | They're called asset allocation.

00:42:08.000 | BlackRock has a couple, but they have almost no assets.

00:42:13.000 | I mean, BlackRock's have a couple billion,

00:42:15.000 | but for them that's small, but it's a small category.

00:42:18.000 | The reason, and I'm pretty sure this is my theory,

00:42:21.000 | but I'm pretty sure I'm right,

00:42:22.000 | advisors are the biggest consumers of ETFs

00:42:25.000 | and advisors want to be the pickers.

00:42:27.000 | And once you, if the advisor shows up

00:42:29.000 | with just one product on their sheet,

00:42:32.000 | that may not go over well.

00:42:33.000 | So I think that's largely the reason why,

00:42:36.000 | plus when you go balanced, it's a one size fits all

00:42:40.000 | and not everybody has the same needs

00:42:42.000 | as the way that balanced fund does it.

00:42:44.000 | You think that's a good theory?

00:42:45.000 | I'm curious to get your thoughts.

00:42:46.000 | - No, I think the first part of that is absolutely correct.

00:42:49.000 | I mean, advisors don't want to give up control

00:42:52.000 | of doing something in an account.

00:42:54.000 | And if they can take a four funds, five funds, 12 funds,

00:42:58.000 | 15 funds and put it in a portfolio and make it complex,

00:43:01.000 | it gives them a reason for being

00:43:03.000 | 'cause then they can rebalance it.

00:43:04.000 | And people get a statement

00:43:06.000 | that has a whole bunch of things on it.

00:43:08.000 | And it looks like the advisor's doing something

00:43:11.000 | and therefore the advisor should get paid a fee.

00:43:13.000 | In reality though, if the client on their own

00:43:17.000 | went out and bought a balanced ETF

00:43:20.000 | that has four or five basic index funds in it,

00:43:24.000 | the client would do just fine.

00:43:27.000 | So where you're talking about the ETF marketplace

00:43:30.000 | is focusing on advisors.

00:43:32.000 | This product, this balanced product that I'm talking about

00:43:36.000 | would focus on a new and huge potential market.

00:43:41.000 | And that is the individual investor

00:43:43.000 | who is embracing ETFs faster

00:43:46.000 | than I think the market and the ETF companies

00:43:50.000 | really understand.

00:43:52.000 | From my business, and I deal with

00:43:54.000 | almost all do-it-yourself investors,

00:43:57.000 | they're buying ETFs.

00:43:59.000 | And they would really like to have balanced ETFs

00:44:03.000 | for the small accounts.

00:44:05.000 | To me, there's a market there,

00:44:07.000 | but it's not the traditional market of institution.

00:44:10.000 | It's not the traditional market of advisor.

00:44:12.000 | It's a new and huge market

00:44:14.000 | of direct to the do-it-yourself investor.

00:44:17.000 | - Yeah, I think you're,

00:44:18.000 | well, you're definitely onto something

00:44:19.000 | with the do-it-yourself individual investor.

00:44:22.000 | That is an area that is growing.

00:44:24.000 | All the research shows that.

00:44:25.000 | We heard some anecdotal data from BlackRock about that.

00:44:28.000 | I think the number I heard is the percentage,

00:44:31.000 | this is ballpark, but some people ask me,

00:44:32.000 | "Who owns the ETF?"

00:44:34.000 | And, you know, it's roughly can break down

00:44:37.000 | like 10% institutions,

00:44:39.000 | depends on how you define institution,

00:44:41.000 | but then maybe 15% do-it-yourself retail,

00:44:44.000 | the rest is advisors.

00:44:45.000 | So a lot of times when I do my analysis,

00:44:47.000 | I default to advisors

00:44:49.000 | because they are the majority of the users.

00:44:52.000 | But you're right, that direct,

00:44:53.000 | especially with the commission-free trading,

00:44:55.000 | I'd only imagine that category is going to grow.

00:44:57.000 | - Absolutely, it's huge.

00:44:58.000 | It's huge.

00:44:59.000 | I don't really, again,

00:45:00.000 | I sometimes talk to ETF providers and say,

00:45:04.000 | "Hey, why don't you launch this or that type of fund?"

00:45:08.000 | Because it seems there would be a market for it.

00:45:10.000 | I remember back in the 1990s, early 2000s,

00:45:14.000 | I said, "Hey, why don't you do factor ETFs?

00:45:16.000 | "Why don't you have value and growth and quality

00:45:19.000 | "and this and that?"

00:45:21.000 | And they said, "That'll never fly."

00:45:22.000 | That was back in early 2000s.

00:45:25.000 | Anyway, seven, eight years later,

00:45:27.000 | there's factor funds everywhere.

00:45:28.000 | And now I'm saying,

00:45:29.000 | "Well, why don't you do balanced ETFs?"

00:45:31.000 | Because this market out there,

00:45:32.000 | this huge individual investor market,

00:45:34.000 | do-it-yourself market, would use them.

00:45:37.000 | And they would appreciate them,

00:45:38.000 | especially if there was some tax advantages to doing it.

00:45:42.000 | But I throw that out there.

00:45:43.000 | I'm not going to do it myself.

00:45:45.000 | But in addition to that,

00:45:46.000 | SEC has just made it easier for companies to issue ETFs.

00:45:52.000 | They no longer need this thing called exemptive relief.

00:45:54.000 | And could you go through some of the regulation changes

00:45:57.000 | that have taken place?

00:45:58.000 | - It speeds up the length

00:46:00.000 | and shrinks the cost for launching.

00:46:03.000 | So it expedites the launching of ETFs.

00:46:06.000 | And it was long overdue.

00:46:08.000 | There was no reason to have this exemptive relief,

00:46:09.000 | especially as ETFs got to multiple trillions in assets.

00:46:13.000 | At one point, I think there was 1,200 ETFs filed.

00:46:16.000 | But this comes,

00:46:18.000 | this would have sped up launches 10 years ago.

00:46:21.000 | I don't think it does much today.

00:46:23.000 | I think that over the last 10 years,

00:46:25.000 | you know, this is why I call the ETF industry the pterodome.

00:46:28.000 | It is absolutely brutal.

00:46:30.000 | The investors are so cost-obsessed,

00:46:33.000 | and they will sell you out for like one basis point.

00:46:36.000 | And we have a chart we call the cost obsession thermometer.

00:46:41.000 | And we just look at the percentage of flows

00:46:44.000 | going to ETFs that charge 20 basis points or less.

00:46:47.000 | That number this year is at an all-time high, 98%.

00:46:51.000 | Last year it was 96%.

00:46:53.000 | If you throw in index funds, you go to 99%.

00:46:56.000 | So it is really unbelievable.

00:46:58.000 | And sometimes the fund will come

00:47:00.000 | and cut a fee by one basis point

00:47:03.000 | and actually can move the needle in flows.

00:47:05.000 | So I think over this year especially,

00:47:08.000 | a lot of people in the pipeline

00:47:10.000 | might think twice before launching

00:47:12.000 | because of just how utterly difficult it is to find success.

00:47:17.000 | And I think that is why this will not do much.

00:47:20.000 | Or I would say this rule might bring up some people

00:47:24.000 | who might have, you know, make it easier

00:47:26.000 | and might attract some new issuers.

00:47:29.000 | But at the same time,

00:47:31.000 | the increasing brutality of the market,

00:47:34.000 | I think, will scare an equal or more amount away.

00:47:38.000 | So you might have even net less launches going forward,

00:47:41.000 | even with the rule.

00:47:42.000 | Although 10 years ago,

00:47:43.000 | I think this would have really expedited launches.

00:47:45.000 | I don't think it does much now.

00:47:47.000 | What about the new rule on non-transparent ETFs?

00:47:52.000 | Presidian funds, LLC, active share, ETF structure.

00:47:56.000 | This is all very new, where in the past,

00:47:59.000 | you had to disclose every day what you had in your ETF.

00:48:02.000 | Now, under this new structure, you don't have to anymore.

00:48:06.000 | Is this going to change things for the active managers?

00:48:11.000 | They hope so.

00:48:12.000 | When you look at the active mutual fund space,

00:48:15.000 | active fixed income mutual funds,

00:48:17.000 | they're seeing over $100 billion in inflows this year.

00:48:20.000 | So as long as rates remain steady or low,

00:48:23.000 | I think active fixed income mutual funds are dandy.

00:48:26.000 | They will probably just continue to launch

00:48:28.000 | the occasional transparent active fund.

00:48:30.000 | On the equity side,

00:48:31.000 | a lot of the managers are hesitant

00:48:33.000 | to put their secret sauce out there in an ETF

00:48:35.000 | that shows their holdings every day.

00:48:37.000 | I think they're overestimating how much people care

00:48:40.000 | in terms of both front running

00:48:42.000 | and just copying their holdings.

00:48:44.000 | I don't know if there's that much interest in doing that.

00:48:48.000 | But anyway, it's their livelihood, right?

00:48:51.000 | They don't want to share their stocks and their weighting.

00:48:54.000 | So there's a couple of different models of ETF structures

00:48:58.000 | that will have a fund trade on exchange,

00:49:00.000 | but without showing the holdings every day.

00:49:02.000 | That way they can have some degree of secrecy

00:49:05.000 | while at the same time benefiting from a lower cost,

00:49:08.000 | overall expense ratio, and tax efficiency,

00:49:11.000 | which is huge, as you mentioned earlier.

00:49:13.000 | So there's a couple of different models.

00:49:15.000 | Some will have like a special representative

00:49:18.000 | who will work with the AP, like a blind trust.

00:49:21.000 | And some will have a proxy portfolio

00:49:24.000 | where the stocks are very close

00:49:26.000 | to what the manager holds or correlated,

00:49:29.000 | but not what they hold.

00:49:30.000 | And so there's a couple of different ideas

00:49:32.000 | on how to do this.

00:49:33.000 | And SEC just approved the first one,

00:49:35.000 | which is the Presidian model.

00:49:36.000 | I expect the other ones to be approved at some point.

00:49:38.000 | And so you have companies like J.P. Morgan, BlackRock,

00:49:41.000 | T. Rowe Price, the list goes on.

00:49:44.000 | American Century, I think,

00:49:45.000 | is the first one who's going to come out next year.

00:49:47.000 | Monster active managers,

00:49:50.000 | hoping this is a way for them to participate

00:49:53.000 | in this sort of new world of ETFs

00:49:56.000 | without having to show their holdings every day.

00:49:58.000 | I'm pretty bearish on it,

00:49:59.000 | but this is what they think might help

00:50:02.000 | stop some of the bleeding

00:50:03.000 | on the active equity mutual fund side

00:50:06.000 | and help them regain some of the customers

00:50:09.000 | that they might be losing.

00:50:11.000 | - Okay, one last question,

00:50:12.000 | and that has to do with the new thing out there,

00:50:16.000 | which is ESG,

00:50:19.000 | Environmental, Social, and Governance ETFs,

00:50:22.000 | which are the new, new thing,

00:50:24.000 | the old, new thing being smart beta.

00:50:27.000 | And I guess the old, old thing being just beta,

00:50:29.000 | which is still collecting the most money.

00:50:31.000 | So we went from beta,

00:50:32.000 | which is still doing well,

00:50:33.000 | to smart beta, which seemed to have slowed down.

00:50:36.000 | And now everybody is ESG-ing.

00:50:39.000 | How does the landscape look for ESG investors?

00:50:44.000 | - Okay, so there's two ways to look at ESG ETFs.

00:50:49.000 | If you look at them isolated,

00:50:51.000 | you could go, okay, well,

00:50:52.000 | ESG ETFs went from 6 billion to 15 billion this year.

00:50:55.000 | They more than doubled their assets.

00:50:58.000 | They're growing faster than everything else.

00:51:01.000 | Okay, fine.

00:51:02.000 | But 15 billion is, what is that?

00:51:05.000 | That's 0.5% of all ETF assets.

00:51:07.000 | So it's microscopic.

00:51:09.000 | And it's microscopic compared to the hype, especially.

00:51:13.000 | There's always articles on ESG.

00:51:15.000 | - What?

00:51:16.000 | Oh, I like your tongue.

00:51:18.000 | - The hype around ESG, the press is good.

00:51:22.000 | You know, look, a lot of the media is based in Manhattan.

00:51:25.000 | I think this is an issue that's important to them.

00:51:27.000 | I don't know how much of the rest of the country

00:51:29.000 | cares about ESG investing.

00:51:31.000 | There's some disconnect.

00:51:32.000 | I've seen it happen.

00:51:33.000 | There's a disconnect that happens a lot

00:51:34.000 | with what the media world might consider important

00:51:38.000 | and what actually investors care about.

00:51:40.000 | And I think ESG may fall in that gap.

00:51:42.000 | Because given the media coverage and the years,

00:51:45.000 | they've been out for 10 years now,

00:51:47.000 | 15 billion isn't that much.

00:51:48.000 | Although again, you gotta give them credit for growing.

00:51:50.000 | So I'm not sure how much actual raw demand is there.

00:51:53.000 | The problem with ESG is that it's subjective.

00:51:55.000 | I don't think any two people

00:51:56.000 | would have the same exact criteria

00:51:58.000 | of what should be in or out of their ESG ETF.

00:52:01.000 | So it might not fit what you want.

00:52:04.000 | And some ESG funds have Exxon.

00:52:06.000 | Some don't, right?

00:52:07.000 | A lot don't.

00:52:08.000 | Vanguard might do it one way.

00:52:09.000 | They might include alcohol.

00:52:10.000 | But you may be fine with alcohol.

00:52:12.000 | This is where the subjectivity also, I think,

00:52:14.000 | is a headwind with ESG.

00:52:16.000 | The good news for ESG

00:52:17.000 | and what I thought caused the bump up

00:52:19.000 | is Vanguard coming out and vanguarding the category.

00:52:22.000 | They came in cheap.

00:52:23.000 | And now the rest of the launches since then,

00:52:25.000 | for the most part, have come in cheap.

00:52:27.000 | So there's now a lot of ESG ETFs

00:52:28.000 | that are well below 20 basis points,

00:52:30.000 | which is that magic number where all the flows go.

00:52:32.000 | So I think that helped a lot.

00:52:34.000 | And as long as they're dirt cheap,

00:52:35.000 | they have a fighting chance, I think, to get flows.

00:52:38.000 | But I'm yet to see real money.

00:52:41.000 | When you said smart beta, let me just give you a compare.

00:52:44.000 | Smart beta ETFs have $920 billion.

00:52:47.000 | Whatever, what's 15 into $920?

00:52:51.000 | I don't know.

00:52:52.000 | Whatever that is.

00:52:53.000 | I'm a CFA, but I would have to get out my calculator

00:52:56.000 | and take a look.

00:52:57.000 | It's probably 30 or 40 times the amount of assets of ESG.

00:53:02.000 | So that's my quick take on that.

00:53:05.000 | But millennials apparently are the generation

00:53:09.000 | that's most interested in them, according to surveys.

00:53:11.000 | But again, I also think the surveys might be overhyped

00:53:15.000 | because who is going to answer on a survey

00:53:18.000 | they're not into ESG and risk being judged?

00:53:21.000 | So I think that the numbers on the surveys

00:53:23.000 | might be higher than reality because people fear

00:53:26.000 | of being the person who doesn't care about ESG.

00:53:29.000 | I always tell people, if you're really into ESG,

00:53:32.000 | why would you not want to own the companies

00:53:34.000 | that you think could be better?

00:53:35.000 | What you should do is just buy a passive index fund

00:53:38.000 | like from Vanguard or BlackRock or State Street

00:53:41.000 | because those corporate governance groups,

00:53:44.000 | once you own the whole index, you're now basically

00:53:46.000 | giving your money to Vanguard or BlackRock's

00:53:48.000 | corporate governance group to go and vote

00:53:50.000 | and they're very ESG oriented.

00:53:52.000 | So I always say that like active managers are out there.

00:53:55.000 | They are concerned about the products and the profits.

00:53:58.000 | And then the rest of the ownership is passive.

00:54:00.000 | They're concerned about ESG.

00:54:01.000 | So I find that's actually like those two things

00:54:04.000 | can live in harmony.

00:54:05.000 | But if you buy the whole index, you own everybody

00:54:07.000 | and you own BlackRock's voting on all those companies,

00:54:10.000 | including the bad actors.

00:54:11.000 | So I would argue that the ESG route might just be

00:54:14.000 | to own the whole market via the index

00:54:17.000 | and give them your votes.

00:54:18.000 | - The large holders of total market index funds

00:54:23.000 | like Vanguard and BlackRock have a ESG responsibility?

00:54:26.000 | I didn't know that.

00:54:27.000 | Could you explain that?

00:54:29.000 | - Yeah, so BlackRock seems to be a little more aggressive

00:54:33.000 | with things like issues like gun control and climate change,

00:54:36.000 | but they're all really interested

00:54:38.000 | in corporate governance.

00:54:40.000 | For example, Vanguard has six principles

00:54:43.000 | for good corporate governance,

00:54:45.000 | including things like independent oversight,

00:54:47.000 | a board accountability, shareholder voting rights

00:54:51.000 | consistent with economic interests,

00:54:53.000 | annual director elections and minimal anti-takeover devices,

00:54:57.000 | sensible compensation tied to performance,

00:54:59.000 | shareholder engagement.

00:55:00.000 | So I think when it comes to Vanguard,

00:55:03.000 | none of that is, "Hey, make me more money."

00:55:06.000 | But I think they're saying,

00:55:07.000 | "Look, if we set up the right parameters,

00:55:10.000 | it gives the company the best chance to be successful."

00:55:13.000 | So I think they're focused more on the G of ESG

00:55:17.000 | and just trust them to vote in the ESG,

00:55:19.000 | to push for ESG policies within those companies.

00:55:22.000 | But that's up to how investors wanna play it.

00:55:26.000 | - Thank you, Eric.

00:55:27.000 | You've been extremely helpful

00:55:29.000 | and very knowledgeable about the ETF marketplace

00:55:33.000 | and looking forward to a lot of great things.

00:55:36.000 | I remember when we first met at a conference

00:55:39.000 | and first heard you speak,

00:55:41.000 | and I knew you were gonna go places,

00:55:43.000 | and you certainly have.

00:55:45.000 | So looking forward to a lot more from you in the future.

00:55:48.000 | Thanks for being on the show.

00:55:49.000 | - Yeah, thanks for having me

00:55:50.000 | and look forward to having you back on ETF IQ again.

00:55:53.000 | - Oh, thanks. Appreciate it.

00:55:55.000 | - This concludes the 15th episode

00:55:57.000 | of "Bogleheads on Investing."

00:55:59.000 | I'm your host, Rick Ferry.

00:56:01.000 | Join us each month to hear a new special guest.

00:56:05.000 | In the meantime, visit bogleheads.org

00:56:08.000 | and the Bogleheads Wiki.

00:56:10.000 | Participate in the forum

00:56:12.000 | and help others find the forum.

00:56:14.000 | Thanks for listening.

00:56:16.000 | [upbeat music]

00:56:19.000 | ♪

00:56:24.000 | (upbeat music)

Bogleheads® on Investing Podcast 015 – Eric Balchunas, host Rick Ferri (audio only)

Chapters