Unraveling the Truth About ETFs: Benefits, Analysis, and the Indexing Bubble Myth
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What kind of money for the rest of us? This is a personal financial on money, how IT works, how to invest IT and how to live without worrying about IT. And your host David stein today is episode four sixty seven.

It's titled how to analyze etf to make Better investment decisions. Last week upset four sixty six on dividend investing. I referred red to an observation by morning star that since the beginning of twenty fourteen, investors have withdrawn one point nine trillion dollars from stock mutual funds.

At the same time, they've added two point nine trillion dollars to stock exchange traded funds, an open image fund, and E, T, S are investment vehicles. They are a means to invest in various asset beat, stocks, bonds, real estate and many, many other need strategies to this helps going to take a look at fun flows into fines and T S. What has changed over the past number of views and y etf have become the preferred investment vehicle for individual investors and even in many cases, institutional investors.

We will see why that is. And because tf have become so dominant and attractive, will look at what how do we go about analyzing the E T S. Because the sheer number of E T S outstanding can be overwhelming.

First, let's take a look at a study by morning star, looking at overall flows into both open and mutual funds. N T. S. The difference between the two is an open and mutual fund doesn't trade on an exchange change, IT trades at the end of the market day, and shares of the open and metro und are bought and sold at the closing net acid value, but different from exchange traded funds which trade throughout the market day, and that trading occurs at a market Price that may differ lightly from the net acid value.

And the net acid value of a mutual fund d or etf is the value of the assets held by that investment vehicle divided by the number of shares outstanding. So that would be the net acid value per share. Now there are market mechanisms in place to keep any T, F praise in line with its net asset value.

If we look at at overall net flows into mutual funds and etf across the world in twenty and twenty two, there was over five hundred billion dollars of outflow from fund in etf. In twenty twenty three, there was a sixty six billion dollar inflow. Let's contrast that to twenty twenty one is coming out of the pandemic or during the pandemic, great deal of liquidity from government programs.

And 备注， those institutions were very polish about buying everything, including stocks, bonds, crypto futures, commodities. Overall net flows in twenty one with two point four trillion dollars, twenty two billion left, and only sixty six billion dollars added in twenty twenty three. If we look at the categories, most categories saw outflows.

The only exception was fixed income. About four hundred billion dollars of flows intersect income. When we talk about these funds, open them to fund any chafts.

IT excludes money market metafiles. And clearly, there was money that went into money market mutual. These are cash equivalent vehicles.

They're not part of the sixty six billion dollars of net inflows into fund to need, T. S. Morning star pointed out.

Because is this idea while there's all this money on the sidelines that potentially could flow in too funds in etf, but they included a chart in the report that i'll linked to in the show notes where IT showed that global money market assets as a percent of long term methods held by investors is seventeen percent. And in the chart that they show IT, IT hasn't really changed. The whole lot is generally had been between fourteen and seventeen percent since twenty thirteen.

So about a decade right around the same percentage. We can compare that to two thousand eight, where money mark metro funds made up forty five percent of long term assets. So there has been a little more flow into money market mutual funds and into bonds in twenty twenty three with flows out of stocks and other assets.

One of the other changes that occurred in twenty and twenty three that morning star points out is that passive investment strategy, sometimes called indexing strategies, that seek to track a specific index, and that index will have rules that are used to construct the index. Those passive strategies slightly surpassed more active strategies. For the first time back in nineteen ninety five, only two percent of assets were passively managed.

Now, at least in the us, is very close to fifty percent. And if we look at U S. Equity and bond outflows year by year by year, there's outflows out of active mutual funds and etf into passive metro funds and e year by year by year, in twenty twenty three alone, two hundred and sixty seven billion dollars left.

The largest active managers, including american funds, lost sixty four billion dollars in assets, fidelity thirty one million. And as as active fund families lose assets, a big portion of the asset are going to etf families. The fun family, including both mutual fund atx with the largest market share, is vanguard, with around a twenty eight percent market share of total U.

S. Assets back in the year two thousand, and they had eleven percent share, much smaller because the act of fund family such as american funds had had a much larger market here. Eyeshades zone by black rock has a ten percent market share now back in the year two thousand, less than one percent.

Same for state street, which owns the spider etf brand, five percent market share now, less than one percent back in the year two thousand. So you've had a big change with big fun families, and we will look at the bigger etf families here in a moment. But activists losing out to passive sixty two percent of pass of investing is in mutual fund.

The rest is in etf. Now earlier, I gave the total market share of vanguard eye e shares and state street that there was a market share of both active and passive. If we just look at the pass of manager who has the largest market chair, that's vanguard with thirty seven percent, followed by eye shares at fifteen percent, then state street at seven percent.

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That's L O N G A N G L outcome long angle dot com. There have been some gainers in the actively manage etf space. Traditionally, when we said etf, we thought of passive management.

The first etf was that the essence t spider that tracked the S M P five hundred index. Most etf initially were etf that tract capitalization waited or size waited indexes, and that still is the bulk of the asset. But there's now actively managed etf that have come on the horizon, which aren't following a specific index.

They're making active decisions, and some of those etf are transparent and disclose their holdings every day. In fact, at this point, most actively managed E, T, S do disclose their holding throughout the trading day in many cases, but at least daily, so that investors can see what is being held. But if we look at the largest accurate managed E T S, there's something interesting about IT, the largest.

And this etf is thirty point five billion dollars an asset, but took in close to thirteen billion dollars just in twenty and twenty three. It's the J P. Morgan equity premium in committee is the largest actively managed etf.

But if you look at what they're doing, they say that they run a defensive equity purfoy lio using bottom up research and then they do an option. They are writing or selling call options to generate income. This is an income strategy with a dividing yield over the past year of almost ten percent, and the S C, C.

IT is seven point nine percent. That's the largest actively manage tf. Most of the return is generated from the income. This is not a traditional stocks selection approach.

When we think of the american funds, for example, these well regarded fun family or our fidelity, the active mutual funds were focused on security selection, seeking to outperform the S M P five hundred or some of their index. The largest actively managed etf isn't so much trying to outperform an index through stocks selection. They just trying to generate income for the shareholders.

If we look at the other largest actively manage etf, seven of them are from dimensional D F A. D F A is is sort of active in they run incredibly diversified funds in a ts with hundreds of holdings. They're active in the sense that there isn't a specific index that they're tracking. But the whole idea of their approaches, some of them are or more value or in IT, but they basically have their selection criteria.

But if it's a factor approach just trying to generate perform and by either value or broad exposure to the market, it's essentially passive, very, very low turnover is just that there isn't necessarily an index that is tracking some of the other advances is is similar to d fa that advantage you a small camp value, one of the largest act, manage tps, credibly diversified. This is not like an active manager with fifty holdings trying to figure out which holds will do Better, Better than the S. M.

P. Five hundred. So we when we talk about what active versus passive IT gets a little model because some of the largest actively managed tf are kind of passive in their approach is just that there isn't an index that they're tracking.

The one large actively managed etf that is in this list is the ark innovation E T. F, with nine point three billion dollars. This is clearly active management try to add value through security selection. And that's when I think of active that's typically what I think of security selection seeking to outperform through security selection.

But many of the strategies and many of the active strategies ATS are more factor based and not focused on security selection and as a result, can get a little model of what is passive versus active. And there's this idea that, well, there's a passive indexing bubble and there's not really consents on. As passive management has gotten a larger and larger share, IT isn't necessarily just going to size way IT indexes.

There are all these other new strategies, division investing, for example, that could be considered passive depending on how it's implemented. I saw a research report that a link to by benari and he did another study, his agents, a model whether the rise and indexing has LED to a pricing bubble where you have more, more funds going to size waited index functionality in whether that's pushing up the Price versus had had not occurred of the underline holdings. And his conclusion, surprisingly, is IT has not he did find that the rise of passive index can lead to more volatility of those underlying holdings.

And he also found what he describes as Price information veness decreased as more assets flow into index funds and passive etf. There's less determine about what's correct Price for the underlying holdings. And this was part of our discussion last week about how Green light capital, for example, David I horn, their approach, they're finding they're buying an underfed company is that under valuation isn't being recognized by market participants.

And so they're having to choose companies where the company management themselves is seeking to reduce the undervaluation through Sherry purchases or increased dividends. And this research, and by paul minority supports that, that is passive investig increases. There's less Price information veness, but that doesn't mean that there's an indexing bubble.

This research suggests that Prices are not any higher for individual securities. And they would be had there are not been the rise and passive management. And that could be because there are so many different strategies that are calling court passive, but following thousands of different indexes with different rules, different factor paches momentum, yield and even other more need strategy.

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That's net sweet dot. Come slash David to get your own KPI checklist. Let's sweet that come slash David. E, T, S, aren't continuing to get a greater market share.

Back twenty years ago when my partners and I launched an asset management division of our advisory firm and used etf to implement the strategy or we called managed portfolio at the time that was kind of found upon because etf and we were an institutional ask manager, why why would you use in etf? But twenty years later, etf are used extensively by institutions, and certainly by because there are Better product compared to open the mutual funds. The overall fees are lower, the cost are lower, the fund families can spend less on shareholder services because investors are buying the etf on a stock exchange.

The secondary market trading is not trading that occur ring with the sponge itself, at least most of the etf trades are not occurring with the sponsor. There's a study by eyeshades so that most of trading in etf is in the secondary market. Now there is primary trading with etf sponsors with authorized participants. They can buy the underlying holdings of etf and they can trade IT with the tf sponsor to exchange IT for shares of the etf. So you have this this trading by authorized to directly with the etf sponsor to create and redeem new shares of the etf.

But most of the trading is in the secondary market, individuals, ying and selling security institutions as well as marketing kers, all to make sure that the market Price of the etf stays very close to the nassif y because of these market participants, the trading costs, the average bid asked spread the difference between the cell Price of etf purchase Price in the U. S. Is about twelve basis point, so very close etf because of the authorized participants, the way that new shares are redeemed and created, that provides an opportunity for etf to keep taxi ability down by exchanging underline holdings with low cost basis with his authorized participants.

We find that T F are a very tax efficient. They're not having to pass on short term and long term capital gains like you typically saw with open their mutual funds. He takes some work being trade.

Now most of us don't need to be trading at very often, but IT is convenient, at least for me psychologically. I want to purchase an etf. I want to sell IT. I can see what the Prices in the market.

I can execute trade and I don't have to wait until the end of the day and have that anxiety of what's onna happen from now until the end of the day that could impact the Price reality. Probably not much happened, but just it's that, that control to be able to sell when I want to sell or buy when I want to buy. And that is an advantage of any T F.

The fees are lower then mutrie und. And the taxes are lower or they're more tax efficient. In the U. S.

There are two hundred thirty five etf families, about fourteen point six two lion dollars and assets, thirty four hundred etf that's up from eighteen hundred and fifty etf in twenty eighteen. Talk about some of the largest black rock band guard state street and vest co. Charles swap first trust, J P.

Morgan based dimensional wisdom try and vanneck make up the ten largest providers and that comprises seventy four percent of etf asset. But if we look at what's going on with etf, it's gone well beyond just size etf. There is more niche sectors we want invest in the global music industry.

There's an etf for. There are are more leverage, E, T, S, and there are more options based income strategy E, T, S. What we've seen is because institutional investors have become more comfortable with etf structure.

There are more institutional tradings to attempts that are available in etf. Rapper, if you can think the strategy, this is probably an etf that mimic that strategy, which is why as individual investors, we need to have an approach to analyzing etf. So we're not overwhelmed.

One reason that we launched asset camp last year and continued to invest in that platform is to provide a the tools and education or individual investors to be able to make well informed decisions about index funds in ATS different strategies. Our approach that we're rolling out next month or asset camp is to be even more specific in what we're calling our monthly system of success will be doing. Webers just showing people how this works and what's going on with the markets.

And IT starts with what happened. If we're wanted to make a portfolio change or wanna understand our portfolio, we need to know what happened in the past and why. And the second thing we need to know is where we know. We understand what the factors were that drove past performance.

What are current conditions? What's the narrative driving market? What is the consensus of investors thinking? Are they overly optimistic? Are they too fearful?

What areas of the stock market are most attracted? What are the risks? That's how I ve approach investing my entire career.

And it's why we create tools to do that, such as acid camp and is certainly these are things we discussed that money for the rest plus. And the third thing then is where we heading. Once we know where market stay in, we can set reasonable expectations for the future.

And then forth, we take action such as to rebaLance our portfolio, but to introduce a new area to invest in. And let's say, we d have found the area that we won investing or someone mentions an etf to us, that looks interesting. Our premium podcast episode money for the restless plus, we look at a lot of different tf strategies and analyze them both to inform how we go about analyzing the tea but also to explore new strategies.

So if you come across a new etf and you're thinking about buying IT, how do you analyze IT first, just like in my book, money for the rest of us, ten questions to matter. The successful investing, we should answer some questions in. The first is what is IT.

Before we invest in anything, including a new T F, we need to be able to explain in simple terms the attribute of that of that investing, be able to explain some of these additional questions, such as how does the etf work. Most E T S either have a White paper, are certainly in the perspective that describes how they go about investing the assets in the etf. This is critical, especially because with over thirty four hundred etf, more monnet strategies, we need to understand how the etf works, what's the expected return? What's the downside risk? How does that work? Third, we need to understand who the sponsor is.

How many access do they have under management? What are some of the other etf that they have? Is this sort of a one off just to see if can attract assets? Or as you look at the different etf families, you realized that they kind of have different themes or approaches.

And some etf families are are comfortable having smaller asset baLances. They might have to V, T, S, all with one hundred million dollars in assets. And they're not at risk of clothing because they are profitable products for the company.

But we need to understand who that spd to is and what's the cost structure in, which is the fourth thing, what are they cost? Whats the management fee? How tax efficient has the etf in? Has IT? Is IT making distributions? If so, are the income to strip tions return of capital or are they capital against distributions? Those are questions we ask about the etf itself.

What is IT? That is a work. Who is the sponsor? What are the cost?

The other three questions have to do with our portfolio and a reasons for buying the etf fit is why you buying IT? Is this for income? Is this A H T F that you wanted buy because you think you to outperform the overall stock market? Are you buying IT to reduce risk? Are you buying IT as an experiment to learn something, to learn a new trading strategy? And you you're just intrigued by what's the store you're telling yourself by buying this etf? We certainly need to know what we're buying, but we ask, ask ourselves, why are we buying? And six is where does that fit in our portfolio? What percent of our portfolio do we intend to put in the C, T, F? Why that percentage?

Is that a large amount is a small how does IT fit within your overall portfolio? Maybe you don't want two dozen holdings in your portfolio, maybe you want to take bigger position. So we need to understand what does IT fit like what additional and does the strategy add? And is is IT meaningful enough to actually add the etf part of entering? Where is the fit? Is asset placement, you know, based on its tax efficiency? Is IT Better to add this new etf to our tax deferred portfolio or to our taxable portfolio? The final question then is what is the time i'm horizon? Under what conditions would we sell this etf or is IT of a long term holdings? So there's there's a framework to analyze T, S.

And i've discussed framework for analyzing the overall market to look at what happened, where we now, where we heading and then they take action. And those actions could be to add a note etf to our portfolio. And to do that, we need to be able describe what IT is, how does that work? Who is the sponge? What are the cost, why we buying IT? Where does that fit in our portfolio and what is our time horizon and our approach for selling the E T S.

There doesn't look cratures gone to be any slowdown in in terms of the number of E T S outstanding, the trends that are in place to more, more E T S, more fun flows out of active management into strategies. But even within the path of strategies, it's muddled because something that is active isn't really stock security base. But IT doesn't have an index that is tracking, but it's incredibly diversified and looks like a passing vehicle with thousands of holing such as the quote, actively managed D F A E P S.

So don't get tripped over whether this is active or passive. Understand the in process of the etf. And I think at this point, we don't to worry about an indexing bubble because there's such a wide variety of approaches that IT doesn't at this point appear to be impacting the pricing more than if we didn't have these index finds because pricing can be driven by psychology of investors, the big magic p tech stocks.

That's not just an indexing thing, that's just desires of people to buy these things out of the A I hype. That ends our discussion on etf, how to analyze them, what's going on with etf market. This is episode four sixty seven.

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