MATT HOUGANManaging DirectorInside ETFs
Presenters:
ETFs 101:
Everything You Need to Know in 60 Minutes or Less
ETFs Are to Mutual Funds…
… As iPhones Are to Rotary Phones
$61,216 $1,209,508
Funds ETFs
Flows Since Financial CrisisMillions Source: Morningstar, ETF.com
ETF Assets Are Soaring
Source: FactSet as of 12/31/2015
0.00
500.00
1,000.00
1,500.00
2,000.00
2,500.00
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Total AUM ($, B)
Why Are ETFs Gaining Share?
Lower Costs
Tax Efficiency
Intraday Trading
Transparency
Access To Anything
An ETF Is …
… like a mutual fund.
It’s structured
It’s managed
It’s regulated
A Mutual Fund With A Twist
Listed on an (like a stock)
Intraday (like a stock)
Exchange
Traded
$10,000
$10,000 $10,000
$10,000
How A Mutual Fund Works
100 @ $100
100 @ $100
100 @ $100
100 @ $100
$40,000
$10,000
$10,000 $10,000
$10,000
How A Mutual Fund Works
$40,000$80,000
100 @ $200
100 @ $200 100 @ $200
100 @ $200100 @ $100
100 @ $100 100 @ $100
100 @ $100
How A Mutual Fund Works
$20,000
$80,000
100 @ $200
100 @ $200 100 @ $200
100 @ $200
$60,000
How A Mutual Fund Works
$60,000
100 @ $200 100 @ $200
100 @ $200$20,000
50 @ $200
$10,000 $70,000
How A Mutual Fund Works
$10,000 of XYZAB Please!
How It Really Works
$10,000 of XYZAB Please!
Broker
How It Really Works
$10,000
702 @ $14.23
Broker
$10,000 of XYZAB Please!
Assets: $120,358,025.58Shares: 8,458,025.58Net Asset Value: $14.23
How It Really Works
100 @ $97.23
$9,723
Broker
100 shares of SPY Please!
How An ETF Works
ETFs, Inc.
?
How An ETF Works
CSCOAAPLCATMSFTIBM
$2.5 million
100K @ $25ETFs, Inc.
AuthorizedParticipant
ETF Anatomy: Creation/Redemption
100K @ $25
IBM
MSFT
AAPL
CAT
CSCO
ETFs, Inc.
AuthorizedParticipant
ETF Anatomy: Creation/Redemption
50K @ $25
AuthorizedParticipant
IBMMSFTAAPLCATCSCOETFs, Inc.
ETF Anatomy: Creation/Redemption
Why Be An AP?
AuthorizedParticipant
$25.00
Fair Value$25.00
$25.00
Fair Value$25.00
AuthorizedParticipant
$25.00
$25.10
Why Be An AP?
Fair Value$25.00
AuthorizedParticipant
$25.00
$25.10
Sell!100K @ $25.10
Why Be An AP?
Fair Value$25.00
$25.00
$25.10
Buy Holdings!
IBM
MSFT
AAPL
CAT
CSCO
AuthorizedParticipant
Why Be An AP?
Selling Pressure
BuyingPressure
AuthorizedParticipant
Fair Value$25.01
$25.01$25.01
Why Be An AP?
Selling Pressure
BuyingPressure
AuthorizedParticipant
Fair Value$25.01
$25.01$25.01
Bought: $25.00Sold: $25.10Margin: $.10
Why Be An AP?
AuthorizedParticipant
$24.90
Buy!100K @ $24.90
Fair Value$25.00
$25.00
Why Be An AP?
AuthorizedParticipant
IBM
MSFT
AAPL
CAT
CSCO
Sell Holdings!
Fair Value$25.00
$24.90
$25.00
Why Be An AP?
AuthorizedParticipant
BuyingPressure
SellingPressure
Fair Value$24.99
Bought: $24.90Sold: $25.00Margin: $.10
$24.99
Why Be An AP?
The Benefits and Risks of ETFsAre Not Accidental
Creation/Redemption Keeps ETF Prices “Fair”
Why Do ETFs Represent 25% Of All Trading Volume, When CEFs Represent Less Than 1%?
Benefit 1: Intraday Trading
Source: Bloomberg as of 03/14/2012
The Beauty of ETFs
Large Cap Equity Mutual Funds: 1.37% Average
Large Cap Equity ETFs: 0.44% Average
ETFs cost fund companies less.So ETFs cost investors less.
Benefit 2: Lower Costs
Source: Morningstar
Active MF Passive MF ETF
Large Cap Blend 1.92% 0.16% 0.00%
Large Cap Value 2.01% 0.08% 0.00%
Large Cap Growth
1.65% 0.04% 0.00%
Mid Cap Blend 4.26% 1.25% 0.00%
Small Cap Blend 3.54% 1.31% 0.00%
Foreign Large Blend
2.50% 0.32% 0.00%
Emerging Market 6.46% 0.02% 0.01%
Benefit 3: Tax Efficiency
Benefit 4: Transparency
Daily Disclosurevs.
“Whenever we want”
1000+ in Registration
1,800+ ETFs285 new in 2015
Benefit 5: Access
Source: Factset of 12/31//2015
Issues With ETFs
Issue: Flash Crash
Rydex S&P 500 Equal-Weight ETF(NYSEArca: RSP)
Issue: Flash Crash
Rydex S&P 500 Equal-Weight ETF(NYSEArca: RSP)
Issue: Commissions
Every transaction has a cost, no matter how low*
*Note new zero-cost commission ETF programs
Issue: Spreads
Liquid Funds = Penny Spreads
Illiquid Funds = > 4% Spreads
Issue: Fair Value
Most ETFs trade close to NAV
But all funds can get out of balance
Product Category Long-Term
Max Rate
Equities 20%
Bonds 20%
Commodity ETFs (Futures) 28%*
Commodity ETNs 20%
Commodity ETFs (Bullion-based) 28%
Currency ETFs 38.6%
Currency ETNs 38.6%
Certain WisdomTree Currency ETFs 20%
Issue: Tax Treatment
Evaluating ETFs
There is No Easy Button
(Can I trust it?)
(Can I trade it?)
(Can I do better?)
Efficiency
Tradability
Fit
Expense Ratios Aren’t Everything
Ticker ERMedian
Tracking Diff.Max
UpsideMax
Downside
IEMG 0.18% -0.07% +0.06% -0.29%
VWO 0.15% -0.14% +0.10% -0.48%
GMM 0.59% -0.67% +1.83% -0.50%
EWEM 0.70% -0.76% +0.46% -2.19%
Expense Ratios Aren’t Everything
Source: FactSet, as of 5/8/2015
Tradability
Over 200 ETFs trade at spreads
of less than 0.05%
Liquidity
Source: FactSet, as of 11/7/2014
Commission Free Trading
Source: FactSet, as of 12/31/2014
0.00%
0.10%
0.20%
0.30%
0.40%
0.50%
0.60%
0.70%
0.80%
0.90%
1.00%
REZ FNIO FTY RTL IYR ICF RWR VNQ
REIT Expense Ratio
Expense Ratio
What’s The True Cost?
Source: Prospectuses, IndexUniverse as of 06/30/2012
-0.20%
0.00%
0.20%
0.40%
0.60%
0.80%
1.00%
REZ FNIO FTY RTL IYR ICF RWR VNQ
ER & Tracking Difference & Spreads
Expense Ratio Annual Tracking Difference Spread
What’s The True Cost?
Source: Prospectuses, IndexUniverse as of 06/30/2012
What’s The True Cost?
0.00%
0.10%
0.20%
0.30%
0.40%
0.50%
0.60%
0.70%
0.80%
0.90%
1.00%
REZ FNIO FTY RTL IYR ICF RWR VNQ
Total Cost For Annual Round Trip
Total Cost Expense Ratio
Source: Prospectuses, IndexUniverse as of 06/30/2012
Fit
The Worst Gold Miner ETF
The Best Gold Miner ETF
All Gold Miner ETFs
Not All ETFs Are Created Equal
7 general Utilities ETFs, over 1 year
8% difference in return
Source: FactSet, as of 12/31/2014
Complex ETFs
ETF Issue: Complex ETFs
How Leveraged/Inverse Funds Really Work
Day 1: Index Level: 100-200% ETF Level: 100
Day 2: Index up 10%Index Level: 110-200% ETF Level: 80
Day 3: Index down 10%Index Level: 99-200% ETF Level: 96
-110%
-90%
-70%
-50%
-30%
-10%
10%
30%
1/29/2009 1/29/2010 1/29/2011 1/29/2012 1/28/2013 1/28/2014 1/28/2015
VIX Index VXX
ETF Issue: Toxic ETFsNet Inflows: >$7 BillionAUM: <$700 Million
Source: Bloomberg, FactSet, AS OF 5/8/2015
Conclusion
$-
$2,000
$4,000
$6,000
$8,000
$10,000
$12,000
$14,000
$16,0001
99
3
19
95
19
97
19
99
20
01
20
03
20
05
20
07
20
09
20
11
20
13
20
15
20
17
20
19
20
21
20
23
Bil
lio
ns
Hougan/Nadig Forecast of ETF Growth
Source: Blackrock & FactSet, as of 12/31/2015
Asset Class Weight Fund Ticker ER
U.S. Equity 40% iShares Core S&P Total U.S. Market ITOT 0.03%
Developed Equity
30% Schwab International Equity SCHF 0.08%
Emerging Markets Equity
5% Schwab Emerging Markets Equity SCHE 0.14%
Fixed Income 15% Schwab U.S. Aggregate Bond SCHZ 0.05%
REITs 5% Schwab U.S. REIT SCHH 0.07%
Commodities 5%UBS E-TRACS DJ-UBS Commodity
ETNDJCI 0.50%
All-In Costs 0.08%
Why? Mostly, Because You Can Do This
Any Questions?
Special Topics
Currency Hedging
What Does This Headline Mean To You?
“
“
If you’re a U.S. Investor, your returns are:
A) Up 9%
B) Up More Than 9%
C) Up Less than 9%
D) There’s No Way To Know
“
“
If the pound is up 5% that year against the dollar, your returns are:
A) Up 9%
B) Up 14%
C) Up 4%
D) There’s No Way To Know
Japan Hedged
-15
-10
-5
0
5
10
15
20
11/14/2013 11/14/2014
Pe
rce
nt
Re
turn
EWJ DBJP
-8
-6
-4
-2
0
2
4
6
8
10
11/14/2013 11/14/2014
Pe
rce
nt
Re
turn
DBEF EFA
EAFE Hedged
-25
-20
-15
-10
-5
0
5
10
15
20
11/14/2013 11/14/2014
Pe
rce
nt
Re
turn
DBBR EWZ
Brazil Hedged
Smart Beta?
Occasional Strong Performance
-5
0
5
10
15
20
25
11/14/2013 11/13/2014
Pe
rce
nt
Ret
urn
CSM MSCI Large Cap
-5
0
5
10
15
20
1/2/2012 12/31/2012
Pe
rce
nt
Ret
urn
CSM MSCI Large Cap
Occasional Strong Performance
-500
-400
-300
-200
-100
0
100
200
300
400
500
-20%
-10%
0%
10%
20%
30%
40%
50%
60%
70%
5/5/2011 10/6/2014
Net
Flo
ws
($,M
)
Tota
l Ret
urn
SPLV Flows SPY SPLV
The Bigger Problem
Source: FactSet
Commodities
Basics of Contango
$40
$60
$80
$100
$120
$140
$160
Co
ntr
act
Pri
ce
Contract in amarket inContango
Contract in amarket inBackwardation
Here’s The Problem With Futures
Source: Bloomberg
-80%
-60%
-40%
-20%
0%
20%
40%
60%
80%
100%
3/31/2011 3/31/2014
Tota
l Ret
urn
Natural Gas Spot UNG