FactSet's Elisabeth Kashner
The Scoop: Deep ETF Trends Insights

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Introduction

Pierre Daillie: Welcome back. I’m Pierre Daillie, Managing Editor at AdvisorAnalyst.com. And this is Insight is Capital. My special guest this episode is Elisabeth Kashner, Vice President and Director of Exchange Traded Fund Research and Analytics at FactSet. Elisabeth, welcome. It’s great to see you again and catch up with you.

Elisabeth Kashner: Oh, Pierre, I was so excited when you reached out. It’s a great day to be working together. Thank you so much for the invitation.

Pierre Daillie: I’m really looking forward to our conversation. I think it’s been a, it’s, we’ve been through this very strange period in markets and, I’m looking forward to, to, hearing from you about, what’s going on in the, in the ETF market, what trends are shaping things for, Investors and advisors alike for the industry.

But first, for those of you who aren’t familiar with Elisabeth, Elisabeth is vice president and director of exchange traded fund research and analytics at Facset. [00:01:00] In this role, she develops tools and methodologies for all aspects of ETF and mutual fund classification and analysis with a focus on costs, risks, trading issues, and performance.

Transcribed Prior to this, she served as Director of Research at ETF. com and published extensively on the classification, efficacy, and persistence of strategic beta strategies and robo advisor portfolio exposures. Elisabeth earned a BA from Brown University and an MS in Financial Analysis from the University of San Francisco.

She is a CFA Charterholder. Thank you for listening and stay tuned. This is the Insight is Capital podcast.

Announcement / Disclaimer: The views and opinions expressed in this broadcast are those of the individual guests and do not necessarily reflect the official policy or position of advisoranalyst. com or of our guests. This broadcast is meant to be for informational purposes only.

Nothing discussed in this broadcast is intended [00:02:00] to be considered as advice.

Pierre Daillie: Elisabeth, great to have you on and really looking forward to our conversation.

Market Trends and ETF Flows in 2024

Pierre Daillie: 2024 has so far been like a wonky year. With investors driving up equity valuations, particularly in the magnificent seven or the five, six or five or four, whatever, it is these days.

while watching the bond market give back the six to eight interest rate cuts. It priced in December of 2023 when funds and fund flows are all over the place or worse undecided as they have been year to date in many cases, given all of the uncertainty, what are you seeing in your research

Elisabeth Kashner: here? I guess the first thing I would say is that, right now, 2024 is on pace to be a slow year overall for ETF flows.

if, if, we were on the same pace as last year, which itself was just a [00:03:00] moderate year, we would have expected about 270 billion year to date, but we’re really only at 184, so that’s significantly off pace. lots of things can happen between now and the end of the year. it feels like it’s too soon to make any predictions on a full year basis, but definitely on a half year basis, it’s a little pokey.

Pierre Daillie: Yeah. there’s a lot, there’s a lot of, holding off and wait and see. it echoes what the Fed has been saying more recently. December was watershed. there was this announcement at the end of November by, chair Powell that they anticipated three rate cuts and inflation, was looking better and employment was still tight, they were looking forward to 24 and then the market got a little bit overexcited and priced in six plus, [00:04:00] seven, eight cuts, got a little bit over its skis in terms of the excitement.

And, so investors largely missed the pop in bond prices and, Look back on that and say, that happened so quickly. I didn’t have time to react to it. although, the markets didn’t wait. And then of course, at the same time, equities popped, as well.

so you’ve got this, mix of activity and uncertainty. some of called, the activity in, the equity market, more of a risk aversion. melt up as opposed to a risk on, vote for stocks. And, lots of, I think lots of investors have also been late to the rally as well, because they just completely missed time there.

things got completely surprised or shocked by [00:05:00] the feds, pivot in November. And now, of course, all that’s been taken back. So you can see why, maybe fun flows have been, on a slower pace than, they should have been, to your comment.

Elisabeth Kashner: I don’t know if there’s a should have been, but certainly what we’ve grown, accustomed to in the past couple of years, there’s also just the very simple explanation that, If you receive a, wind call, windfall or some cash income, and it goes into your brokerage account and it sits in your settlement fund is yielding north of 5 percent per year with zero risk, right?

And so that’s a very attractive alternative. It’s hard to beat that story at the moment.

Pierre Daillie: I agree. I think what’s made things weird is, that stocks have run up while bond [00:06:00] yields have backed up to, four and a half, 4. 6, 4. 7 in the, especially like if you go into longer, in the longer durations in the 10 years and 30 years, but investors are, investors are still hesitant to.

Weigh into the longer duration bonds. there’s no need to at this point, but. it feels, like one of these markets where investors, what do I do? And what, what, if, what, what if things turn? What if the, stock run up, turns into a correction or what, what if, rates go higher and I’m in, longer duration, or I’m in TLT or something, and, it keeps on, the yields keep backing up.

And there was, such a confusion, I think, is, maybe the correct word. I

Elisabeth Kashner: mean, I, think you’re describing the normal anxiety of the tactical asset [00:07:00] allocator, right? Of somebody trying to position for the next month, two months, three months, six months, and is then forever anxious about.

getting it wrong or getting it not right enough or missing the biggest moment or, not getting out soon enough, right? All of those, I think, are continual questions, right? We saw them. really front and center, when the meme stocks were on a tear and when thematic investing was all the rage.

And, my comment back at the time then was thematic ETFs are useful tools, but they’re very difficult to time, right? You need to really know when to get in and when to get out and have a plan. And I think most of the tactical positioning that you’re discussing right now really, falls in the same category.

Bitcoin ETFs and Market Dynamics

Elisabeth Kashner: But one thing that I do think is different this year, and surely I’m not the first person to note it, is that, because early, in the year in January, we saw the SEC give the green light to launching spot [00:08:00] Bitcoin ETFs, investors have had another, I wouldn’t quite call it an asset class, but they’ve had another investment type to consider.

And, that is one of the striking things about this year’s flows. Is if you look at it by, market segment, Bitcoin is number three, it’s right there behind us, large cap in us total market. And it’s right above broad investment grade bonds. I certainly hope that we don’t have, five to 10 percent of investor assets writ large going into Bitcoin rather, the annual flows are one thing.

and of course there’s been a lot of musical chairs in terms of, money going out of Grayscale and into, BlackRock and Fidelity and some of the other major providers. but that is definitely something that’s new on our charts for the year. but the other thing that, I just glossed by what was [00:09:00] in position one and two position one and two are the steady eddies.

It’s us large cap in us total market, right? It’s S and P 500 funds, Vanguard, total stock market, those. Are not tactical plays. Those are long term strategic buy and hold, which has really been the foundation of the ETF industry for the longest time. the more it changes, the more it stays the same.

Pardon my French.

Pierre Daillie: No, that was good. But I, yeah, to your point, I think, it’s the activity in, in, New money, That, that has defined this year. And, I think a lot of investors are opting for. shorter term bonds, shorter term bond funds, [00:10:00] something with, low duration and, you’re getting the yield for that.

I think that’s, the interesting thing. I think that’s the confusing thing at the same time is that you have all these yield opportunities, which one do you go for? where do you place. Your funds to get the yield. Are you taking too much risk? If you go too far out, or are you taking not enough risk if you go too short?

And that’s where, that’s, that’s been a toss up between maybe investors, because of where we’ve backed up to in the yields, investors are laddering again. And, looking at, their 6040 portfolio and, wondering, what they can do tactically. And that’s where number three comes in, which is this new kid on the block, the Bitcoin ETF.

And so that, that sort of seems to be where the new activity is gone. And then, as you said, the steady strategic activity has remained the same. [00:11:00] Incremental funds is, behavior of incremental flows is very interesting.

Elisabeth Kashner: Yeah, and we’re not really, aside from Bitcoin, we’re not really seeing, a ton of tactical movement at the very tops of the charts.

So large US large cap, number one, us total market, number two, Bitcoin, number three, broad, fixed, broad investment grade, fixed income, number four, us mid cap, number five, global fixed income, number six, that’s often like active managers, a go anywhere mandate, broad based US corporate investment grades, number seven, us large cap growth, number eight.

Intermediate, U. S. treasuries, number nine and last is, not last, but number 10 is developed ex U. S. total market. Most of those are your classic portfolio building blocks, except for the Bitcoin. There’s nothing out there that’s screaming tactical in a way that the thematics did a couple of [00:12:00] years back.

Pierre Daillie: Yeah. Very, interesting. we saw, in terms of our, activity and. Content this year that, that sentiment again has echoed, which is wait and see, pay attention to some macro, what’s happening in fundamentals, what’s happening in earnings. but above all, it’s what’s happening, the market’s watching the Fed, right?

Elisabeth Kashner: and the yield curve, like when you look at the yield curve, you’re not incentivized to go out any longer than two months, Right. There’s no maturity premium, so why wouldn’t you just buy a two month T bill or just stick your money in a money market fund and go do something else?

Pierre Daillie: Exactly.

Challenges and Strategies for Asset Managers

Pierre Daillie: Elisabeth, what are the, what, are the key trends in ETF investments that you saw in 2023? [00:13:00]

Elisabeth Kashner: great question. And thank you for asking, I think the first thing that we saw was a more normalization of the overall level of flows, back to a healthy, almost 600 billion, continued interest in, a fixed income.

sometimes I think the information is more interesting when you do a deeper dive. And to me, the most fascinating phenomenon of 2023 was that we saw this real sort of parting of the ways between asset managers and investors in that, investors continued to gravitate to the very cheapest products.

with, continuing to push down overall expense ratios, just by virtue of pouring more and more money into the cheapest alternatives wherever they can. But, asset managers pivoted and, in [00:14:00] some cases started raising expense ratios. And, that to me was the most curious and perplexing thing that I saw, in 2023.

Pierre Daillie: Is it like, it’s a tough business. Like I, I, grew up in the time of mutual fund, of the mutual fund boom. And the MERs on mutual funds, going back 25 years were, by today’s standards, astronomical, right? When you compare, that mutual fund set MERS of, north of 2 percent here in Canada, and then compare that to an index fund, that’s almost free at 10 beeps.

Yep. it’s not, it’s, there seems to be, obviously, for, obvious reasons, investors are gravitating to economical choices for their investments because then they get to keep more and more of it, more of their returns.

Speaker 4: Yes.

Pierre Daillie: But seeing as the industry is, having a hard time with maybe profitability on some fronts, making money as business, as a business, is that part of the reason why, some asset managers raise their MERs?

it, it, was to their detriment, right?

Elisabeth Kashner: it, it absolutely was, investors weren’t having it, I do not envy the asset managers, their job. I think you’re absolutely right. That it’s a much more difficult environment than it was when you and I were just coming up. we are not aging at all, but the children, they’re growing so nicely.

Speaker 4: That’s right. That’s how

Elisabeth Kashner: I look at it.

Speaker 4: That’s funny.

Elisabeth Kashner: Yeah, exactly. and I think the rise of passive investing, the rise of enormous scale, and the participation, especially of Vanguard, where they position themselves as an at cost organization. more of a mutual ownership structure that has allowed them to really have a laser focus on costs, has just, it’s put a lot of pressure on the industry.

You’re absolutely right. And there’s a couple of things at play here. there, there’s a, there’s go big, go niche or go home. So [00:15:00] that’s, what I’m hearing a lot in the asset management space is that, and You, there’s definitely a line of thought out there that says you can charge a premium for performance or you can charge a premium for unique product.

I’m not convinced that either of those is actually true, but, I also don’t sit in a lot of asset management boardrooms when they make the decisions about fund fees one by one. there’s also just this perennial trade off between, the assets that are currently sitting in your fund versus the assets that you want to attract.

And so if you’re happy with your asset levels and you think that your existing investors won’t leave, whether it’s out of, fear of paying capital gains tax or just not wanting to, bother or not even noticing some sort of inertia. you, might be able to ride that asset base for a long time and ride it at a higher cost, even at the, the expense of potentially attracting some new investment.[00:16:00]

that’s one strategy that’s out there. there’s still brand loyalty. There’s still wining and dining your clients. it, when number one, number two, and number three by assets are BlackRock, Vanguard, and State Street, and they’re charging respectively 16 basis points, five basis points, and 12 basis points on an asset weighted basis.

those are some big, those are some big obstacles, right?

Pierre Daillie: yeah, that’s a very high barriers to entry and then of course they’re also on the receiving end of, the department of labor’s rulings for 401ks, right? they’re getting, that’s that juggernaut of flows every month.

They’re getting all these monthly, defined contributions to, to add to their asset base. without really having to do anything other than continue to do what they do. And so where, where, new entrance to the market come in is more on the discretionary side or, it’s all discretionary ultimately, but, the incremental.

Attracting incremental flows, like new money, somebody got to pay out from their company or they sold a business or some new money has come in where, do they place it? And I think those, specialty, I, those explore items, like thematics of the past, where thematics had boomed, are they now being replaced by active strategies?

are some of the big houses, the big issuers. Looking at getting into the active space, getting into sort of the all in one space where, they’re providing, asset allocation type funds that are, incorporating, multi strategy or multi asset strategies, into one, like there’s, there’s, there’s stuff happening in the market. That’s interesting enough to, collect a higher MER. And as you said, it’s either really interesting or it’s new or it’s novel or, it’s, active. active also commands a higher MERs, truly active strategies, probably need to and should, command higher MERs, I’m looking at for example.

In the all in one category where you have 60, 40, some 60, 40 strategies blended with commodities or, the, these, hybrid strategies that are, designed to be more all weather like are commanding higher MERS as well, right?

Elisabeth Kashner: there’s what the asset managers charge and then there’s what the investors do.

Speaker 4: Right.

Elisabeth Kashner: and so you’ve mentioned so many different components of the markets in your question. You talked, I think a little bit about, one and done funds, like a target date or a target risk kind of product. Like you might find typically in your 401k, you’ve talked about. model portfolios, which can be a more, tailored or, custom or just, unique blend of, core and [00:17:00] explore.

you also talked about active management, And that’s where I’ve done a good bit of research. let, me, give you a picture of the market, at least as it stood at the end of 2023. I

Pierre Daillie: took a look, Elisabeth, sorry, before you do that, I just wanted to ask you, cause I’m quoting you, but you’ve wrote recently that the average asset weighted expense ratio for the entire ETF ecosystem dropped to 0.

172%.

Speaker 4: Yeah. Per

Pierre Daillie: year, that’s, if you’re launching a new ETF company, that just, that, that seems, impossible, right? So

Elisabeth Kashner: it’s not easy, right. And we’ve seen over the past couple of years, certainly since the passage of the ETF rule or six C11, as we call it, that’s what it is called.

Speaker 4: Yeah.

Elisabeth Kashner: we’ve, we’ve seen [00:18:00] both startups. And, old hands alike pile into the ETF industry. and I think despite. The data out there regarding what fees are, we also see a lot of asset managers who are saying to themselves, ETFs are growing when almost every other wrapper is shrinking or maybe being stable in size.

So ETFs are clearly what I want to, where I want to be now. How am I going to get there? And, There’s a lot of optimism out there and God bless the optimists. Where would we be without them? We, we’d have so much less inventiveness. We wouldn’t have much of a vibrant economy. and I would probably still be eating, boring Campbell’s soup from the 1960s rather than just the amazing array of, food product that I have in front of me, right?

So, God bless the optimists, [00:19:00] but sometimes the optimism. Might do with a little, tempering, in, reality. and, so this, I think is just the perfect moment for me to talk about, actively managed equity ETFs, right? Because we’ve just, we’ve seen the floodgates open between 6C11 and custom baskets, and the availability, and then the sort of lack of investor interest in active non transparent.

We’ve really seen the market settle into the, Active, fully transparent equity ETF over the course of 2023, there were 168 firms that were competing in the actively managed equity space amongst us. Demiciled ETFs. I’m not talking about Canada today. Sorry, my friend.

Pierre Daillie: No, that’s

Speaker 4: fine.

Elisabeth Kashner: And, of those 80, sorry, four firms [00:20:00] held.

or attracted, I should say four firms attracted 89 percent of the flows. The other 164 were fighting over 11%, right? So it’s really remarkable and I’m not done, right? So if you, if you look at those, the four, who were they? They were dimensional JPMorgan Chase, American Century and Capital Group. They posted asset weighted average expense ratios of 23 basis points for Dimensional 34 for JP Morgan Chase, 25 for American Century, and 39 for Capital Group.

And then the other guys, those 164 of them on an asset weighted basis, they were coming in at 61 basis points. So you have the optimists, they’re out there, they’re launching, they’re competing, they’ve got products, they’ve got stories, they’ve got sales staff, right? But [00:21:00] they are also operating in a hugely competitive landscape, and so I find it totally unsurprising that the big four there are much more competitive on the cost front.

Pierre Daillie: Yeah, and, it was easier for those four giants in the, from the asset management business, with their preexisting fund business, mutual fund business to, Come in and replicate some of their key strategies into ETFs, into ETF wrappers, even systematize them in some cases in order to get the costs lower, like shops like American century and capital group, who are exceptional, exceptional fund management companies.

of course, JP Morgan Chase. No. that’s,

Elisabeth Kashner: yeah. they’re, old hands.

Pierre Daillie: They already have the [00:22:00] Yeah, they already have the scale. So yes. Even if, even if they were to lose money for many years after launching their e their newly formed, their new ETFs, they’d probably be okay.

But, for the other 164 you that means that you have to be exceptional. You have to be doing something exceptional in order to collect those higher M. E. R. s.

you have to be providing something extraordinary in order to stay in business, to be sustainable, because of the, high bar.

There’s such a high bar to entry in, in, on the ETF side of the business. You can, it’s, it almost makes me wonder, like, why not just, if you have a strategy that demands a higher MER, why not, just launch a mutual fund [00:23:00] and go that route, but given what, given your point that ETFs is where it’s happening, You have to find a way to solve that problem or crack that nut.

that, that is the, difficulty that’s facing these other 164 issuers and out of the 164, how many are still functioning today?

Elisabeth Kashner: A handful dropped out. I can open up my spreadsheet and give you an exact count, but that makes for a boring podcast.

most of them are sticking it out, but you do bring up a good point, which is about the overall rate of closures.

and we have seen, a real pickup in, in the number of closures and closures as a percent. over, over the years. and [00:24:00] to me, this is really, it’s a healthy thing. And, I, think we should not bemoan the closures because it’s a good sign that, we have rational players in the market and when they see that something is not working rather than keep at it for five 20 years, there are, they’re applying their energies elsewhere.

So 2023 was a particularly high closure rate year. we saw about 8 percent of, the number of funds that were open at the, at the end of the prior year, we saw about 8 percent close over the course of the year. there’s only two times in ETF history where that number has been higher, 2020, when we also had a whole bunch of, ETNs closing for business.

And that was a wacky year, of course, as you remember, and also 2008, I don’t have to remind you about 2008, [00:25:00] right? No. To me, I, guess I disagree with you ever so slightly about the barriers to entry. I think there, the barriers to entry are quite low, especially after 6C11, but the barriers to success are quite high.

Pierre Daillie: Yeah. And I think that’s, more along the lines of what I mean is not, it’s not so much that you can’t launch an ETF. It’s, how do you stay in business? How do you make, how do you remain economical and be able to run a business if you’re competing. It’s, in such a challenging environment.

Elisabeth Kashner: Yeah. But, just, to, pick on Cap Group for a hot minute, their ETFs are real bright light in their overall business. If you look. a big picture at their asset levels, like they’re still suffering outflows, right? Their mutual funds [00:26:00] are losing money faster than their ETFs are, taking it in.

And so when you see evidence like that, what you have to figure out how to do is to be profitable at a price point that, will clear the market, right? So you have to just get much more efficient. We’ll have to really figure out how to operate at scale. You have to do really well with your capital markets management because that makes a big difference to investors too.

we’re going to see more and more in the asset management space, people leveraging AI, Just, investing in, in, products and consultants and whatever it is that they can do to make themselves profitable. At the level that actually clears the market because the market has spoken.

Pierre Daillie: I, I, can [00:27:00] see a silver lining is that, for those companies that are in the ETF and mutual fund space, that it will bring efficiency, more efficiency, as you said, not only to the ETF space that they’re, maybe new entrants to, newer entrants to, but, to the existing mutual fund space that they’re in, where they have to lower the fees on their mutual funds as well, in order to compete.

as with as much equilibrium as possible.

Regulatory Changes and ETF Approvals

Elisabeth Kashner: Yeah, I think that leads right into where we are now in, regulatory issues that we’ve seen at least a dozen firms file for permission to issue ETFs as a share class of the mutual fund, as Vanguard has done, Vanguard had a patent on that structure for, two decades.

And now that patent has expired. Lots and lots of players are looking [00:28:00] for the SEC to grant approval to do exactly that. Northern Trust was the newest one, just hit the wires this morning. Northern Trust is now in line with lots and lots of its competitors. And if, if any of those get granted, then, from an investor point of view, there’s definitely operational and tax efficiency to be had.

Where the sometimes in the case of Vanguard, especially when they were just starting up in their ETF business, it was a trade off because, the mutual fund lent economies of scale to the ETF and the ETF lent tax efficiency to the mutual fund. So each of the structures had something to gain, that may or may not be true in some of the other asset managers that we’re talking about.

and of course we’ll see what the SEC says, if they’re willing to, apply that, permission [00:29:00] to more actively managed products, generally Vanguard has them on their very low turnover or passive funds. does the IRS have a say about having, mutual fund taxes washed out by the ETF heartbeat trade?

There’s a lot of questions that are out there. I’m not a lawyer, I’m not a regulator. but I think just to bring that into the conversation and say, not only can you learn from the ETF landscape, how to operate your business in a more efficient manner, you might actually be able to borrow the very best features of the ETF and bring them into a mutual fund wrapper, SEC watchers, let me know when you hear something interesting, would you?

Pierre Daillie: Yeah.

ETF Fee Structures and Market Impact

Pierre Daillie: Elisabetheth, did we, I know you started off by mentioning that ETF issuers, some of them raised their MERS. what were your findings on that? What, was [00:30:00] the reason they did that?

Elisabeth Kashner: some of them was a result rather of inaction, not action. So the, case that I dug into the most deeply.

was, IWD and IWF it’s the, iShares Russell 1000 value and growth ETFs. and you have to really go deep, deep, into the prospectus to understand how they actually set the fees on those ETFs. And it’s a complicated formula where it’s, relative to the asset level in those ETFs, but also a set of ETFs that are not even in the Russell suite and maybe not even exclusively equity.

There were some fixed income ones in there. But it had to do on a formulaic basis with what the asset level in that pool of ETFs was. And, as it grew, the incremental charges would shrink and as a trunk, the incremental charges would rise. [00:31:00] And, because we saw markets contract so much in 2022 in both the equity and the fixed income space, some of the thresholds that had been crossed on the way up with those products getting cheaper and cheaper, they were also crossed on the way down.

and so that was, there was no, fund board action for IWD or IWF that created a change. They were simply following the letter of their prospectus,

Pierre Daillie: right? So it was a, It was more of a logistical thing. It wasn’t, it had nothing to do with, deciding to raise fees and make more money.

It had to do with just operational concerns.

Elisabeth Kashner: yeah, it, it really was just like, this is how we do it. This is the formula. This has been the formula for decades. We’re going to keep following the formula. No, I did make an argument in my blog that, hardly anybody [00:32:00] digs in that deep to the prospectus, right?

I’m an ETF analyst. I look at the industry every day. I had never like actually gone through and done the math and ran the formula and said, Oh, this is what’s going on. but I’ve been writing about it. I wanted to be absolutely sure I knew what I was talking about. So I did my homework there.

But the average investor not only will not do that, the average investor will just look on the fund homepage and, to see a number that they’d been accustomed to see falling, to see it start to rise. It’s not a good look,

Pierre Daillie: right? Exactly. and they’re not likely to do the analysis at all. all they see is that the price went up.

And

Elisabeth Kashner: exactly.

Pierre Daillie: Exactly.

Elisabeth Kashner: and meanwhile, Vanguard has identical product in the market at a much lower price point. That is definitely a case where if you’re a BlackRock, you’re most [00:33:00] likely thinking about your existing asset base rather than, growing it too much and just hoping you can hang on, hoping you’ve got people who put that position on in the year 2000 or 02 or something like that.

And. Are you literally going to take it to their grade?

Pierre Daillie: Yeah, because yeah, if you bought it last year and then the fee went up, maybe, under that circumstance, you might be tempted to switch to the lower fee equal, but if you’ve owned it for 10 years, And you’ve had the capital appreciation from it.

You’re not likely, the same, yeah, the same way homeowners are not likely to move right now.

Elisabeth Kashner: exactly, Or, I would put it a different way in that, how many decades of fund ownership would you need in order to make up for the capital gains hit that you just took in, selling, so the difference [00:34:00] of eight or 10 basis points a year, it’s not going to, Not, going to hold a candle to, what, is it going to be like 20 percent tax on, what, maybe doubling or tripling your money.

that’s, and then under current tax law. if you pass on and you leave a position to your heirs, the cost basis gets reset to whatever it was at the day of your passing. And

Speaker 4: you

Elisabeth Kashner: know, anything held in a taxable account where the investor has a hope of never paying taxes on it.

yeah, don’t pay a higher fee to the grave.

Pierre Daillie: Yeah, exactly. the, that’s a different circumstance altogether.

Investor Sensitivity and Market Behavior

Pierre Daillie: how sensitive, I, guess the industry itself has, [00:35:00] because of the, the mantra of low cost, are investors really they’re sent, they’re very sensitive to the fees that are charged.

But how sensitive are they? is it a self fulfilling thing? have we, because we, because the ETF industry is always talking about low fees, how big does the difference have to be between competing products for an investor to say, okay, my ETF went up by so many basis points, 10, 15 beeps this past year, in this.

And then over here at Vanguard is the same product or substantially less. How much less.

Elisabeth Kashner: so I think, we can look at that, by way of flows,

Speaker 4: right.

Elisabeth Kashner: and what we see is that, I took the data back to 2016 [00:36:00] and. Every year flows have gone to cheaper and cheaper products, right?

So the overall change in expense ratio, which has just gone down, every year. most years, about half of that has been attributed, attributable to investor activity and the other half to asset managers. And the asset managers have been seeing what the investor preferences and they’ve been, competing to slice off basis points here and there.

2023 was really extraordinary for that not being the case. But, when you look at the fee wars, if you dive into a very specific market segment, like for example, Investment grade, corporates, short, intermediate, long, you can watch the volley between, Schwab and Blackrock and Vanguard, boom, I’m dropping the basis point. I’m dropping the basis point. I’m dropping the basis point. I’m [00:37:00] dropping the basis points. And that’s because they know what’s happening in, the flows. And then I think there’s this one other piece of information that’s important to put out there, which is that.

I think you’re right that investors are willing to, in some cases pay up for quality, which generally translates to performance. but it’s just so exceptionally difficult to generate out performance year after year and quarter after quarter. And, the team over at, S& P global indices, the research lab, they’d published SPIVA by S& P active versus passive scorecard.

And. you’d be hard pressed to find a sub asset class in either the equity or the fixed income space where active produces, long term out performance versus the index and even [00:38:00] harder pressed to find anything where there’s any notable persistence, meaning this team that did it this quarter.

surely they’ll do it next quarter.

Pierre Daillie: right,

Elisabeth Kashner: Except that’s really not what the evidence shows. And I think where you see the fee wars having had their greatest effect is on the largest products, which are also, the broadest and simplest, right? It’s the entire U S equity market.

It’s the entire X U S equity market. It’s the entire U S investment grade bond market. those are some huge funds and they’re, you can have them for three basis points a piece. Bank of New York has some products that are at zero basis points. Like you can have a global market cap weighted portfolio and investment grade bonds essentially for free.

And so that’s that’s what is out there [00:39:00] to beat.

Pierre Daillie: Yeah, that’s, that makes it exceptionally challenging.

Elisabeth Kashner: But it makes it a great time to invest in faster. I had a young adult recently come to me and say, here are the options in my 401k. And there were a whole bunch of size and style type funds, like a mid cap value and a small cap growth.

And, you’re, set. Here’s a space exploration fund and here’s a real estate fund. And then here’s our target date suite. And, they’re very simple. They’ve got a glide path, they’ve got four components and they’re eight basis points a piece. And I said, young man, target date, the only question is, do you want one that’s a little riskier or a little less risky, you’re a birth year might indicate that you should buy one for say 2060, but if you want to take more risk, buy the 2070 product.

that’s, what you [00:40:00] should be deciding here.

Pierre Daillie: Yeah, I, yeah, I think when, you consider, what a time it is to be an investor and all the options that are available at such low cost, it really does, allow you to put the focus back on, making the right asset allocation decisions and not be concerned so much about, what you’re paying for, who you’re paying for.

the, it’s, I just, I can’t help feeling so much of the business is becoming commoditized and, that, You really have, it’s really easy today to build a core portfolio and then be able to, maybe use the excess fee [00:41:00] budget to explore things like alternatives, alternative strategies, to diversify, that 60 40 traditional portfolio with, a lot of these new options that are coming into the market and, it, and I think a lot of advisors are starting to think that way.

They’re starting to think in terms of, fee alpha tax alpha. They’re starting to think in terms of, rebalancing alpha. they’re starting to think in terms of, fee budgeting, being able to, because I’ve got all these low cost core items over here for the bulk of my portfolio, I can maybe go, I can feel more at ease about getting into that more expensive space.

Or more, that, that active space where the MERS are higher because they’re doing something special. And I think [00:42:00] maybe that’s where these other 164 entrants are looking competitively, which is there is a demand for. hedge fund replication, there is a demand for, all in ones.

There is a demand for asset allocation strategies that are, structurally uncorrelated to the rest of my portfolio or other return streams that cost more like CTAs or commodity, strategies that might be, might end up in an ETF wrapper. And, That do cost more money, the carry is a lot higher on, on, on, on those funds, the cost is higher on those funds, but some of those, new funds also have carry, right?

Sorry, I got it mixed up, but some, for example, some CTAs, some, of these esoteric, more esoteric alternatives have. like some of our conversations have been informed by this, which is that, on our [00:43:00] podcast, which is that, that, you can have your, you can have your core portfolio and then you can get some of these other alternative strategies that actually help you pay for the rest of your portfolio because they add incrementally to your return.

Elisabeth Kashner: Do they?

Pierre Daillie: They,

Elisabeth Kashner: they might?

Pierre Daillie: Yeah. They might

Elisabeth Kashner: or they might not.

Pierre Daillie: They might and they might not, but assuming that they, assuming that the objectives are carried out and met.

Elisabeth Kashner: Yeah, certainly the intention is that. you know that’s the setup, ex ante.

Speaker 4: yeah,

Elisabeth Kashner: but, it’s, it is very hard to find the diversifier that, in the end really pays for itself.

I’m a may, maybe I’m a little salty because, my, my father, when he passed left my mom in [00:44:00] good shape, God bless, but, he also left her with a lot of complex private investments and he was overweighted in corporate real estate, and I’m watching my mom sitting with these portfolios that were supposed to wind up last year or the year before, or this year, and they’re extending and they’ve got more capital calls and dad thought he was doing great getting in with.

private, hard to get managers getting an asset class that he couldn’t get, in the public markets. And, I think, of course, nobody expected what would happen with COVID and commercial real estate, but, those IRRs aren’t looking so great,

Pierre Daillie: Yeah. I’m sorry to hear about your, the passing of your father.

Elisabeth Kashner: Oh gosh. It was eight years ago already.

Pierre Daillie: Okay. Sorry. I, But

Elisabeth Kashner: yeah, he, he was a tidy man, but he left my mom with a mess financially. investors are [00:45:00] tired of paying country club dues only to go in and find that the hamburgers at the, burger bar are, overdone, like overcooked and cold, and who,

Pierre Daillie: that’s a great analogy,

Elisabeth Kashner: right?

Pierre Daillie: yeah.

Elisabeth Kashner: and you don’t get the best food at the country club because it’s exclusive. So there you get what they serve,

Speaker 4: although they probably have to do like a

Elisabeth Kashner: really, a really good gin and tonic else, they’ll lose members.

Pierre Daillie: Yeah. They got to make up for it somehow.

Elisabeth Kashner: Yeah.

Pierre Daillie: Yeah, absolutely.

Future Outlook and Investment Strategies

Pierre Daillie: Elisabeth, what’s the outlook for the ETF industry in light of these developments? What’s your outlook for the industry in light of the developments you saw last year and, for, so far the, what you’ve noticed this year.

Elisabeth Kashner: So we’re, and we’re nearly halfway through this year, right?

[00:46:00] my outlook for the industry as a whole continues to be really bullish. we’ve seen inflows every single year since 1993. we’ve seen larger and larger percents of the public funds space, of that money moving into ETFs and out of mutual funds. so for the industry writ large, I think, it’s, it’s, good times ahead.

There, there’s a lot of runway there. I would say, definitely keeping my eye on two developments, that we are really seeing, the retirement in the five 29 space, we’re seeing a lot more use of, collective investment trusts, which are not public funds. and they can often be even cheaper to run than an ETF because, they have a different regulatory structure and they operate at massive scale.

[00:47:00] So that’s, I’m on the institutional side and keeping an eye on that and also, interval funds, which are closed end funds that have a get out of jail free redemption at nav on, a quarterly or semi annual basis, that solves some of the problems of closed end funds, but may also be allowed to hold much less liquid assets.

So I think that is potentially an interesting structure out there. does that mean that any firm entering the ETF business, has a growth opportunity? I think our entire conversation has pointed the opposite way, that it’s still a really tough business as an asset manager to make a buck.

and for those who are thinking about entering. I would just really make sure you understand the market conditions.

Speaker 4: right.

Elisabeth Kashner: but, and for the ETF investor, there are so many options. We’re close to [00:48:00] having 3, 500 ETFs trading on us exchanges. When I started in this business back in 2010, the number was 968.

Speaker 4: Right.

Elisabeth Kashner: I come to think of it, I think it was, exactly, 14 years ago. that’s just, it’s an explosion of choice and choice can, it can be liberating. It can also be confusing, but, if you put some time and effort and thought into it, you can build yourself an extraordinary portfolio that is broad and cheap and efficient and maybe has a little spice to it.

Pierre Daillie: Yeah, I, I think as you said, and, forgive me, I, lost you, I think at the moment when you said that this is, I think you said this is a fantastic time to be an investor, right?

Elisabeth Kashner: I sure did. I sure did. [00:49:00]

Pierre Daillie: Yeah. I would echo, that sentiment that it’s, that there’s never been a better time to be an investor than right now.

Elisabeth Kashner: I think that’s really true. Yeah. Absolutely. and one thing that is, that is, I think a constant in, financial services is, to always remember to sit in the seat of the investor and to try and speak with the voice of the investor. you never get in trouble, whether you’re in the C suite or the bar or a podcast like this, if you say, I stand in the shoes of the investor and I think for the end investor.

You never get in trouble saying that, right? And there’s a reason for that. And that’s because the investors are the lifeblood of the industry. They’re who we are serving and through market action, we’re, they’re telling us where the service is good and where the service is not so good.

Pierre Daillie: [00:50:00] Yeah, absolutely.

I think if, there was a danger at times when investors could become disillusioned by the entire industry, by the market, whether it was during times of upheaval or times of, controversy where, scandals broke out.

and, I think the early 2000s was like that.

Where, investors really questioned what was going on in the marketplace. And then, of course after that, all hell broke loose in 2008.

investors have been through a lot and, they’ve become, they ha I, guess to answer the question I asked earlier, our investors really that sensitive and the answer to that is absolutely

Elisabeth Kashner: You

Pierre Daillie: know? and,

Elisabeth Kashner: and I think you also asked in a roundabout way earlier, In, the world of the three basis point portfolio, what is the role of the advisor? And sometimes the [00:51:00] best thing an advisor can do is to help provide that emotional and psychological stability, right? So that an investor doesn’t become his or her own worst enemy.

and I think that, behavioral aspect is, is really notable and there’s a lot of work to be done in that regard.

Pierre Daillie: Yeah. ETFs are extremely easy to trade.

Elisabeth Kashner: Yes, sir.

Pierre Daillie: And, for that reason, it’s, a potential behavioral minefield where, some investors might feel like these are so easy to trade.

I can get in and get out. I can do whatever I want. I can move to whatever part of the market I want to whenever I want to. but as you said, it’s not necessarily the best choice. as investors who maybe exited the market in March of 2020 found out.

Elisabeth Kashner: Yep, exactly. that, that’s why Jack Bogle was so [00:52:00] opposed to them for so many years.

He thought that it was, too sharp a knife and people were just going to cut themselves.

Pierre Daillie: Yeah. And, I think it’s. because of advisors that investors are making proper use of these instruments for the most part, I think maybe that, might not be true as much in the DIY market, but, in the advised market, in the advisory space, you’d be, you’d have a hard time finding an advisor who would say okay to their client when their client said, I want to get out of the market.

I want to get out. I want to do this. I want to go there. I want to get into cash. Get me out. the advisor says, that’s not a good idea.

Speaker 4: Can we think this through please?

Pierre Daillie: Yeah. If there’s no, if there’s no intermediary, then, panic feeds on itself. And, investors do stupid things sometimes without, to, to your point, becoming their own worst [00:53:00] enemies.

Elisabeth, any, final thoughts, any parting thoughts? What, can investors do right now? What would you say to investors who are on how to navigate the market, how to navigate this space?

Elisabeth Kashner: My advice is so boring, Pierre, because it’s been the same thing for more than a decade. It’s do your homework, understand what, it is that you want to buy, what, else is out there competing in that space.

why do you want to buy the exact thing you want to buy? How does it work? not just what’s in the portfolio right now, but what can you expect in the portfolio in the future? So if it’s a passive fund, learn about the index that it’s tracking and, how is it constructed, what are its rule sets if it’s an active, then you have to learn about the people in the process and all that.

And that it’s really very worth the time that you invest. ETFs are from a user’s point of view, a little bit more [00:54:00] complicated than mutual funds. and Many people make the mistake that they say I know all I need to know about this fund because I read what its name is and I saw the expense ratio.

and so in that regard, I would advise people to invest a little bit more time. We are only talking about your life savings.

Pierre Daillie: That’s it, right? That’s, it. That’s not all we’re talking about here. That’s all we’re talking

Elisabeth Kashner: about here, except, at, some point my dog is going to have something to say, and it won’t be about her life savings.

Pierre Daillie: No, Elisabeth, thank you so much. it’s great to catch up with you and I hope we can do this again soon. And, Thank you so much for your incredibly valuable time and insight.

Elisabeth Kashner: thank you so much, Pierre. It’s been a real pleasure. I always feel like I learn a lot from talking to you and you’re asking really interesting and insightful questions.

And I appreciate that you’re, you’re [00:55:00] representing the investor, the advisor, the asset manager, you’re wearing a lot of hats. I hope you get to rest this weekend.

Pierre Daillie: Thank you so much, Elisabeth.