Christine Benz: Hi, I'm Christine Benz for Morningstar.com. Assets in exchange-traded funds just surpassed $4 trillion. Joining me to share insights on this and other news stories in the realm of ETFs is Ben Johnson. He is director of global ETF research for Morningstar.
Ben, thank you so much for being here.
Ben Johnson: Thanks for having me, Christine.
Benz: Ben, big milestone here. We've been watching ETFs gather assets rather rapidly over the past decade, certainly. Let's talk about the significance of this $4 trillion milestone. What do you make of that?
Johnson: Well, I think, like most major numeric milestones, there's not much of substance here, right? So, when the Dow crossed 20,000 finally, it wasn't like there was a balloon drop, and we were all newly minted millionaires. But if nothing else, it marks an occasion to look back and to see how far this universe has come over the years.
So, nearly 25 years ago, we've gone from just one tiny little fund listed up in Toronto, so that's our ETF trivia fun fact of the day ...
Benz: And what was that fund?
Johnson: It was the Toronto Participation Share. So, it was the first ever exchange-traded fund. We've gone from that one fund to now nearly 7,000 exchange-traded products from 300-plus providers listed in nearly five dozen different nations around the world. And almost uniformly, what we've seen is that exchange-traded products, which are just a technology--they are just a new way to package an investment strategy and distribute to deliver them to the end investor--that technology has had a democratizing, a leveling force. It's brought, most importantly, institutional-level pricing down to individuals who can tap into an exchange, can invest in an ETF in an amount as low as a single share, for a fee that used to be the exclusive domain of the largest institutional investors in the world. There is no arguing that that has been to the good of the end investor.
Benz: And it has also put downward pressure on even active funds, where they have been losing market share to ETFs, and they've had to cut fees in many cases?
Johnson: That's absolutely been the case. So, much of ETFs' gain have come at the expense of relatively high-cost funds and high-cost actively managed funds, many of which, quite frankly, have been benchmark-huggers to begin with, who have been charging active fees for passivelike, or if not worse, performance. So, all the more important in that not just within the ETF ecosystem, the ETF universe itself we've seen these positive benefits, there's been sort of ancillary benefits as well to the extent that ETFs have really turned the screws on many active managers.
Benz: OK. So, you mentioned product proliferation, which we've certainly seen. But the bulk of assets still are in not that many ETFs. Let's talk about that.
Johnson: If you look at the U.S. ETF marketplace, for example, and just rank order the 2,000-plus exchange-traded products that are listed today, what you see is that the top 100 have three quarters of investors' assets. They've also seen three quarters of the net new flows that ETFs have witnessed over the course of the trailing three years. Those top 100 ETFs are almost uniformly tracking indexes that are broadly diversified, more often than not market-capitalization weighted. Their fees on average are markedly lower than those charged by the remaining 1,900-plus exchange-traded products. So, while in many cases, this level of concentration might cause some worries, might warrant caution, if anything, I see this as a positive in that on average investors are keeping with the most broadly diversified, least expensive options on the menu which is good behavior. Now, they might be using them in less than ideal manners, but at least, in terms of their selections, they are selecting the better funds that are out there.
Benz: That's good to know. Now, all of the news items that you brought do revolve around the (number) four. So, we had $4 trillion in assets, in total ETF assets. Vanguard Total Stock Market Index Fund just slicing its expense ratio to 4 basis points for the ETF. Let's talk about that. There have been price wars among some of the big providers. Vanguard is now at 4 basis points.
Johnson: And 4 basis points--riffing off the number four as you alluded to, Christine--low, very low, not the lowest. There are two ETFs, the iShares S&P Core Total Stock Market ETF, ITOT is the ticker, the Schwab US Broad Market ETF, SCHB being the ticker, both charge identical fees of 3 basis points. Now, the difference 3 basis points and 4 basis points when it comes to a hypothetical $10,000 investment is a buck a year in terms of your fee savings.
So, as these fees reach sort of the theoretical lower threshold being zero, so kind of free beta, if you will, what matters more is investors' personal circumstances, their personal preferences, because saving a buck or two here or there isn't really going to move the needle for a long-term investor.
So, you have to understand, does it make sense to switch wholesale from one fund family or one brokerage to another? Probably not. Does it make sense to redirect some of your incremental savings, your incremental investments from one provider to another? It might, it might not. You have to take into account also your taxable status, your taxable setting. Is this in a tax-deferred account, a taxable account? All of these various considerations matter far more, I would argue, over the long term than trying to save a dollar or two here or there, fighting among what are increasingly commodified funds.
Benz: That makes sense. On the other hand, though, say, I have that 25-basis-point index fund, and I see, well, there are some ETFs on the market that can do it for 3 basis points or 4 basis points, that might be enough to make a switch if I have a meaningful position there?
Johnson: That could absolutely move the needle in a meaningful way for you. But again, it's important to understand, what am I going to unlock potentially in the process. So, take into account your personal circumstances, are there embedded gains in there, is this fund in a taxable or a tax-deferred account? Be careful because being a penny wise could end up making you look a pound foolish.
Benz: Right. Now, the first two news items that we discussed were both very positive developments for investors. Lower costs, investors in general getting some democratization and getting lower expenses. This next item though, 4 times-leveraged ETFs got approval with the SEC. I am guessing this is a development that you don't like quite as much.
Johnson: This is the latest example, Christine, of ETF and exchange-traded product development gone wild. So, over the course of the past few years we've seen a pair of restaurant ETFs, we've seen the obesity ETF come to market. We've seen a whiskey ETF. We've seen, almost seen a bitcoin ETF that was …
Benz: Marijuana ETF, right, in Canada.
Johnson: Marijuana ETF. You name it. What we see, as I mentioned before, is that most of investors' hard-earned money is going to cheap, broadly diversified, very useful core portfolio building blocks, and a whole host of various product providers that are trying to bask in sort of the halo effect of those very broad, very useful, very inexpensive products. Investors are well-served to ignore the riffraff and focus on what you can control, which is the level of diversification in your portfolio, the fees that you're paying. And again, all of the evidence points to the fact that investors are doing a fairly remarkable job of keeping it simple and keeping it cheap when it comes to selecting ETF for their portfolios.
Benz: They are saying no to the quadruple leveraged products. What is the providers' goal in something like this? Is the idea just to pick up assets?
Johnson: Well, I think, any time you see a niche product like that, it's exactly that. It's to take something one step further. So, to reference Spinal Tap here, there are things that go to three now, these go to four. And there is a market for that, but it is very small, it is made up of investors who are very sophisticated, who are trading these in a manner to exploit certain circumstances, certain nuances that to the average investor are just going to make their head spin. So, to the extent that they are listed on the exchange alongside a lot of these cheap building blocks, creates a potential danger because a naive investor who doesn't understand all of those finer points could very well do harm to themselves and to their wealth by using these funds.
Benz: OK. Good point. Always great to hear your insights, Ben. Thank you for being here.
Johnson: Thanks for having me.
Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.