Eric Balchunas on How Important Fees Are to Fund Performance

for Bloomberg Intelligence, and he has great ideas. I love talking with Eric. I'm very glad you could join us. Uh. You know, we were talking yesterday about a couple of moves that Fidelity has has made, uh and black Rock has made to cut expenses as passive management takes a hold, how much our investors prioritizing the cheapness of funds over what they actually offer right now, it's it's everything, uh that you know. The phrase I use his expense ratio

is the new past performance chart. I think this really gets down to trust. I think investors just trust a fee more than a pretty chart. Right now. And I don't know if it's from decades of seeing the chart buying into it. It's not working out because a lot of times investors will buy in it after the chart goes up and you know, it's hard to maintain our performance.

Or it's just this spread of information that's been going on for about ten years that the Internet really helped to get out there, which is how important fees are in your in your final performance. Fees are a big contributor and the one thing you can control. So give us a sense of just how much more money has gone to the cheapest fees versus the most expensive. I'll throw out a few stats here. So last year, six

billion dollars went into ETFs. Over half of that money went to products charging nine basis points or less UM. So that's once that so basically free, basically free. Yeah, I mean if you look at UM I've did this study where I you know, put everything into different buckets. It's going in active mutual funds. Funds that charge less than forty basis points that are active saw inflows d F A Vanguard or two big issuers in that area.

Index funds that charge less than twenty saw more inflows than once charged forty So even within index funds, which are already passive, there's the cost migration. So I think when you look at the we put the flow every mutual fund, share class and e T F on a big spreadsheet, divided into buckets by expense ratios, and we found that by the vast majority of money goes to zero to ten basis points, then the next is ten

to twenty, and it cascades down to about forty. Then at forty six it starts going down until plus ninety is the biggest outflow. So there's definitely a big correlation between the how much you charge and the flows you're seeing. Are the e t F issuers as well as the brokerage firms. Are they victims of their own success? And how many people does it to run a business that is going in this direction? Right? Good question. I have a piece out today that looks at the fact that

you need human beings to do this. You also need human beings to analyze ETFs. It's not all robots, but I do think it's gonna definitely put some pressure on the operations and the human element of running an asset manager. We've already seen that. I mean, you wrote a story just yesterday calling, uh, you know, with the situation of pressure cooker for asset managers, and I think that's a pretty good term. So they're probably gonna have to do

some things you saw Janice. I think this is the biggest, biggest example, Janice got together with Henderson. So I think you're gonna see more and more companies hooking up with other companies to get big enough so they can lower their fees and get scale going. And that will be the new game for the next decade. All right, So you see this migration toward passive, it doesn't this sort of raise alarms that people are going at the wrong time. I mean, the more people go into passive, the more

opportunities there ought to be for active investors to outperform. Now, yes and no. So the fact that everybody's going into passive has helped lift assets in the same indexes. So right now, it's actually helping that there's this sort of call we'll call it a mini bubble. Right a lot of people are going into passive. It's lifting up stocks

in the SMP. In other words, it's a self fulfilling prophecy because the more people go in, the more stocks rise, and then they see good performance and they keep going in. You talk to really smart managers that know their factors back and forth. They claim that I'm just gonna sit in value and wait till this little mini passive bubble pops and I'll then I'll be the hero. The question is when, because remember this isn't just the move to passive,

it's a cost migration. Just so happens that the cheapest stuff is you know, index based, so passive is drawing those assets. The quint is when will this all play out? Right now, passive investments only own about twelve percent of the stock market, so the majority is still in other things, mostly active that so this pendulum could swing a lot further. So if you're waiting, how long do you wait until

this happens? The second thing a smart Beta. You just made the sales pitch for smart Beta rob or not? He says, why would you want to buy an index where they reward price and they give more waiting to stuff that's bigger and pricier. You should come with me. I actually put higher weightings and value things that are cheaper. So smart Beta has funneled some money for people who are investing based on what you just said, but still using passive products to try to reward stocks that are

trading cheaper or or in a momentum spurt. That's the whole smart beta sales pitch. You know, as you talk, I just keep thinking, how much does passive have to own before they've become a dominant force in a market? And I think this is one big question a lot of people are analyzing. There's not really a good answer to it. You might say that there is, but well, well we had an event. We had John Vogel he said it could be nine before it's a problem. Wow.

Thanks very much. Eric Balcunis, he is an expert when it comes to E t F. He's our senior et F analyst for Bloomberg Intelligence and you can follow him on Twitter at Eric Valtunist. Well, when we want to know more about municipal bonds, we call on one person, Joe Maisak. He is editor of Bloomberg Briefs for the municipal market and he joins us. Now, Joe, thanks very much for being here. Let's talk about municipal bonds and what may or may not happen to the municipal bond market.

If the Fedow Reserve A deigns to increase interest rates twenty five basis points in a couple of weeks, tons of uh of actually good things follow on the hills of of higher yields PIM. If we see the triple a ten year ago to maybe four percent, I see things like insurance rising. Uh, there will be the muni junk bottle of revive swaps will come back. The auction rate securities market, which has been sort of dead for um,

you know, since two thousand seven, that will probably revive. Um, We're probably going to see a little help for public pensions. And why don't I toss in a little bit uh more stadium construction, uh to sort of go hand in hand with muni junk. And right now the returns are pretty good, right, muni bond returns in February, we're the highest since two tho correct, Yes, and uh, you know it's still you know, these are the yields have been

solo for so long. Uh, it's it's almost incredible how flat the market has been about two and a half percent and ten years. Okay, So one place that has not been flat is with Puerto Rico municipal bonds. And we did get some news this week with the new governor ra Cio. We're proposing a fiscal plan that included, uh it was it, coverage of about two thirds of bond payments over the next I don't know, nine years or so, a little little less than that. Uh, he

said about one point two billion. I think the control Board, the oversight, the Federal Oversight Committee, Uh, you know, they see him paying maybe eight million. The kind of surprising thing is he also asked for a complete stay on any litigation to be extended to the end of the year. So bond holders are sort of up in arms about that. Yeah, but they don't seem to care. I think they didn't

really respond much to this, did they. But the bond prices, Yeah, the fact that, like, you know, all of a sudden, the amount that's covered under this fiscal plan is completely insufficient for what for to cover their losses, and people are just sort of like, yeah, whatever, you know, it's right now. They're going to enter the negotiation period with the governor. And it's the surprising thing about the governors.

He can panned as the uh as the man who's going to repay the debt, and now that he's in office, repaying the debt is a lot less appetizing. Shall we say, can we talk about some numbers, because I was just looking at a comparison. California, which actually went re entered the green muni market, uh this week with an issuance California for a ten year averages two point six seven percent.

That's obviously triple tax free. New York State two point three one percent, and then you've got these outliers Illinois four point five seven percent. Tell us a little bit about the volume of issuance, because supply also affects the price. You know, this year we started off first year, I think January was around thirty billion. We're probably up to over the first two months maybe fifty five billion or so. And this is off a little bit. Of course, last

you was a record pace. We had forward six billion, So this year we're off a little bit. It's a little slack, however, you know, you bring this up and next week, all of a sudden, we see a whole batch of state general obligation bonds, including two point four billion from California. So the states seemed to be looking to take advantage of maybe the last shot at rates

this low. One reason why mini bonds initially sold off after President Trump was elected was because people were ratcheting uh back their expectations for how high their taxes might go and expect expecting some tax relief. This basically gives less of a benefit to municipal bonds, which are tax free. Now that we really have not seen a tax plan, uh and we don't know how soon it will be implemented. Is that part of what's bringing people back to the

mini market too. Well, they have to put their money to work, and you have, uh, you know, tax concerns, um. But you know, the whole tax picture I think has sort of been put on the back burner for a while. Like you say, it's was something that instead of coming here in June, July or August, which is what the administration has talked about, most people really think it's going to be very late in the year, probably more like next year. The administration has a lot uh to worry

about between now and then, especially the Healthcare Act. Thanks very much for joining us. Joe Maisak. He is the editor of Bloomberg Briefs on Municipal Markets. Always enjoyed listening to you, and of course meanings We're gonna have to wait and see what the foto reserved does. And maybe

this will increase the issuance of municipal bands well. And this might actually help with the whole idea of infrastructure spending uh, as President Trump has proposed, perhaps by a sort of a back channel with private money pim fox.

There is so much data that is available today. There are some good statistics about just how much the n s A has, for example, compared to prior administrations during the communist era, when people thought, you know, oh my gosh, the government has such a handle on what everyone is doing. But now we have so much data that we need

to rely on algorithms to sort through it and find patterns. Uh. But are these algorithms really better at sifting through the data, albeit the massive tropes that we have, and coming up with conclusions and humans? I want to bring in Kathy O'Neill Bloomberg View columnists h and also a mathematician who has been a professor, hedge fund analyst and data scientist, and she wrote a fabulous column about how in the world of big data, more isn't always better. Kathy uh,

first of all. Just to put this into perspective, just how prevalent are algorithms in decision making processes throughout the economy at this point. How dependent are we upon them? That's a great question, um. And people don't really realize this because a lot of the algorithms are actually happening behind the scenes and we can't even see them. But it turns out algorithms are being used on basically every important decision in somebody's life, every time they have an option,

and they're sort of competing with other people. So that means you know, college admissions, getting a job, even while you're on the job, how you're being evaluated, how much you pay for insurance, you know, how much you you what kind of ap are you get for credit? Um. Even things like policing and how long you're going to jail if you get if you if you're guilty. Um,

those are all determined by algorithms. Never mind all the things that are happening online of course, and the political micro targeting, all the ads you see on politics, which

or are all algorithmically defined. So yeah, it's it's absolutely everywhere. Um. And what's especially concerning is the moments like when you're trying to get a job and you send your resume in and there are algorithms that filter your resume based on you know, used to be just keyword searches, like what kind of words did you say on your resume? But now it's all sorts of other kinds of correlative information about your resume and you will never know that.

Just to be clear, like, you'll either get a callback or you won't. But if you don't get a callback, you won't know why, and it might be because of an algorithm. I wonder if you can give us an example of an algorithm that's gone wrong. Yeah, well, I actually wrote a book about this called Weapons of Mass Destruction. UM. Very good book. I did read it. Oh, oh, thank

you so much, FIM. UM. So I would say, a lot of algorithms go wrong, um for the people they are targeted, but not necessarily for the people that build the algorithms. So to be clear, UM, one of the main points of the book is that, UM, what you know It depends on this on your perspective on whether something's going wrong. But one of the one of the examples of my book, UM, it comes from the world

of education. UM. In their teacher assessment algorithms, and teachers are basically being scored between zero and a hundred UM. And I think that is probably the best example of a terrible algorithm, because it's very inconsistent. I found a teacher who got a ninety six one year and a six another year UM. And another teacher got fired for a bad score, even though she thinks that her score

was artificially low because other teachers cheating. UM. And there's I mean, I think the critical point about these algorithms isn't that they're bad, because of course there's bad algorithms out there. The critical point is that they're being used as if they're scientifically they have scientific authority. UM. So people trust them in a kind of under an overexaggerated way because of their mathematical nature. And so that's one of the things I was trying to get go after

in my book. As a mathematician, I don't want people to blindly trust mathematics. But the point of mathematics is that it's actually supposed to clarify things, not obfuscate them. Well to that point, how can companies and universe these make sure that their algorithms are doing the right thing? I mean, what's the check here on how to make

the algorithms better. The answer isn't necessarily for a human being to be trying to sift through all the data themselves, because at this point it's that's an unsustainable solution given the amount of data that a lot of these algorithms are tasked with the processing. Absolutely true, and I'm not I am not anti algorithm whatsoever. What I'm trying to um suggest um is that we create standards of evidence that the algorithms are meaningful, that they have statistical meaning,

but they're also that they're fair, and they're they're legal. Um. A lot of the algorithms I examined in my book actually I think are probably illegal. But because regulators don't know how to examine algorithms, um, they're you know, companies are getting away with stuff. So in particular with the algorithms for hiring, they're kind of replacing their HR divisions with algorithms without making sure that all those all the algorithms are actually you know, they reflect fair hiring practices,

which there's plenty of laws around that. So my point is like we need to create evidence and to demand evidence from the people that build these algorithms and use all these algorithms that what they're doing is actually legal

and fair. A point to you, is it possible that what's going on is algorithms are being used to cut costs in a corporate setting, and that the reason it's being done is because then there is no personal accountability for the result, that is, you nailed it on the head, Like I observe just many, many examples of these algorithms that are what I call weapons of math destruction, and

they're very powerful, their secret and their destructive. And one of the things I noticed sort of after writing the book is that there's a kind of certain characteristics of a situation that are ripe for these kinds of algorithms. And it's exactly what you just said. It's when people don't want to take personal responsibility for tricky decisions. Tricky is asians like is this a good teacher or not?

Is this a good applicant or not? Those are tricky and they know that it can go wrong, and they would like to say it's not me, it's the algorithm. And that's when the situation is right for for pretty nasty things happen. Well, it certainly reminds me of the Stanley Kubrick movie, Uh, Doctor Strange Love, because right, I mean the doomsday machine. It just takes it takes over, and there's no way to really get a human being in between that and and the dire consequences. Thank you

very much. Cathy O'Neil is a Bloomberg View columnists and you can follow her on Twitter at math Babe dot org. Yes indeed, and she is also the author of the book Weapons of Math Destruction. A lot has been said about President Trump's immigration policies, particularly as they pertain to Mexico and our other southern neighbors. I want to bring in someone who could talk more about that. Hector Barretto, who is chairman of the Latino Coalition and former US

Small Business Administrator under George W. Bush. Hector, I'm glad you could join us. First, I want to start with a question, how different are President Trump's proposed immigration policies to the ones that were implemented under former President Barack Obama. I think we're saying under Bush or who I worked for. UM, you know, the policies are very different. Obviously, every administration

has a different take on it. We don't know all the specifics about what the immigration policy is going to be, especially going forward with regards to countries like Mexico. You know, I worked for President Bush, and the first thing he did when he uh got into office was he put forth in an initiative with Mexico called the Partnership for Prosperity. We worked on that for eight years while I was in the administration. Uh. Less so in the last administration

in terms of things like the Partnership for Prosperity. Obviously, there was never comprehensive immigration reform under the Obama administration, and we don't know what the immigration reform proposals are going to be uh in in this administration. Do you think that immigration policies need to be reformed in the last Absolutely? Well, I mean, you know, I think everybody stipulates that our immigrations UH system are policies towards immigration

don't really work for anybody. They don't work for the immigrants that are here, they don't work for the economy, they don't really work for anybody. So, you know, everybody basically says it's a broken system and we need to fix it, but nobody can coalesce around what that looks like and so that's why we keep kicking this can down the road. Remember, we haven't had immigration reform in the United States since nineteen six that was President Reagan.

So we've been thirty years dealing with a lot of these issues. And I think a lot of people on both sides, they all are very frustrated and and hope bowl that we can get something done in this administration. Hector, I want to just bring a little bit more detailed to the conversation. You previously before your role in a business on a large scale, you worked in your family's restaurant, uh,

import export business, construction accompany, and so on. In US, Hispanic buying power was larger than the gross domestic product of Mexico and it is growing substantially. Uh, we're talking about a buying power of about thirteen point nine trillion dollars, right, that's uh, that's the total. Is there a way for this immigration plus a I don't know if you want to call it immigration, but a nafter revamp, trade policy revamp that could actually make that an even more a

stronger figure. How can it help the business about it? Look, you know, I serve in a lot of different capacities. I'm also on the board of the US Chamber of Commerce. This has been a major, major focus and an initiative for us for many, many years. And these things are connected. Uh, you know you were talking about the family businesses. You know,

I'm the son of an immigrant. My father, Hector Bretto Sr. Was an immigrant from Mexico in the fifties and he was the founder of the U. S Hispanic Chamber of Commerce. We've learned about these issues all my life in our family. We know how important that they are, and they are interconnected. Look, purchasing power in the United States. Just Hispanics in the

United States is one point five trillion dollars. My father used to always say, you know, the Hispanics in the United States have more purchasing power than all the the the Hispanics in Mexico and a lot of countries in Latin America. And and that is going to grow Hispanic business, which I'm very passionate. About four million companies that are generating close to seven hundred billion in revenues and they

could double every five years. And many of those have connections and linkages back to Mexico and other parts of Latin America. So there. You know, there are a lot of reasons we should have immigration re form, and there's a lot of reasons we had to look at some of these trade deals. But the first reason is it's in our self interest in this country. And so hopefully we're gonna see some leadership coming out of Congress, coming out of the White House, and it needs to be bipartisan.

There's no way, we've learned this over thirty years that you can make this kind of change without having buy in from both sides. You know, as you talk, it's very optimistic view of things, coalition bringing together. It doesn't really mesh with some of the rhetoric that we've heard. We've heard about building the wall, we've heard about those bad ombraise, We've heard about a lot of things from President Trump to get out of this country. We've heard

about ice agents going and rounding people up. I mean, are your members scared, Well, there's a lot of people that are scared, not just in my community, but there's a lot of members in my and my group who are also very optimistic. And you know, business people tend to be up a mystic. We see the glasses half full. We wouldn't go into business if we didn't, if we didn't, if we didn't, if we didn't, think that understood. But

do you think that as as such? Right now? Are people worried about their businesses getting harmed because of exporting power to Mexico and a possible deterioration of the relationship the US has with Mexico. Look, you probably know this is that small business companies in the United States is up, you know, almost at historic highs right now. And it's not historic highs because they feel that their businesses are going to be failing. They felt that over the last

eight years, they felt that were all these barriers. But when they hear the administration saying, hey, look we get it. We've got a lower regulations on you, we've got a lower taxes on You've gotta make healthcare easier for you to get. And yes, we've got to renegotiate trade deals because you know what small businesses are the ones that

don't participate in trade deals. Were of all the companies that do international trade, and we're less than thirty percent of the trade dollars and that's not lost on those twenty seven million small businesses. So you know, uh, we hear a lot of things, and it goes back and forth. We're trying to focus on the things that are actually happening, the real things that are happening, not the stuff that

you know gets scandalized. And every day there's a there's a new threat to to the world as we know it. I mean, we're gonna be paying very close attention and we're gonna be calling balls and strikes. We're not going to agree with everything that comes out of Washington, d C. But where we can, where we can help create that environment so we can start more small businesses instead of having them fail as they have over the last eight years. We're very interested and focused on that. We have to

have a seat at the table. We have to be speaking to the people that are in power. Not everybody agrees and not ever. That's why we have elections. But after the election is over, it would be irresponsible and we think mal practice for us to just to check out for the next four years. Hector, I want to thank you very much for coming in and sharing your thoughts with us. So this is a very important topic.

Hector Barretto is the chairman of the Latino Coalition. They are based in uh Irvine, California, and in Washington, do you see him? Well, of course, and I'm sure you're there quite a bit these days. We are. We have a major event next week, so thank you. Having'll give you ten seconds tell us about it. We're having a policy event Latino Coalition. Sp administrators coming over the White House at a very high level will be participating. We've

got a half a dozen Congressmen. And if you're in Washington and interested in attending a small business event with the fastest growing segment of small business, you gotta be at the Latino Coalition next Thursday in Washington, d C. All right, see there, we give we give you the little plug. That's good thing for you, you know, at least excuse me, I was noting that. You know, Mexico is no longer the top origin country among the most recent immigrants to the United States. China and India have

overtaken Mexico as the most common countries of origin. Hector Burrado, thank you very much once again, Chairman of the Latino Coalition. Thanks for listening to the Bloomberg pien L podcast. You can subscribe and listen to interviews at iTunes, SoundCloud or whatever. Podcast platform you prefer. I'm pim Fox. I'm out there on Twitter at pim Fox. I'm out there on Twitter at Lisa Abramo. It's One before the Podcast. You can always catch us worldwide on Bloomberg Radio