Under the Hood

and this is no different. There's certain criteria due diligence, things you should look for, some of the more important than others. But there are many things you can do and it's not that hard. But some of the terms in E t F DI diligence can be a little frightening, a little jargon E. But we have the perfect guy here today to help simplify all that. He works for the c f r A. His name is Todd Rosenbluth, and he's sort of exactly who you are. He's a mutual fund and E t F analyst. Yeah, I mean

he's kind of like me in another world. He works at his company. I work at my work competition, but we're also Piers. Todd writes really great stuff. I enjoy it. I also up push back on it. Sometimes we've had some friendly debates. I see Todd all the time on the circuit circuit. That's the thing. That's the thing. I know that sounds funny, but like there's conferences. You see Todd on panels and likewise. So he's the perfect guy

to help simplify this because that's all he does. And I like that he is have a mutual fun background because E t F analyists who know the mutual fund really well tend to have a richer look at the E t F structure. So we're gonna talk about due diligence, which let's come up with a better title. How about under the hood. It's cliche, but I think in this case this is the perfect metaphor. We will go from the food store to the car. Right, we got our groceries.

Now we're in the car. This week's episode. Okay, Todd Rosen Blues, thanks for joining us. Good to be here. Thanks, So, Todd, who are you? I'm in New York? Go totally? Do you want to get So? I head up the E t F and mutual fund research for a company called c f R A and it's literally called c f r A. It is literally called t f A so used to the business used to be owned by ms C. I uh the name c f A came out with it.

I'm a former employee of S and P. I ran the mutual fund and et F research at c f A. I'm a former equity analyst that covered tech and telecom stocks, and before that was a mutual fund analyst at the company and at Value Line, and for the last seven years have been dedicated specifically to E t F s and to mutual funds and providing analysis for our n clients and and the general public in a range of ETF. So, tell me what your day looks like then, So a

couple of things that are primarily day today. So I'm looking at trends that are going on in the marketplace, looking at investment ideas, and then trying to explain how you can participate in those investment ideas using either an E t F and or a mutual fund. Is part of what I do. So I typically write about two or three articles on a weekly basis that could publish for our clients. I'm dealing with reporters, including from Bloomberg that are working on their own stories and adding an

input an independent perspective in that regard. And then we have clients so that are subscribing and advisors and retail clients that have access to our research and that want to hear more or have questions beyond what that is, or that possibly want to learn about us before they sign up. And then I'm part of those conversations as well. You said the word independent. Yes, c f r A doesn't offer their own mutual funds or e t F. C f R A doesn't have investment banking relationships the

way that you're Morgan Stanley or Goldman Sachs does. That offers research on investment ideas were purely the best ideas and from an et F perspective, which is relevant for this topic. We have an equal number of e t F that we like as a number of e t F s that we don't like, So we we cover the whole universe. We have about t fs that we have an opinion on and roughly in one side of the bucket, roughly on the other side, you're not going to find that from others that are covering ets often

want to just tell you what's a good idea. So I get Todd's emails, and that's one of the reasons I thought he would be a great guest as be because Todd is unique from your average et F person because a lot of times they get pretty much all in on e t F. It's like kool aid city. Todd still recommends mutual funds, and he has a reason for doing it. He also has a background of mutual funds and equities. You can put that together. It makes your et F analysis, I think, richer and deeper, and

I think that's what makes Todd kind of unique. So how did you find the e t F? Todd? So my company, when I was at S and P, we were covering individual stocks. We were seeing the trend that investors were looking to invest in e t F s, and we wanted to come out in a different perspective. So the way that we look at in the way we did back now almost ten years ago and we continue to do so, is to us and E t

F is a basket of securities. Whether it's a stock ETF it holds Apple and IBM and Facebook and what have you. If it holds individual bonds, then you should do that as well. So we come at this from a perspective that we cover individual stocks. We have by hold cell recommendations on individual stocks, and what is going to drive an E t F forward is going to

be what's inside that portfolio. Now, there's other things that we use in our research, but so we just really took the underlying holdings and formed took the E t F rapper and decided to do things that were connected

to it. Now at the risk of the commercial part of it, we use other things that are outside of holdings analysis, and I know we'll get into it from a due diligence perspective, but there are things that are unique to an e t F. It trades on an exchange, so there's bid esque spread analysis, you can do it's trades, and you can do technical analysis and the rest of getting too far in the weeds here, there's things you can do that are unique to an e t F

then you would a mutual fund or an individual stock. What was your lightbulb moment that you realized, boy, these things are for real. Yeah, well it's you started seeing people buying them because it was the way to get exposure to a certain trend. So I even remember back when I was not an e t F analyst. But I remember people before we had to tech boom the Triple ques. The power shares product which actually just go was by Triple Q. Still, that's how common that name

has become, which is a NASDAC one. It's the largest stocks non financial within a n Aztec. Side of what it is, people were buying that, I don't think they understood what it wasn't. In fact, I think people still think of it as only a tech reality thing. And so I just started digging into this, understanding more of what it was. And then when S and P got back around to looking into this, I was very happy to be able to do that because I had that

background having been a former mutual fund analyst. So before you were an E t F analyst, you were a mutual fund analyst. So tell me about how you view a mutual fund versus in et F. What's that difference like? Yeah, So we cover both of them. I head up the research for both our E t F business and our mutual fund business. We have separate ratings on e t F s then mutual funds. There's others that are combining

that together. We think there's a role for both in et F and or a mutual fund in the portfolio, whether it's actively managed or not so passively managed and index based, but the things that you need to focus on are different. So we don't believe the past performance of an e t F is going to give you much insight as to where is it going to go

uh in the future. So there's no there's no disrespect to anybody who's running an e t F portfolio or running an e t F itself that's tracking the SMP five index or the m s c I e F index or what have you. But their job is to track that index, and they're pretty good at probably doing that. But there isn't the same skill set in picking stocks, buying a new when things are falling in value, or

spotting new trends in that regard. So whereas we use a performance track record in mutual fund research at c f A, we don't really on that for our e t F research. The SMP five hundred is going to be up roughly this year, it's unlikely to do that in two thousand and eighteen, and and whether or not it did well this year really should have no bearing on how well it did going forward. People aren't buying e t s that way anymore, and we don't do

research there. One the thing I do you want to talk about here is sort of what an e T F does, right, because it tracks an index, right, so when you're evaluating them, can you talk about how you look at that index? Right? So what we're doing in part is less looking at the index itself and the name of the index and the rules of the index, although I think that's extremely important for an investor to do. We're looking at what is currently inside the portfolio, what

fit that criteria that was there? You're you're correct, It's very transparent. You can understand what's inside that portfolio. And if it's a market cap weighted the largest companies tend to have the highest exposure, which is in you know, I keep using the I shares SMP five hundred of the Vanguard five hundred product or the Spider five hundred products. So I give everybody that's in their full color independent analysts. So that's how that's where it comes about independent analyst

where about uh for what that is? Then then the largest companies, the apples, the ibm s are going to dominate that and and our opinion of those stocks is gonna matter more? To use the SMP five hundred as the example. There's an equal weighted product that's out there from Guggenheim. RSP is a ticker same exact companies, but they treat every stock equally. There's more MidCap exposure than

you'd find versus the other SPI index products. We're gonna offer take not whether it is equal waiting better than a market cap waiting approach, but is now a better time to be in those companies across the SNP five index as opposed to being dominated by those mega cab companies, the behemoths that are that have earned their their stripes. This brings up a big point, which is who is

the user and what is their goal? And and my work I have that is a big difficulty because on the terminal we have mostly institutions, but there's some advisors and I don't know if they're looking to make a quick buck over a week or they want to go in for the long haul. I think, you know, there are different and that's the thing with et s. Everyone uses them so in terms of like if it's a

good time or not. I think there's a challenge with what is the investor, how big are they, how concerned are they about certain areas of the e t F, and what's their holding period? How do you determine who the investor is and what their goal is when recommending an e t F. Yes, so we're trying to offer one opinion on an e t F, not multiple opinions that are out there to trying to target to the audience for what it is. And and I understand where

you're coming from in that regard. But that institutional investor that then is on their own running, you know, money for their own, you know, doing something for their parents, would want to buy the should buy the same et F for the same reasons, necessarily because it's a good et F that fits their approach. So we have three different ways that we look at costs, and one of them is the expense ratio. One of them is the bid ask spread. I'm gonna leave the third one out

for the moment for what it is. If you are more of a buy and hold individual investor or a buy and hold institutional investor, then that expense ratio is gonna matter more. If you're a more frequent trader, whether again, whether you're an institutional investor, or you've a brokerage account where it's unlimited trading or what per trade, and some of these things are commissioned free, then that bid ask spread is going to matter more because the trading costs

are gonna add up. We use both of those they're roughly equally weighted from a cost perspective, and the way that we have a ranking of each et F, but we still think that you need to not only know that, and you need to know other things that are important. So the holdings, the how it's trading. From a technical perspective, is there liquidity that's tied to that portfolio as well?

And if you can, you can screen so you can use our research the same way you could be able to use on the Bloomberg terminal, and you can say, well, we don't care about the bits spread. Then you can choose to it's still in the rating, but you can be able to filter and store based on certain characteristics that better fit your needs. So actually talk to me

about what your work looks like. Yeah, so we there's two different ways that that people have access to or things that they subscribe to, either an individual or an advisor or an institutional investor that has access to our research. One, we have an opinion generated report on plus ETFs that count. I use plus because that number keeps changing. Uh. We typically cover an e t F about three months into its history. So what was there today and what is

there in a couple of weeks. That number is going to change, and that opinion is going to say overweight if we like it. It's gonna say underweight if we don't like it, and it's gonna say market weight if we're neutral, And it's gonna show you what are the drivers of that ranking overall and what are the characteristics. The second thing, which Eric was kind enough to offer compliments on on the commentary, is I published content that is more long form in nature, more like an article

that has a specific investment topic. Why we think now is a good time to either be favorable or unfavorable on that topic, and then talk about some of the e t f s or mutual funds as relevant that fit in to that trend with really trying to diagnose

what are the differences in those products. So, if it's a technology focus, you know, what do we think of large cap technology versus something that offers more smaller companies inside that versus something that is more rigorous from a fundamental perspective, looking at certain characteristics like dividends, for example, and there's there's an e t F for that as well. There's ant for everything. There's an e t F for almost everything. If there wasn't, then we wouldn't see more

white space. We wouldn't see you know how many How many ets have we launched this year? Over fifty and there's more in registration to come out in two thousand eighteen, so there's still some white space or equally as important. And again I think we'll probably get there from a due diligence aspect. There's two or three or four of these et fs that are closely aligned for a certain investment theme, which makes the choice harder. It makes it

more fun for Eric and myself to offer commentary and security. Yes, the industry continues to grow and then and thankfully they need more. And even though more money is going into some of the cheaper products, people still want to buy some of these products tied to lithium for example, or cybersecurity, and you want to know what else? What do you think of that? And that's that's where hopefully cf A can come in. Yeah, we put a no doubt on buy back and buy back ETFs, which is when companies

buy back their shares. And there's a couple of e t fs for that, not just one. And the guy who runs b I was he was shocked there was an e t F for buy back. So I'm like, yeah, it's like five years old. There's two of them, p kW, but then there's another buy back and the differences between the two of them are pretty drastic, the fee, the way they're weighted, everything, and so you have two different experiences even though they're both called the buy back ETF.

And that's ultimately what you know. I think Todd and I share is trying to make sure you understand that. But I agree with them. When you look at the holdings and you look at the waitings, that's the engine that is the most important part of the car, or the e t F in this case is so let's actually talk about due diligence and how you approach that. So say I take an e t F off the shelf,

what's the first thing I should do? So the first thing I think you should do is look at the holdings to go where Eric said, you should understand what it is that's inside that portfolio. I'm assuming that someone who's you know, you didn't just randomly walk into the

store and not know which store you walked into. So if you chose a certain story, you went there for a certain purpose in mind, and so you didn't go into a department store and look for milk necessarily to open the hood and it's like, okay, what's in here? So and to try to understand how that fits into

what lver else you own. And if this is the first et F that you're buying, then what you should be buying is something that's extremely diversified, diversified from if it's U, S, E. T F from various sectors, healthcare, technology, financials, what have you. But you should take a look at. So we do research on the entire portfolio, but the top ten holdings, which either are heavy waitings with in

the portfolio or they're slightly heavy weightings. If it's something is more equally weighted, and those names should be something that you want to have within your portfolio. You know, we will offer research that will tell you what do we think of what that is. But even if you didn't want to use our research and you just want on went onto a fact sheet, or went onto a website, or you found an E t F ticker on the

on the great Bloomberg terminal that's there. If you don't know what these companies are, and these are not companies that make sense to have in your portfolio, then this shouldn't be anything you should be doing any further digging on. I'll take this even further and I'll say I have a golden rule for picking E t F s, and it's thou shalt not pick an E t F based on the name. Yes. So I'll give you two examples real quick. The I shares China E t F. This

is a famous one. Todd knows where I'm going with this. F x I. It's the most traded, came out first, but it's half financials and a lot of those are state own banks. You're not getting a lot of that tech in the tech surge that had China has, so f x I can lag the rest of China because it doesn't have that tech. Or another when the social media E t F. Right, that sounds pretty innocent, right, oh, social media Facebook? I like that a third of it

is emerging markets. It's much more volatile and filled with companies that you may not even ever heard of. And so those are some examples. And there's Gold Funds that you think holds the goal but holds gold future. So the name sometimes works, but a lot of times it isn't what you think. So I'll offer another example there and then perhaps we're gonna stay in the weeds. Eric and I could probably do this going back and forth and tickers. So I used for full disclosure. Again, I

used to work at SNP. I continue to use this E t F as an example. Beforehand, I'll give two of them. The Spider SNP home Builder E t F only has a third of its exposure in home builders. It has home furnishing companies, It has building product companies. These are all related to the housing marketplace. But and not surprisingly, this year, it's lagging behind. It's similarly named but yet different. I shares Home Construction E t F

I t B. It's about half performance. So for the Spider product x HB about six for that I shares I t B product. Why is I shares I TV doing better? Well? It holds home builders, it has six waiting in a very strong performing area. The second one I like to do, and again I love the product. I really think that Wisdom Trees h E d J the Europe Hedge product, is an excellent product. It provides you amazing exposure to the Eurozone. But it doesn't have the word zone in its name. It only has exposure

to Germany, France, Italy, Spain. It has no exposure to the United Kingdom, no exposure to Switzerland, two of the largest countries that are in Europe. We've seen the UK look to brexit. Well, it's already brexited. These Wisdom Tree e t F it's not there and it wasn't there, And if you're trying to invest in those countries, this isn't the e t F for you. It's a very good one, it's just not an e t F for you for that exposure. And I think of the home builders,

I looked at this one a lot. That's probably the most stark difference. There could be a couple other in the same category, but they their average performance difference every year is about seven percent, so they're nowhere close. But I will say that they You could argue that names are actually okay because home construction is like I'm putting up the walls and the roof, and then I'm out right that's and then home Builders is like, oh, we're

gonna build a home. Honey, We're gonna go to home depot. We're gonna get a jacuzzi. You know, we're gonna get a dish washed, right, Yeah, we're going to well it holds whirlpool. Oh no, I understand that, but I didn't know you were getting a jacuzi, and I'm not I wish Okay, this is wishful thinking time. Okay, right, if you had if you had a hundred thousand dollars to invest, instead of putting it into an ETF, you could invest it in your home a lot differently correct and home built.

Like I'm just saying, home builders is a liberal take on building a home, whereas home construction is. But the point is one of them is going to be a lot more volatile. The other one is gonna move a lot less volatile because it's going to have more stocks

that move more with the market. So bringing it back to where your initial question was on it, and again, Eric and could probably do examples of tickers like this for more than you have time talking about Eric I did not know we stop we we we started you. So you asked about what what do you look for?

What I didn't lead with and what I still think people are spending too much attention on is the performance record of that e t F. So which one of those two examples is going to do best or did the best in two thousand and seventeen has no bearing whatsoever on what's going to happen in two thousand eighteen. And if you looked at a three year track record, which is what some people people commonly do with a mutual fund, you're not gonna get much understanding two thousand eighteen.

We're going to have likely tax cuts for corporations that are going to be differently, We're likely to have the Federal Reserve raised interest rates, which is going to impact not only the stock market but the bond market. What worked in two thousand and seventeen is not going to

work again in two thousand eighteen. And we think investors need to be buying an et F using the windshield in front of them instead of just the review mirror that's available in the car, which is the you know, the fine print, which it always says past performance, not indicative of future results. But people are buying products, or they used to be buying products in that regard, I

think they're buying things now. Is as Eric will probably lead into for something other than just the performance the performance record, but something else tied to fees. And just one quick thing on home builders. I think that this is where it comes into what are using ets for? If you're trading them and you're looking to play rates and and you know economic data around home construction. I

think these ETFs are great trading tools for that. But for most people who just want to take advantage of the low costs and the tax efficiency, you're gonna get a couple of homebuilders in your bigger, more mammoth mainstream ETFs like the SMP five the broad market. So I think that's also an important thing here. When you're looking at the sort of windshield and what to play and what not to play, a lot of these stocks are. Are you feel a little bit of them in the

bigger indices? I want to Actually we've said windshield twice now, and I'm imagining you with like in a cockpit with a windshield in front of you, like and as long as we were talking about holdings holding is obviously going to be a big part of that. What else is on your windshield? So in addition to the holdings that we had that we had that we focus on, we

we do think that expense ratio is important. So the more money that goes into your investment and less into the pocket of the asset manager, the better your potential returns can be. Now, the the in that example of that home construction one, just to beat that one, that dead horse a little bit. Boy, let's not dead house. So we're beating the dead house, right, We're beating the dead house man. The gap is much bigger than the

expense ratio. But if you bought things that were cheaper, all things equal, if they're close enough in alignment, you're gonna be better off. So we use the expense ratio in our analysis. We also think that liquidity is something

that matters at the e T F level. So e T s that have more assets tend to be traded more frequently if they trade, if there's more people who want to buy it when you're looking to sell it, that trading costs and also known as that bid ask spread is going to be much lower, and that's going to be another cost that's important for your returns. Just two quick metaphors, and the I tend to look at expense ratio as a termite, and it's living in your total return, and the smaller it is, the less it's

going to eat out of that total return. And this, ultimately, like Todd said earlier, is why active managers have struggled. It's not because they're that bad. They kind of have to play behind the starting line. They have to overcome a one percent expense ratio or something like that. Then all the trading costs and the fund which are usually

another percent. So you could say that the e t F for index fund plays with a huge lead there right behind the starting line, which would be the expense ratio. And so if you're active, you've got to make that whole gap up just to be even. Then you got to try to outperform beyond that. And that ultimately hits to why this whole passive thing is is getting so big,

is because people are understanding that. And so the I agree, and the expense ratio should be a decision part the decision making process, especially if it's something that is well diversified. So we again have referenced the spire a couple of times. There's three e t f s that are out there that track that market cap weighted product. Two of them are four basis points. The third one is nine basis points.

You know, as Eric has talked about beforehand, I believe you know, money is going into the cheaper products because it's a similar product. The differences. You know, if you invested ten thousand dollars in the eye Shares product versus the spider product in the beginning of this year, you would have saved four dollars enough to buy yourself a cup of coffee someplace, But it really didn't make that much of a difference of what's there or a slice

of pizza and penn station. Yeah, I heard Joel recommends not eating because he threw up after he did, but not enough to pay for termite damage exactly. But the lower the fee, the better, as long as there's enough similarity in the strategies that you're comparing with one another. This whole concept of going to just the cheapest fund, You're right, one basis point, cheaper is now moving billions of dollars. One okay, this one's four basis points that

if I'm gonna put my money into it. I agree that it's short sighted, But do you think that there's some do you understand why people are doing that. Do you think that there's this backlash over the last twenty years where they thought, man, I paid all this money and I didn't really get a lot out of it. The only thing I trust right now is the cost. Like it's become like almost like a backlash against trusting performance in the past. So I think people should be

buying among the cheapest products that are out there. But I think what they should do is they should pick up two or three products that fit that criteria of what they're looking for. And you can screen on various platform brokerage platforms. You can do it on Bloomberg, you can do it from our research tools at cf A. Find three et fs that are out there. Let the expense ratio be one of the characteristics said you look at.

But then similarly, even though I don't think people should buy based on the cheat on the best performing e t F, if you saw a performance differential old that was a couple of basis points, then by the cheapest one that's out there, it really doesn't matter. From the alternatives. But if you look at something and you see something is outperforming by four hundred, five hundred, six hundred basis points versus something else, and it's more expensive or it's cheaper,

you might want to investigate why that is. Do a little bit further analysis to say, here's what this is, here's what's different. There's been product feed cuts have happened, and we saw, you know, State Street, for example, lower the fees quite sharply in there now commissioned free available on on a certain platform as well. There's similarities between what's going in and what you know, it's State Street replaced on the TV Melitary platform. But then there's some differences.

If you're looking at things that are dividends or you're looking at things that are outside the United States, there's a big gap because they're constructed differently. And so I understand why people are buying the cheapest. You want to pay as little as possible for that, but you you'd want to get a second opinion before you ended up. You don't go to the cheapest Karmaca antic that's out there.

There's a reason things are cheap sometimes sometimes, and I agree there's definitely something to that and again the holdings and the waitings are like the engine back to the car metaphor. And you're right. I also think a lot of this low lowest of the low cost is driven by advisors who are worried about this. There's a fiduciary rule coming and they are now connecting fiduciary with cheapness.

They just think if they don't pick the lowest cost product possible, they might get sued for not being fiduciary. And that's a whole another sort of angle on this. But I think you're right. There is possible people could crowd in to something that they didn't really want just because it was a little cheaper than the other one.

But there's things the good I'll do. The good for the fact that fees are coming down is things that you wouldn't have paid attention to you beforehand because the price was too high is now available and on someone's radar screen. And now there's more choices, so there's more

low cost choices to consider. You don't have to just buy something because it undercut by by one pain or a dollar out of your your ten dollar investment, but it's available for you to be able to compare and contrast with and I love that there's more choices that's out there. One again, you know, career longevity. They need someone to help store through this universe that's out there. I also love it because you know, you don't want to just buy something just because it's at the front

of the register. You know, they you know, at a at a story, they'll try to get you by your eyes hatch something for where it is. It doesn't necessarily mean it's the right thing for you. There's certain things that are at a different level of the shelf that make a lot of sense for you overall totally. But this is where this gets when I when we point out cheap stuff, especially on Twitter, I'll get the same

comment from different people, and it's it's almost inevitable. An active manager will go, well, would you pay you know, would you always pick the cheapest clothes or the cheapest car? Yes, there is what you're saying is true. But this is different because cost does come out of your return. It's not the same. It's complicated. It's not just like oh if because if a manager charges four percent, that does

not mean you're they're going to do better. It's not the same as buying closer cars where like, okay, a Lamborghini is what um call it half a mill half a million dollars. That's definitely the best car, right right, Yeah, it's better than the Chete Right, it's better than a Chevette. Okay, fine, But in in investing, it's possible if you paid a hedge fund three the Vanguard whatever at four basis points could outperform it and that cost could be a big difference.

That that's that's where it's there's it's a there's a gray area. I think, oh, completely agree, so you should. That's why caut shouldn't be the only thing that matters. Holding shouldn't be the only thing that matters. Performance should be the only thing that matters. The good thing is e t s are transparent. They tell you what's happening. The e t F providers on their website will show you everything that was in the portfolio as of yesterday.

They'll show you a bunch of metrics as they have to, and thankfully they have to so we can do research that comparis and contrastings. You have that on the Bloomberg turnminal as well. To be able to do that. It's there for you to then learn as much as possible about your potential investment, the same way you would learn as much as possible when deciding again whether to buy a car and what it is, or what school you might put your kid into, or what neighborhood you might

look to buy a house. And but you just shouldn't buy the cheapest just because it's the cheapest. So we talked about holdings and we talked about costs, which are probably like the two most important things from a due diligence standpoint. But let's kind of change gears and go next level and talk about some of the things that you guys, being the professionals that you are incorporating into due diligence. And there's a word that I want to drop that I think we want to start with, which

is liquidity. How do you guys look at that? Liquidity is another way of how much it's traded, how much activity is there there. And you know, volume is what most people think of because stocks have volume and that's all they have. But in e t F this gets a little complicated because the way shares are created and redeemed. You could use the basket of the E t F as another source of liquidity. So it's complicated, but I think in general you should start looking at the volume.

But I'm pretty liberal. I think unless it doesn't trade that much, or trade let's say less than um, we'll call it maybe like a million dollars a day. Some ETFs are really like on the death watches. Ron Roland would call them. There's e t f that are like on life support. There maybe like four or five of those. Then there's a middle pack where you probably have to be careful putting in maybe a certain kind of order,

like a limit order. But then I'd say the top five e t f s you're probably just fine doing that. And so if you had to have a cut off of volume, I would say maybe over ten or twenty million dollars worth of volume a day. And you know that's they're gonna have pretty tight spreads. That's just there's there's nuances to this, but generally that's that's what I

think of as liquidity. Yeah, and so the connection to spreads, which is part of the cost conversation that we that we had earlier, I think is relevant specifically with equity e t F. So we look at the bid Esque spread as a metric that we use within our within our research at c f r A, we don't look at the trading volume specifically, and when we're looking at it, it's more at the shared traded as opposed to the dollar mant You can see it's reported in both ways.

You just have to make sure you're doing the math to figure out what that is the number of shares you might be putting in. I think I would think of it this way, if you are looking to put in a trade and how much was your amount of money to go in in relation to what that daily volume is, and if it's disproportionately high, then I'd be concerned. That would be a red flag for me as an individual investor, because I may be able to buy the shares. That's it's not too hard to find someone who wants

to have shares created. As Eric talked about, it's the getting out part when you want to get out that that tends to be the bigger challenge. And often when you want to get out, when other people want to get out too, and the price you end up paying a couple of other things. So one bec because these if we're talking about equity e t F S new shares can be created relatively easily when there's high demand

for what that is. And if you're buying a large cap oriented ETF that holds Apple and Exxon and Facebook and what have you, then there's liquidity and those underlying shares that new things can get be created quite easily. If you're looking at emerging markets, or you're looking at small caps um or you're looking perhaps at you know, something that's more narrow and focus thematic for where it is, where there's a number of stocks that don't trade as

frequently individually, then that should be a bigger problem. Within bond ETFs are fixed income ETFs, we do think liquidity should matter so trading volume in relation to market cap in part because and I know you guys have talked about this beforehand, not every bond trades on a daily basis, even though the e t F that holds those bonds trades on a daily basis. So to create new shares of a bond is a little bit harder to be able to do to get full representation of what's out there.

And so that's why we've it gets more important to pay attention to liquidity in the bond ETF product specifically if we're talking about something like on a corporate space or an emerging market space, but high yield bonds, you know, something like a quarter of the underlying bonds inside are trading, possibly on a daily basis. I think it's even less. But um, you know, like we said last week that that is definitely when I would not call plain vanilla,

which is high yield. But I just wanted to take a quick step back and sort of define bit as spread. I think it's a term that sounds kind of jargon. E really just think about it about there's people who are in the middle of all this action, right they buy and sell shares so that you can buy and

sell shares. We call the market makers. They make a market in that right, So you can think of Las Vegas, or if you've ever had a bookie, not that I have, but you know, if you have out there, you know they called the vig It's a little tiny piece just for them being in the middle and offering two markets to people. And that is what the spread is. And the more the E t F trades, the bid is what they'll sell it to you for. The ask is what they're asking to buy it. So you's usually a

hiny difference and that's just what they keep. So a lot of e T s trade with what's called a penny spread, so they're only keeping a penny of that transaction. Some can creep up to three, four or five cents. But if you take that in turn into a percentage, you're looking at maybe one to twenty basis points and was Todd was looking at early. The longer you're holding period,

the more that gets diluted over time. So when you talk about mutual funds, they have front end loads where they they and a lot of mutual funds but charge you five percent just to get in. That is what I look at the spread as it's sort of a an initial fee for getting in. And you could look at one two twenty basis points as nickel dime compared

to a load in a mutual fund. So I think sometimes that's a kind of a different way to look at what a spread is as a cover charge basically, yeah, cover charge, Yeah, that's a good that's a good way of thinking of it as well. I do think the way the way that you're thinking of it as important. So people who are at first embracing E T F s and perhaps are learning more about it through through

these podcasts. Are coming at it from a mutual fund world where you're used to putting in an order whenever you want to put in an order, and it gets executed, and your money gets taken from you and put into the underlying investments at four pm when the market is closed, or after four pm when the market has closed in

that regard, and then nothing. It's just all happens behind the scenes and they take out whatever that sales load is and and your ten tho dollars ends up being nine and fifty dollars less or whatever it is for the cost. The e t F is transparent. They you can see what's happening there. That's an advantage to you as an investor, but it shouldn't scare you out of doing it. The same way if you're going to buy a stock, there is a trading cost to buying a stock.

There's a trading cost to buying an e t F. It's just because things are so competitive, the same way it is in the ets space. In this market maker space, when there's a lot of volume, the costs come down quite low and are quite favorable for a potential investor. If you're buying something that nobody else is buying, you're gonna have to pay a premium for that execution to get that trade taken part of it. And that may

make sense for you to do. It may be worth it because it's the only way to get exposure to a certain trend. Yeah, and I would I have a term I called exotic nous. Think about what you're buying. Okay, if it's you know, junk bonds or the Vietnam etiam, if it seems exotic, know that there's probably some some frictional costs that are going to be associated with that, Whereas if it's plain vanilla, you're probably gonna be charged

hardly anything in terms of that cover charge. So because the cover charge that like in the high yield area, that may not show up in the spread. But then there's also the pre there's other ways that. In other words, there's no free lunch. You know, the people who are making these markets and doing all this work, they're gonna take a cut for themselves. It's just the much smaller cut compared to what a load was for a mutual fund. Yeah, So if I could just do the free lunch part,

of it. Because we're seeing more and more these days, and we touched on earlier of of I think ket and Merritrade when they made changes to the platform. We're seeing commission free products widely available on various brokerage platforms Schwab, Fidelity, e Trade, TV, Merriage Trade to all these very merrow Edge I think has it as well. And so that's a cost that you'd be paying from a commission standpoint that continues to come down, but there is still a

cost there. Something can be commissioned free. It sounds well, okay, great, I can be able to buy this and not pay any additional charges or cover charges for what that is. But if that trading costs a bit, ask spread is relatively wide because no one else is doing it. It's showing up on this platform perhaps because the asset manager wants to make this. They want to get premium shelf space for what it is. Some things again that are showing up on there makes sense in a portfolio and

some things don't. And it really is something that investor needs to go beyond. Okay, so back to this next level windshield. You guys are in this cockpit, look at all your various stuff there's another one, volatility. How do you take that into account? So we do. The only metric from an et F perspective that we rely on historical performance, is a standard deviation. If an e t F has a three year track record, we use that three year stand deviation. If it doesn't yet have a

three year track record, we still are rating it. We cover about fo et F that don't yet have a three year track record at c f R A, but we do think it's relevant. So above average returns taking on above average risk isn't necessarily a good thing for every investor. Some people are willing to deal with that

level of volatility from within. So again, you don't want to just pick two thousand seventeen's best performing securities e t F. They're often the best performing ones in two thousand and seventeen because they significantly underperformed in two thousand sixteen, and then there's a good chance that they're gonna revert back to the mean in two thousand eighteen if there's a lot of vlatility. So we that's one of the things that we focus on at c f R A

standard deviation. Standard deviation sounds like something from stats class in college. So but I'm telling you this is I'm gonna format it for you. You were gone skiing, I know you have, right, yeah, snowboarding, Yeah, of course. Anyway, Well I like to ski, Joel likes the snowboard. Anyway, we get to top of the hill. There's a sign for how steep the slope is? Right, double black, diamond, blue green for that's where Yeah, that's right, am I

he where's the bunny slope called? Because that's what I'm using on. So you got you got a Philly's jacket, right, and it's like unzipped and flapping in the breeze. I can totally see you on the green. I know your type. I'll let you live with that image because it's better than the reality. But that's okay. So the ski slope metaphor works. And when we when Todd talked earlier about whether you're buying equal weighted or how it's weighted, and

you could buy it, you could be unpleasantly surprised. Standard deviation will tell you how much up and down you're gonna experience. All standard deviation says say the standard deviation is that just means there's a two third percent chance that it's going to go up or down. That's the range. So what you want to do is look at where the sp I think right now, the standard viation is about six percent, maybe seven percent. That's a little low because volatility has been low. So where is this et

F I'm gonna buy? Take something like XOP the spider oil drillers exploration. Sounds like a pretty general sector play, but that probably has a standard deviation of of cent. So you gotta go, okay, this is three times is likely to lose me or win me money than the S and P five hunter. But then a bond ETF might have a standard deviation of two percent or three percent. That is why that is so key because if you miss something on the holdings or the waitings, the standard

deviation will alert you to what might be inside. Because you could have an equal uh market cap weighted portfolio, but you might not notice they're all small caps, and the standardviation will clue you out that hey, this is gonna be a wild ride. So you did the Philly thing. I'm I'm a met fan, not a you know, not a good year. This past year for in here with it's been is going to be a better one. Pitchers

won't get hurt. But you know, to use a baseball analogy, you know, singles and doubles is a good way of going if you're if you're a home run hitter and you're aiming for the home runs and swinging for the fences for what it is, you're gonna strike out quite

a bit. So something that has relatively low volatility, a relatively consistent performance is going to be a You could be a three hitter getting singles and doubles all the time and be able to do that as opposed to again, met fan, not a Yankee fan, Aron Judge, you hit some runs and strikes out quite a bit. Good ballplayer, different different kind of expectations that you have. Okay, so Todd, here we are marching along through your checklist. What do

we come to next? So we covered a number of things. We covered holdings, we covered costs, we covered liquidity. The one thing that we don't use that I know others do is tracking ERA, which is what so how well that e t F tracks the underlying index that it

chose to track. And so the reason we don't do that is, as I guess a couple of things, but most importantly most e t F s are tracking a different index then something else you might be considering, and so yes, it makes sense if you're dealing with those three SMP five hundred index based products that we talked about this year, we're seeing about a five basis point differential between SPY and I, v V and v O,

the three SMP five d index based products. Coincidentally, that's the difference in the fee that's there, and so that's one of the reasons that they'll be different. But if you're looking at one, you know, we use home builders as an example, But if you're looking at a low volatility e t F from power Shares s p l V and a minium minimum alatility e t F from I Shares U s m V as the example, the indexes are quite different. The rules are different, the holdings

are different, the sector exposure is different. The fact that one tracks its index better than the other one really doesn't tell you how well it's doing, because it's it's trying to track something completely different. How well it I am at following one recipe and how well Eric is at following a completely different recipe doesn't make any sense if I'm making you know, peanut butter and jelly sandwich,

and he's making meat ball palm. That's all that Eric knows how to make, as you mentioned food, because he goes crazy. He's now he cannot focus on the show anymore. But how do you feel about tracking air? So I agree with Todd, You're right, they're all tracking different things. I guess I would look at it because the I would take a step back though. What's an E T S purpose in this life? It is to track an index.

I mean that's ultimately what it's designed to do. And people think it's like a robot, right, Like there's how right from Space Odyssey sitting there tracking the index. But there are human beings who tracking an index and a lot of things happen, rebalances, corporate actions. They've got to make sure they track that index well. And that's passive portfolio management. I think it's an underrated job. It's because if you tie you in and nobody cares, like, you know,

there's if you're not noticed, that's a good thing. But so that's why I bring up if you notice a high tracking difference, that could be a red flag. So you look at the index return and you look at the e t F return. If they're really far off you, they want to just think, Okay, why you know what's going on? Like the Vietnam ETF. Back to that one that does have a high tracking error. But in that one you can go, well, that's because I'm getting local

Vietnamese stocks. It's a lot of it's highly exotic. I'll live with it. But if you see how high tracking on like a MidCap growth fund or something like that, it might mean somebody is to sleep at the wheel. Correct. I want to ask you one more question that gets right to the heart of who you are and what you do, because you're both an analyst for mutual funds and for e t f s. And obviously we've talked a lot about the growth of the e t F, but to some extent, that's at the expense of the

mutual fund. So what do you think the future of the mutual fund is? So I think that we're going to continue to see money bleeding out of actively managed funds, and it's certainly inexpensive actively managed funds. It's been happening within the equity space. Investors are still quite comfortable paying somebody to drive the car. In the fixed income space and and wanting an uber driver, so to speak. The difference between active and equity and active and fixed income.

Don't you think that because the SMPS market cap weighted and that's the big benchmark, and like the stocks do better, they get a bigger waiting So it's harder to beat something that's got this momentum in it, whereas on the fixed income side, the aggregate bond index that is ours is weighted by the debt the company has outstanding, and thus it doesn't have that momentum feel and it's just way easier to beat. You Do you think that plays into what you just Yes, I think it completely plays

in it. And I think in part there's a people are comparing it perhaps to the wrong thing. So Bloomberg Barkley's also has something that's a different fixed income UH index. I I know the ticker that's part of it that I Shares has. It's a core fixed income product that's there that that has some high yield exposure to it. It has a little bit more corporate instead of just

being tied to the treasuries that's there. It is a little bit harder, but people don't feel comfortable following what's going on in the Federal Reserve and following corporate issuance the same way they do tracking what's going on in the stock market. So people are willing to pay for often average performance within the fixed income space. I do

think that's gonna shift. I think in two thousand and eighteen we're gonna see harder returns to come by for actively managed funds as the Fed continues to raise interest rates. If we hit a year now that we have E t F choices where the average actively managed bond fund declines and value, that's gonna be a red flag in two thousand and nineteen for people to go, wait, I'm

paying how much for you to lose money? I might as well pay seven eight basis points for a G G or B and D from Vanguard or or some of the dozens of other products that are low costs in nature. So I do think they have a role active and passive and mutual funds and ETFs can play a role in both portfolios. But I do think the tide is continuing to shift towards gtfs. But as long as people want to know something about mutual funds, then we'd see if or A want to help them with

tools to be able to do that. So closing question, Yeah, favorite et F ticker, My favorite E t F ticker. She I didn't come prepared for that one. That's why we put on the skin your brain. I know they're all in there, all floating around. It looks like it's like a ticker soup in there. I don't have a favorite ticker the ones. So I find things being just that when I paint a good picture of what it is. So like you wood and cut with your paper related

and forest products, the image works out quite well. There's a wood, there's a wood w o O D which owns timber companies, and then there's a cut E t F C. Actually both doing really well. I mean they're good performs. So those are two that come to mind because you can picture the image for where it is. Uh. Because because it's a verb, I'm a fan of the

verb tickers. But my favorite is move to me. That is the Mona Lisa of E t F tickers because not only is it a verb, but it's something everyone loves. A cow saying move. It's like kind of takes you back to your childhood. That's the global Agribusiness ETF know what. Probably Number one is that we didn't really ask him for his favorite, but he felt you said both of you. If there's a ticker that's out there that someone thinks would be interesting, there's likely to be an et F

to follow suit. Todd Rosen Blooth, thank you so much for joining us in a pleasure. Guys, thanks for listening to Trillions. Until next time, we can find us in the Bloomberg Terminal, Bloomberg dot com, Apple Podcast, and a bunch of other places that probably haven't heard about yet. We'd love to hear from you. We're on Twitter, I'm at Joel Webber Show, Key's at Eric Faltunas. Trillions is produced by Jordan Bell with help from Magnus Henrickson. Francesca

Levie is the head of Bloomberg Podcast. Bye.