Dear friends,

Welcome to summer.

All of us hope that it’s not going to be a long, hot one.

Some months it’s easy to write a welcome note, some months not. This is one of those latter times. Over the night just passed there were ongoing instances of “civil unrest” (the police chief’s term) with a caravan of 100 cars proceeding from one shopping plaza to the next. Four people – including a police officer simply driving his car – were shot; two, not including the officer, died. Many of the caravanning cars bore Minnesota plates. That followed a day in which there was a huge, peaceful, multi-ethnic protest which was shepherded safely through the city by Davenport police. We’ll live with a curfew in the days ahead.

Meanwhile, life is constrained by a pandemic.

Many – environmentalists and activists, journalists and doctors, local law enforcement and elected leaders – will work, often enough at substantial personal risk and for sometimes pitiful compensation, to make life safer and saner for all of us. We don’t agree with everything they write, say or do. The key is whether we attribute those differences of opinion to some malign impulse on their part, and so think ill of them.

On whole, I’ll probably assume that the people who were good and wise when we agreed with them, remain so even in disagreement. I’ll talk, I’ll listen, and I’ll trust they’ll do the same.

What’s crazy?

Let’s put aside for now all of the people who have too much time on their hands and use it to create faux Oreos:

I’ll focus instead on the market.

We’ll be experiencing a little turbulence.

Once upon a time, gaining or losing 1% in a day seemed like a lot.

No more. The Leuthold Group has been tracking days on which the market gains or loses 3% or more in a single session. That’s roughly a 750 point swing in the Dow. Since the February 19th peak there have been 13 days when the S&P 500 fell by more than 3% and 12 days when it gained more than 3% (data from Research.Leuthold). Measured intra-day, rather than at the close, March saw 14 thousand-point moves on the Dow.

Which reasonably leads to the question …

You made how much?

Quick quiz: the market’s been completely crazy for 12 months. At the end of it all, how much has the market returned over the past 12 months?

1. 5%
2. nada / zilch / zippo
3. -5%

The answer is, “none of the above.” Over the past 12 months, Vanguard Total Stock Market Index (VTSMX) is up precisely 10% which is to say, it’s been a perfectly normal year in the markets?

Did we just have a bear market?

Are we over it yet?

The downturn we experienced was the fastest and, if over, shortest bear market in history.  Driven by computer programs that initiate 70-80% of all trades, an average of 15.6 billion shares traded daily, the greatest total in 11 years. The stock market fell 20%, the bear market threshold, in just 16 days. That’s faster, by seven days than the collapse that heralded the Great Depression. By the end of Day 19, the market was down 30%. The bear market then lasted only 37 days (Feb. 19 – Mar. 23) before beginning a rebound that never retested the market low.

The Leuthold Group concludes, “The current rally is either the first up-leg of a new bull market or the second-largest bear market rally in the last 125 years” (5/29/2020). The key question is whether the S&P 500 closes above 3,386, its February 19 peak. We begin June at 3044 on the S&P 500, so Leuthold thinks the signal for a new bull is about 11% up from here.

Mid-year changes to Snowball’s portfolio

I made two changes to my retirement portfolio in May. It’s rare that I make mid-year changes (heck, it’s rare that I make any changes) but I try to report them when I do. Other than a small Roth IRA, my workplace retirement portfolio is split between TIAA-CREF and T. Rowe Price.

In the TIAA-CREF portfolio, I sold all shares of my CREF Stock and Dodge & Cox International, plus TIAA-CREF Lifecycle Retirement Income, and replaced them with CREF Social Choice Account (QCSCIX). Social Choice is balanced, with assets divided between foreign and domestic stocks (about 60%) and bonds and other fixed-income securities, including money market instruments (about 40%). Currently, about half its equity exposure and one-third of its fixed-income portfolio is international. In asset allocation terms, it constituted a minor reduction in my equity exposure. I am, however, more comfortable with a portfolio that takes ESG factors into account and Social Choice accomplishes that goal. The expense ratio is 0.24% and it has a four-star rating from Morningstar.

In the T. Rowe Price portfolio, I sold most of my individual equity funds and replaced them with T. Rowe Price Multi-Strategy Total Return (TMSRX). It’s Price’s version of a hedge fund and incorporates a bunch of non-correlated strategies.

Risk Allocation, as of 4/30/2020

I trust Price rather more than I trust the current state of the market. The fund held up well during the turbulence, with a net gain of 0.6% through April 30 and 3.2% through May 30. Its annualized lifetime return is 4.1% while its average multi-alternative peer lost 3.7% annualized.

I’m working on a profile of the fund, but haven’t heard back from T. Rowe Price yet about a couple of statistical questions. Expect it in July!

What’s working?

Martin Ryan, an MFO reader, dropped a note that said it might be helpful if I … oh, you know, tried to identify what was working. Good suggestion, sir!

One thought: be very wary about latching on to what’s working right now. That’s a lot like learning to depend on the reactions you learned while visiting a circus funhouse. My own inclination is to make any bets very carefully.

A second thought: talking about the performance of broad categories of investment masks more than it reveals. By way of illustration, here are the category returns for a half dozen ways of hedging your exposure to the stock market. I’m using the S&P 500 as a surrogate for that.

So what do we see? Two-thirds of the categories outperformed the S&P 500 during the four exciting months that began the year … but the best of them returned less than half as much as the S&P over the longer term.

But that masks a lot. The vanilla 60/40 category beats the flexible portfolio category, where managers are trusted to decide how much to allocate and where, by a lot. But when we ask the screener at MFO Premium to give us a list of the YTD returns of all 60/40 and all flexible funds, we discover that all of the top 10 funds and 17 of the top 20 on the list are from the lower-performing category:

We profile KL Allocation elsewhere in this issue.

The takeaway is that you need to get beyond the labels and try to find a strategy that makes sense to you, whose risks you understand and which you’re willing to live with for the next five or ten years.

Here are the top YTD performers in each category, and their five-year record.

“Absolute return” funds are Lipper’s ultimate “do anything it takes to finish in the black” flexible category.

ATAC Rotation (ATACX), Arin Large Cap Theta (AVOLX), RiverPark Long/Short Opportunity (RLSIX), and Infinity Q Diversified Alpha (IQDNX) have all earned MFO’s “Great Owl” designation. That signals the fact that they’re posted top 20% risk-adjusted returns in every trailing period beyond one year.

What’s not working?

“Famous old guys” have had a rough start to the year. Here are three notables, with the YTD through 4/30 returns.

Bill Miller, a guy with a 15-year streak, Miller Income (LMCJX), -31%

Bruce Berkowitz, Morningstar manager of the decade for 2000-10, Fairholme Allocation (FAAFX), –15%

Whoever’s running Sequoia (SEQUX), -10.9%

Sadly, value funds have had it even worse. If you rank-order all large-cap value, core and growth funds by their YTD returns, there is not one large-cap value fund in the top 200.

The Top Values

The researchers at the Leuthold Group offered a fascinating observation of why this might be true. The market, they argue, bifurcated around 1990, around the launch of the worldwide web, into two separate markets. “New era” companies have seen a steady, nearly 50% rise in return-on-equity (sometimes called “operating profitability”), and they’ve seen their average p/e ratios sit above 35 for 25 years. The other 75% of corporations are at the same p/e as in the 1950s and 60s as their profitability has steadily slumped (James Paulsen, “Two Conundrums? A single answer,” 6/1/2020). The trapped 75% largely defines the universe for most value investors.

 One glimmer of hope is Rupal Bhansali’s Ariel Global Fund (AGLYX) which was down just 5.7% through April 30. That makes it pretty much the top value fund this year. Lipper classifies it as a global large-cap value fund. We recognize it as a “Great Owl” for sustained excellence over its eight-year existence. Our profile of it is here.

Thanks!

For being here. For reading and, at least occasionally, writing back to me. For your good humor and your good leads on funds and stories.

Several folks poked gently at the implication that my celebration of “grown-ups” last month pointed to folks with just one set of political beliefs. Nope. Far from it. When I think of grown-ups, I think of the final line of J.M. Barrie’s Peter Pan:

When Margaret grows up she will have a daughter, who is to be Peter’s mother in turn; and thus it will go on, so long as children are gay and innocent and heartless.

“Gay and innocent and heartless.” Curious and unexpected line with an unexpected juxtaposition: “innocent and heartless.” It reflects an old judgment that compassion grows only through travail. We take a few hits and suddenly feel for others. Catherynne Valente, in her novel The Girl Who Circumnavigated Fairyland in a Ship of Her Own Making (2011) makes the point more plainly:

One ought not to judge her: all children are Heartless. They have not grown a heart yet, which is why they can climb high trees and say shocking things and leap so very high grown-up hearts flutter in terror. Hearts weigh quite a lot. That is why it takes so long to grow one.

My guess is that grown-ups are people who care, a lot, about others; they care about getting it right, they often start with the facts rather than the fears or the comfortable conclusions, they listen and are willing to grow from what they hear. Some grown-ups are McCain-shaped (John rather more than Meghan) and some look like Mike Tomlin (sorry, Pittsburgh native here). Some grown-ups are shaped like Tim Walz, the governor of Minnesota, and others like Mike DeWine, the governor of Ohio. Good guys, with very different political inclinations, trying really, really hard to deal as best they can with really, really hard challenges.

And so, thanks for your notes. I appreciate good-spirited disagreement and the opportunity to reflect and perhaps grow.

Thanks to Wilson, Martin, and Sunil, and to the good folks at S&F Investments. Thanks, as ever, to the good folks who’ve expressed their confidence by being “subscribers” to MFO; that is, who’ve set up modest monthly contributions through our PayPal link. They are Gregory, William, Matthew, the other William, Brian, David, and Doug

Support good journalism

I would, at this point, often enough encourage you to support MFO. But really, for now, I’d much rather you support those struggling to support us all. Light is, after all, a great disinfectant. The power of independent journalism came sharply to mind as I read a front-page story in The Wall Street Journal. Entitled “Facebook Executives Shut Down Efforts to Make the Site Less Divisive” (paywall, 5/26/2020), journalists Jeff Horwitz and Deepa Seetharaman drew on internal Facebook documents to show that the company knows its tearing at the fabric of society … and consciously rejected its own team’s efforts to make the site less malignant.

A Facebook team had a blunt message for senior executives. The company’s algorithms weren’t bringing people together. They were driving people apart.

“Our algorithms exploit the human brain’s attraction to divisiveness,” read a slide from a 2018 presentation. “If left unchecked,” it warned, Facebook would feed users “more and more divisive content in an effort to gain user attention & increase time on the platform.” …

But in the end, Facebook’s interest was fleeting. Mr. Zuckerberg and other senior executives largely shelved the basic research, according to previously unreported internal documents and people familiar with the effort, and weakened or blocked efforts to apply its conclusions to Facebook products.

The reporters conclude,

In essence, Facebook is under fire for making the world more divided. Many of its own experts appeared to agree—and to believe Facebook could mitigate many of the problems. The company chose not to.

It is a long, powerful, painful piece that looks equally at Facebook’s culpable knowledge and at its leadership’s self-serving excuses (couldn’t afford to be “paternalistic”) to preserve their profits (and vast paychecks) against the needs of the broader society. You might like or dislike Facebook, use or not use it, welcome or reject “social considerations” that impede profitability, but you surely benefit from a clearer understanding of the situation.

So, subscribe to your local paper. If you’re a professional, certainly support one of the more-expensive elite outlets: The Wall Street Journal, Financial Times, New York Times, and others. Electronic subscriptions are cheap and keep their lights on. Contribute to Marketplace, home of some of the clearest, least polemical explanations of the economy and finance that you’ll ever find. (I listen to both Marketplace and their Make Me Smart podcast pretty much daily). Consider ProPublica, a non-profit that supports public interest journalism. (Dear lord, there’s an entire underground mask economy! “The Secret, Absurd World of Coronavirus Mask Traders and Middlemen Trying To Get Rich Off Government Money,” 6/1/2020)

When in doubt, contribute to your food bank. Shop local. Cut a housebound neighbor’s lawn. That all creates the “together” in the phrase, “we’ll get through this together.”

Be careful out there!

Wow! What a year it has been so far! Coronavirus is at the top of the list. For me personally, there was a diagnosis, uncertainty, denial, surgery, and then recovery. After recovery, I took an assignment involving significant travel with less time to spend researching and investing for a couple of months followed by lots of free time. These two life events did not impact how I invest as much as the last rule, to “Develop a Simple Investment Process Based on Rules and Guidelines”. First, I wanted portfolios that were stable enough that I would be comfortable holding them unattended for months at a time during a bear market. For this reason, I created three relatively simple model portfolios that I follow with different accounts. Second, I began researching managed portfolios and accounts at Charles Schwab, Fidelity, and Vanguard, in case my wife needs to manage our investments. I put a small account into a Charles Schwab Intelligent Portfolio (Robo-Adviser) to see how well it does.

I first got the idea of writing the rules of investing last November, but most of the rules that I found were about trading and market timing. I wanted rules that were more applicable to the average individual investor. Here are a few of my favorite rules of investing,some of which are provided by Lance Roberts in Market & Investing Wisdoms For 2020.

• • “In my view, the greatest way to optimize the positioning of a portfolio at a given point in time is through deciding what balance it should strike between aggressiveness and defensiveness. And I believe the aggressiveness/defensiveness balance should be adjusted over time in response to changes in the state of the investment environment and where a number of elements stand in their cycles.” – Howard Marks
  • …the investor should never have less than 25% or more than 75% of his funds in common stocks. – Benjamin Graham
  • Always insist on a margin of safety – James Montier
  • Be fearful when others are greedy and greedy when others are fearful. – Warren Buffet
  • Don’t trust your own opinion and back your judgment until the action of the market itself confirms your opinion. – Jesse Livermore
  • The money lost by speculation alone is small compared with the gigantic sums lost by so-called investors who have let their investments ride. – Jesse Livermore
  • Always keep a good part of your capital in a cash reserve. Never invest all your funds. – Bernard Baruch

My Simple Process

I use an investment model to estimate how much I should have invested in stocks and bonds that are consistent with the rules of the famous investors above. The point is to determine whether one should be aggressive or defensive. With the uncertainties surrounding COVID-19 and a global slowdown, I choose to be more defensive. To select the funds, I create a single value to rank all funds based on Return (Martin Ratio, Sortino Ratio, Period Return, MFO Rank), Risk (Ulcer Index, MFO Risk, average down cycle performance), Yield, Quality (Family Rating, Expenses, Age, Composite MFO, % Junk Bonds, Bond Rating), Valuation (Discount, Price to Cash, Sales, and Earnings) and Momentum (3- and 10-month trends, 3-month performance, and Fund Flows). 

I use a nine bucket approach based on diversification and safety. I hold at least one fund in at least seven buckets. These are Buckets #1 – #4 for increasing Risk, Inflation, Global bonds, Global Investments, and Defensive.

I am going to use the Fidelity Moderate Model Portfolio as an example. The system is automated and takes about an hour per month.

Fidelity Moderate Portfolio

There are 13 funds in the Fidelity Moderate Portfolio and the overall rank and its components are shown in Chart #1. The best rank is 100 and the worst is 0. The funds shaded green are doing well. The yellow funds are okay. The funds shaded red are candidates to be replaced.

Chart # 1:  Fidelity Moderate Portfolio Factor Rank

Chart #2 is created from the Mutual Fund Observer Portfolio Tool showing the same funds from for the past two years. The portfolio has an average annual return of 7.1% with a maximum drawdown of 8.9%. It is classified by MFO as Conservative (MFO Risk = 2). Weight is the percent of the portfolio allocated to a fund. Most of the red funds had a maximum drawdown of 18 to 27 percent over the past two years with real estate and emerging markets performing the worst. These are candidates for replacement. I hold many of these for purposes of diversification so temporary short term performance is not a reason alone to make a trade.

Chart # 2:  Fidelity Moderate Portfolio Metrics – 2 years

Chart #3 shows the top-ranked Fidelity Mutual Funds by selecting one fund for each of the nine Buckets. I am overweight in bonds and not interested in exchanging one bond fund for another. The Fidelity Select Telecommunication Portfolio (FSTCX) is interesting, but I already own a Telecomm fund. I also already own the Baron Global Advantage Retail Portfolio Fund (BGAFX).

Chart # 3:  Top Ranked Fidelity Funds Per Bucket Classification

I may also include Closed End Funds in the Fidelity Moderate Portfolio. Chart #4 is interesting. Each of the funds has a low Ulcer Index (risk) and a respectable Martin Ratio (risk-adjusted return). These warrant more research when I am not traveling.

Chart # 4:  Top Ranked Closed End Funds Per Bucket Classification

Of the Top Ranked Exchange Rated Funds, the Blackrock Aaa – A Rated Corporate Bond Fund (QLTA) is the only one of interest to me. I maintain a small amount of gold in each of my portfolios which has reduced volatility and increased returns.

Chart # 5:  Top Ranked Exchange Traded Funds Per Bucket Classification

Fidelity Conservative Portfolio

The Fidelity Conservative Portfolio that I also follow is likewise classified as Conservative (MFO Risk = 2) but has a slightly lower Ulcer Index than the Fidelity Moderate Portfolio. The portfolio has an average annual return of 6.0% with a maximum drawdown of 7.1%. 

Chart # 6:  Fidelity Conservative Portfolio Metrics – 2 Years

 Vanguard Conservative Portfolio

The Vanguard Conservative Portfolio had a lower return of 4.8% for the past two years, a maximum drawdown of 7.7%.  Its yield is 3.1%. 

Chart # 7:  Vanguard Conservative Portfolio Metrics

 The Top Ranked Vanguard Funds with one fund per bucket classification are shown in Chart #8. The Vanguard Health Care (VGHAX), LifeStrategy Conservative Growth (VSCGX), and US Growth (VWUAX) are potential replacements for the T. Rowe Price Global Multi-Sector Bond Fund (PRSNX).  The rest, I want to keep for diversification.

 Chart # 8:  Top Ranked Vanguard Funds Per Bucket Classification

Top Charles Schwab Funds

Chart #9 contains the Top Ranked Funds available at Charles Schwab. The T. Rowe Price New America Growth (PRWAX) and T. Rowe Price Global Stock Fund (PRGSX) are interesting stock funds and deserve additional research.

Chart # 9:  Top Ranked Charles Schwab Funds Per Bucket Classification

Closing

I appreciate the services that the good people at Mutual Fund Observer provide. They have reduced the amount of time that I spent doing research and provided a quantitative method for investing. I have spent too many hours during my life looking at charts and tables trying to determine trends. The method that I use now quantifies those trends.

Disclaimer

I am not an economist nor an investment professional. I became interested in economic forecasting and modeling in 2007 when a mortgage loan officer told me that there was a huge financial crisis coming. There were signs of financial stress if you knew where to look. I have read dozens of books on business cycles since then. Discovering the rich database at the St. Louis Federal Reserve (FRED) provides most of the data to create an Investment Model. The tools at Mutual Fund Observer provide the means for implementing and validating the Investment Model.

On May 15, 2020, an unassuming filing with revolutionary potential appeared in the Securities and Exchange Commission’s EDGAR database. It was an N-1A, initial prospectus, filing for two ETFs: SmartETFs Dividend Builder ETF and SmartETFs Asia Pacific Dividend Builder ETF. Both unremarkably offered “to provide investors with dividend income and long-term capital growth.”

The real news appeared on page 9 of the document:

The SmartETFs Asia Pacific Dividend Builder ETF will adopt the performance history of its predecessor fund, the Guinness Atkinson Asia Pacific Dividend Builder Fund.

And on page 18:

At that time, SmartETFs Dividend Builder ETF will adopt the performance history of its predecessor Fund, the Guinness Atkinson Dividend Builder Fund.

And though they didn’t know it yet, two trillion-dollar industries – mutual funds and ETFs – were shaken.

Assuming final SEC approval, this will be the first instance in which a current mutual fund seamlessly transforms into an ETF, bringing along its asset base, long-term record, Morningstar (and MFO) ratings, and analyst coverage. Conversions of hedge funds into mutual funds are common, and conversions to or from the world of closed-end funds are rare but not unprecedented.

Allowing a mutual fund to become an ETF is unprecedented. And, potentially, very good, very disruptive news.

The packaging of professional money management services for the common investor has a series of milestones:

1893: closed-end funds, which trade on secondary exchanges like stocks, launch

1928: the first open-end mutual funds, including the first no-load Scudder fund, launch. Those first launches included the Massachusetts Investors Trust and Wellington Fund. By 1929, there were 19 open-end funds and 700 CEFs.

1940: the Investment Company Act of 1940 sets in place the regulations that still form the basis of the industry’s rules. For that reason, cognoscenti sometimes refer to “’40 Act funds.”

1993: launch of the first exchange-traded fund, State Street’s S&P 500 Trust ETF. Originally all ETFs shared three characteristics: they were passive, they could be bought and sold minute-by-minute with “fresh” prices, and their portfolios were fully transparent. That transparency was critical since you want to be sure that the amount you paid for a share of an ETF was exactly the same as the value of the securities in the portfolio.

2008: launch of the first actively-managed ETF, Bear Stearns Current Yield ETF (YYY). A very philosophical ticker symbol. The fund sought “as high a level of current income as is consistent with the preservation of capital and liquidity,” which is to say that it was a sort of high-yield money market fund. Still fully transparent, but actively managed.

2020, April: the first non-transparent, actively-managed ETFs launch, the American Century Focused Dynamic Growth ETF (FDG) and American Century Focused Large Cap Value ETF (FLV). While both of the ETFs were brand new, FDG was a near-clone of an existing fund that continues to operate: the five-star $400 million American Century Focused Dynamic Growth Fund (ACFOX).

2020, July: the first direct conversion of mutual funds into transparent, actively-managed ETFs occurs.

For whom is that good news?

The shareholders of Guinness Atkinson Dividend Builder Fund (GAINX) and Guinness Atkinson Asia Pacific Dividend Builders Fund (GAADX) are the first and surest winners. ETFs have four advantages, three of which are structural, over mutual funds:

1. They have structurally lower costs. Mutual funds are subject to several sets of expenses, such as state registrations and “stocking fees” at brokerages such as Schwab, that ETFs don’t have to bear. That allows an adviser to offer the exact same services for less in an ETF wrapper than in a fund wrapper.
2. They allow investors to control the timing of capital gains taxation. Most mutual funds generate tax bills annually because accrued capital gains from portfolio trading have to be distributed in the year in which they’re accrued. As a result, investors pay capital gains even in years where they fund lost money and they did not sell any fund shares. With ETFs, the capital gains bill comes due when the shares are sold.
3. They might be marginally more tax efficient. One source of portfolio churn, hence taxes, is forced selling to meet redemptions. There are a couple of structural features of ETFs that allow them to avoid generating taxable events.
4. They have not been repeatedly defamed by self-interested marketers and lazy financial journalists looking for cheap stories. “80% of mutual funds failed to beat the market last year” is utterly fatuous – beating the market isn’t the goal, one year is an irrelevant time period, risk matters as much as returns, very nearly all passive products also trail the market – but has made it hard to approach investors, young, professional or otherwise. The term “skunked” comes to mind. The repackage offers a clean slate.

The owners of mutual fund boutiques are potentially the second set of winners if they choose to be. The excess structural costs of operating a mutual fund are largely fixed expenses; that is, a $20,000 fee is assessed whether you manage a million or a billion. As a result, reducing the structural costs that are unique to the mutual fund wrapper has the greatest impact on small funds. A $20,000 savings will have a far greater effect on the expense ratio of the $14 million Guinness Atkinson Dividend Builder than on the $814 million Eaton Vance Dividend Builder. In discussions last year, the president of Guinness Atkinson was estimating 60-80 bps savings. That’s roughly in line with the American Century experience, where the ETF version of Focused Dynamic Growth charges half what the mutual fund version does, 45 bps versus 85 bps (subsidized).

Similarly, the challenge of broad availability disproportionately impacts small funds. Platforms such as Schwab reportedly have a $100 million minimum for considering the inclusion of a fund on their platform, and then only for a substantial price. As a practical matter, the only way for a fund to reach $100 million is if they’re on the platform but, Catch-22 ho! they can’t get on the platform until …

That said, many of the owners of boutique firms are remarkably resistant to innovation. I’ve heard the phrase “well, that’s the way we do things here” rather more than “we need to look at things with fresh eyes and embrace change or this thing’s going to become a death spiral!”

To whom is the disruption coming?

Disruptee #1: The ETF industry, many of whose players are doomed anyway.

There’s an awful lot of unwarranted strutting about by “players” in that industry. Their general demeanor is “we’re ETFs and we’re the Kings of Creation.”

Nice story. Delusional, but still nice.

Two things to consider:

1. the ETF industry is dominated by a handful of mutual fund companies.

   If we look at the 50 most successful ETF launches of the past three years, you notice some familiar names:

   American Century, BlackRock, Columbia, Invesco, Janus, JPMorgan, PIMCO, Schwab, State Street, Vanguard, USAA …

   When you take out offerings from traditional fund companies, you have eliminated 40 of the top 50 new ETFs.

   Those same firms offer all of the 100 largest ETFs. The first pure-play ETF issuer on the list might be … Morningstar? FlexShares Morningstar Global Upstream Natural Resources Index appears around #190 with $3.1 billion in assets. (USCF appears higher on the list with the USCF Oil ETF (USO) that suffered a 75% price collapse this year, has apparently been cut off by its broker from buying futures contracts, and is apparently under federal investigation for improper risk disclosure so I’m not quite sure of its status.)

2. many independent ETFs linger at death’s door.

   About a thousand ETFs had been liquidated by the start of 2020, while others had been “creatively repurposed” so that one day’s Cloud Computing ETF is the next day’s Industrial Hemp Fund. The long-running ETF Deathwatch had 399 names on its list in March; 54 names had been removed in the month, nearly half of those through … well, death. Deathwatch tracks funds with under $25 million in assets and low trading volume. Academic studies put the … uh, deadline, at about $30 million in assets.

   Take a quick snapshot of the 655 ETFs launched in the last three years. Three hundred and sixty – 55% – are at or below the $30 million deadline with many other ETFs launched in the period already liquidated.

We reported last year on a series of news analyses that suggest that ETF marketers might be consciously gaming the system to generate a self-sustaining bandwagon effect. Take the case of one of the most explosive ETF launches ever … a JPMorgan Japan fund?

The Invesco QQQ Trust (QQQ) was the ETF to capture the largest inflows this week―$1.2 billion―but the week belonged to another fund, the JPMorgan BetaBuilders Japan ETF (BBJP). Inflows for BBJP totaled more than $1 billion during the period, which is remarkable considering the fund had less than $10 million in assets a little over a week ago. (‘BBJP’ 2nd-Fastest ETF To $1B Assets, 28 July 2018)

How can you explain a billion dollars swooping in over the course of a week? A carefully constructed bandwagon and, it seems, just one of many. Asjylyn Loder of The Wall Street Journal reports:

JPMorgan Chase & Co. launched an exchange-traded fund last June that invests in Japanese stocks. The fund raised $1.7 billion in six weeks, making it one of the fastest ETFs ever to surpass $1 billion in assets.

The biggest buyers: JPMorgan’s clients.

By buying JPMorgan’s ETFs on behalf of customers, JPMorgan’s private bank and wealth management divisions helped the JPMorgan BetaBuilders Japan reach $3.3 billion in assets by the end of the year.

It wasn’t an isolated case. JPMorgan’s ETFs raised $15.6 billion last year, most of it from JPMorgan affiliates … The tide of client money helped boost the New York bank from an ETF also-ran to the 10th largest ETF issuer. By the end of 2018, JPMorgan affiliates owned 53% of the firm’s ETF assets, and the bank was the top shareholder of 23 of its 31 ETFs.

JPMorgan isn’t the only ETF issuer that steers clients into in-house funds. Almost every issuer has repackaged some of their ETFs into other investment products … The practice has even earned its own nickname: BYOA, for “Bring Your Own Assets.” (JPMorgan ETFs Are a Hit, but With Its Own Clients, 11 March 2019 – with thanks to Ms. Loder for her excellent reporting)

That essentially corroborates the investigative work done by Elizabeth Kashner at ETF.com. In “Tough Times for New ETFs” (2/21/2019), she makes two interesting points: ETF liquidations are rising steadily and almost no new ETF launches lead to sustainable asset levels. In general, the only ETFs that make serious money are the ETFs that are used in the portfolios of other funds. Beyond that, for all the hype and pageantry, it looks like the market has peaked.

Deep, cleansing breath. Deep, cleansing breath. I am not picking on the ETF industry. I’m merely suggesting that things are not nearly as secure as the headlines portray.

500 mutual funds have under $100 million in assets but have earned four- and five-star ratings from Morningstar. If even a fraction of those funds transitioned to ETFs, bringing long, exceptional records, and suddenly low expenses, and improved tax efficiency, it would upset the ETF equation in a major way.

Disruptee #2: the mutual fund industry, many of whose players are doomed anyway.

Which is pretty obvious.

Bottom line: Nothing’s guaranteed. It might be that the SmartETF path is seen as too burdensome, or the simple pigheadedness prevails. There are surely marketing questions to be answered since many traditional firms still offer loaded funds or have comfortable existing relationships with advisors that they don’t want to disrupt.

That said, the SmartETF launch opens a pathway to relevance for hundreds of small, strong mutual funds … and a new challenge for many of their ETF peers.

Guinness Atkinson Dividend Builder embodies an entirely sensible strategy, well-executed and popular with European investors. We’ve profiled the fund in the past, and we’ll offer a Launch Alert with updated information as soon as the ETF goes live.