Mullooly Asset Management
Fiduciary Fee-Only Financial Planner | Investment Advisor in Wall, NJ
Mullooly Asset Management
There are 3500 ETF's: what will be next?
Are you ready to navigate the booming world of exchange-traded funds (ETFs) with confidence? In our latest episode, Tom and I unravel the complexities of ETFs, shedding light on their mechanics, how they track indices, and the pivotal role of periodic rebalancing. Inspired by Jason Zweig's insightful Wall Street Journal article, we dive into the explosive growth of the ETF market—from a modest 1,300 funds in 2014 to nearly 3,500 today, managing close to $10 trillion in assets. We debate whether investors should pay attention to the specific companies that make up these indices or stick to the tried-and-true rules-based strategies of the funds. Plus, we offer practical advice on structuring a portfolio that avoids overlap and maintains optimal allocation.
The thrill and timing of investing in new funds can be a game-changer. We discuss why timing is crucial when buying and selling ETFs and how this fits into a broader investment strategy. Tom and I also reflect on the latest trends in the investing industry, hinting at some intriguing developments that could shape future market strategies. This episode promises to be a treasure trove of insights, whether you're just dipping your toes into the investment waters or you're a seasoned pro. Tune in for a thoughtful discussion that will help refine your investment strategy and keep you ahead of the curve in the dynamic ETF market.
Hello and welcome back to the Malouli Asset video and podcast. This week we're joined by Tom Tom, thanks for hopping on with me. We're going to talk about one of our favorite writers here in the office. Jason Zweig wrote a piece in the Wall Street Journal. He asked the question what's left to be ETFed?
Speaker 2:It's a good question.
Speaker 1:It is a good question. So just to refresh, when we say ETF, we're talking about exchange traded funds and these ETFs track indices. This is where the term index fund comes from. So these indices have rules for what companies to include and exclude, based on what their investment objective is. When rebalances happen, they usually happen on set dates a couple of times throughout the year, usually quarterly.
Speaker 1:Each fund does things differently, but when these rebalances happen, companies go in and companies go out and, like I said, every ETF has a different set of rules. So, just as an example, the S&P 500, the most common index in the world, the most common ETF in the world, spy, recently did a rebalance and Dell computers came in to the S&P 500, while American Airlines and Etsy went out. These are not buy and sell recommendations. Just wanted to highlight some of the different companies coming in and out of these indices as an example. So the question that I have for you, tom, is there seems to be an ETF and an index for everything nowadays. Do investors need to worry about the companies coming out of the indices and the ETFs or is it more about sticking with the rules-based strategies of these funds and not jumping into and out of different funds depending on what exposure they get.
Speaker 2:I think if you're going to be a long-term investor, an exchange-traded fund may be appropriate for you, because all of the changes in an underlying index are happening below the surface, so you don't even have to get involved in something like that.
Speaker 2:If you've owned the S&P 500 for the last 10 years, 15, 20 years, there have been a lot of companies that have been added and an equal number that have been dropped over the years. You don't even see it. And that actually works out really well, because people don't point to certain points in history and say this is when this company wasn't in the S&P 500. All they're looking at is the yardstick itself. What did the S&P 500 do and how did my investments measure up against that yardstick? Along those lines, it doesn't really matter if you're talking about the S&P 500 or you're talking about the Dow Jones Industrial Average, the Russell 1000, the Russell 2000. There's a lot of indices out there that you can measure against. In fact, when ETFs were first started about 30 years ago, in 1993 and 1994. They were all passive baskets of stocks, more indices so they could create more products, more ETFs.
Speaker 1:Yeah, the ETF business is booming and that's something that Jason writes about. That's something that Jason writes about. I'm going to pull up a chart here that just shows the explosion of different funds and how many funds there are compared to just 10 years ago. So here we go, right, here we have 2014. There was about 1,300 different ETFs and now there is just about 3,500 different ETFs 10 years later. So an explosion, and it's big business for these different fund companies.
Speaker 1:They're trying to slice the investment universe every which way. I mean, the main driver of Jason's article was talking about how there's now an ETF for companies that have been removed from indices. The theory behind this one is that these companies actually tend to. While they might underperform in the short term, they're actually pretty good long-term buys because they're undervalued. And now that a lot of these rebalances are public and people know the rules, people are trying to front run these trades and buy or sell these companies based on whether they're coming into or out of an index, just to represent the dollar total of US ETFs. Again, similar looking chart up into the right in 2015, jumps under $2 trillion in US ETFs and now we're approaching $10 trillion. So these fund companies know what they're doing. They want to entice investors with these more active styles of funds instead of the passive funds that you were talking about, tom.
Speaker 1:Another question I have for you here is with all these different styles of funds, all these different types of funds, how do investors know how many funds is an appropriate amount to have in their investment account? A typical mistake or misconception that we have that. We see a lot, and this is more with 401k plans and these are mutual funds, but I think it's still the same thing where you'll have a menu of 30 funds in a 401k and someone will want to be diversified, so they'll sprinkle a little money around in all of these 30 funds, and I think we both know the answer here. But what should folks be doing instead? How many funds is an appropriate amount to have in an overall portfolio?
Speaker 2:Well, in our industry, I think, a lot of folks that ask us questions like this. They just want an answer. They just want to know okay, I should have five funds, I should have eight funds. There is no hard and fast answer for that. One of the things that we do when someone comes in and they want us to take a look at their investment positions, we'll go in and see where's the overlap or where are the problems with the allocations, and so we've seen some folks bring in statements whether it's their 401k or their individual investments and they'll own these target date funds. Now, a target date fund is a fund of funds. It's basically your own allocation, and so you wind up getting folks that have money in the 2030 fund. That means that, basically, you're looking to retire in 2030, but they'll also have money in the 2035 fund. The 2040 fund You'll also find you know further and further out the spectrum.
Speaker 2:On the flip side, you'll also find folks that say well, I want to have a lot of money in growth, and so they will own a couple of different growth funds. When you go beneath the surface, you find that a lot of times these exchange traded funds or mutual funds will have many of the same positions and so, mistakenly or not done on purpose, you're going to find that some folks wind up having an unusually large position in one stock, like uh, uh, pick one Uh. But you're also going.
Speaker 1:You're on. They own seven different large cap us us large cap funds right.
Speaker 2:And they all own the same names.
Speaker 1:Exactly so. I think it's like you said. You got to look at what the funds are doing and, to you know, this is not the fault of the end 401k user. That's. Sometimes it's difficult to determine what the fund is investing in and you kind of have to know what to look out for there.
Speaker 2:The other problem that comes with that is like a school of fish. Have you ever seen a school of fish change directions? They all go at the same time, and so if you own large cap growth and that falls out of favor and that is the majority of how your money is invested in your portfolio you could be taking a lot more risk than you ever realized, and that's something that we try to drive home. So I think it's important to have allocations across the spectrum, meaning you want to have some large cap, mid cap, small cap. You also want to have growth, you want to have value, you want to have some things for income. But overloading in one area, one side of the market or one corner of the investment spectrum not a good idea.
Speaker 1:You're not diversified just because you own nine different funds. You could own nine different large cap US funds and they're all doing the same thing, like you said. So the idea with diversification is you're exposing yourself to different areas of the market, not the same, not overloading in the same area of the market. Just wanted to share my screen one more time and talk about I know I asked before should we be jumping from fund to fund here or just kind of maintain an asset allocation that's broadly diversified? So I'm just going to pop up some stats from the Morningstar Mind the Gap study.
Speaker 1:I love looking at this information whenever it comes out and this shows the different types of funds going back 10 years, and just to spell it out for our listeners and viewers, here we have the investor return, which you can see here, though these are the blue bars and then the total return, which is indicated by the black marks here on the chart, and moral of the story is that investors tend to underperform the funds they own and it's pronounced I think this is something I want to drill home on it's pronounced in different types of funds.
Speaker 1:So in non-traditional equity funds the gap is 2.3%, which is much higher than the average 1.1%. Sector funds 2.6%, much higher again, but in allocation funds, whereas the non-traditional equity or the sector equity funds are used more as trading vehicles. My point by showing that data there is to illustrate that it might be exciting to invest in these new funds that are coming out. You have to worry about, like like you said before, the timing of buying and selling these funds and uh and, and taking that all into account when you're building out an investment philosophy so a lot to consider a lot to consider.
Speaker 1:There we'll see what's left to be ets. I'm sure the investing industry and all these fund companies will develop more strategies along the way. That will leave us chuckling and give us some more fuel for the fire here on the videos and podcasts. So, tom, thanks again for joining me and we'll be back with you on the next video podcast.
Speaker 2:Sounds good. See you then.