The Reformed Broker on Smart Money Being Stupidby
Joshua Brown, CEO of Ritholtz Wealth Management, is known for a lot of things -- television appearances, tweeting
as @downtownjoshbrown to his 86,000 followers, a widely read blog and his story of going from a commission-based broker to a fee-based adviser. It's a story captured perfectly in the name of his website: TheReformedBroker.com
Brown, whose often-colorful commentary covers all things Wall Street, knows a lot about exchange-traded funds. He should, since the firm he co-founded with Bloomberg View columnist Barry Ritholtz last year uses them extensively. Ventured & Gained spoke with Brown after his keynote speech at ETF Boot Camp, a two-day event about all aspects of bringing new ETFs to market, hosted by ETF Trends. Here are edited highlights of the conversation.
John Bogle has said that ETFs give investors too much temptation to trade. As an adviser, is that a temptation?
We run some money by asset allocation, which is very low turnover. And then we run some money that's a little more tactical. The temptation to trade, whether there are ETFs in the world or not, is going to be there. It doesn’t really matter if you provide the product. They will find it. They will find currencies. They’ll find futures. They’ll find a sports book. The people that are traditionally passive will remain passive and the people that are traditionally more aggressive will act in a more aggressive way.
At ETF Boot camp you said that increasingly the hot new investment products are ETFs. Is this good or is it product overload?
Like all matters of choice, the more choice you have doesn’t necessarily make things better, but it's cool that it exists. For someone like me, if I’m looking to express an investing opinion on something, and there’s a product that lets me do it, that’s great.
One example of that is KraneShares, a firm that specializes in [ETFs that give exposure to] tough-to-access mainland China companies and Chinese Internet companies. That fills a need. That’s an area that we are interested in and want to have some allocation to for progressive clients. Brendan Ahern there is putting out products that are very different than the main China ETF that people use, the iShares China Large Cap (FXI
), which completely doesn’t work for the way that we want to express that trade.
The story in China is the rise of the consumer. China hasn’t spent 30 years building Wal-Marts and chain stores, so now when that rising consumer wants to shop, the way they are doing it is online. If you're somebody looking for exposure to that trend, buying FXI – which is essentially state-owned banks and oil companies – is not really getting the benefit of what’s happening. So every once in a while a company like KraneShares comes out and does something really innovative and it’s great.
Why do you think, then, that when there are flows back into China, FXI still gets the lion’s share of the “smart” money?
I’ll tell you why: because people are stupid. It's the same thing with iShares Emerging Markets ETF (EEM) . It's an inferior index to Vanguard’s emerging markets one (VWO ). There are a lot of things wrong with it, and the most important thing is that it costs triple what it should. So why does it have billions in assets? Because it’s very liquid, it was an early entrant into the market and hedge funds feel comfortable trading it. It’s what they've always done.
It’s like Yogi Berra says about a restaurant: “Nobody goes there anymore. It’s too crowded.” Everyone’s trading EEM because everyone’s trading EEM.
In your book, "Clash of the Financial Pundits," many of the pundits you interviewed said that buy-and-hold investing using index funds is probably the best advice you can give. Yet in the financial media, particularly television, it's all about the latest stock moves and earnings and is overall more trading-oriented. Why is that?
Because I think there is a value to understanding what's going on, even if it doesn't mean you have to do something about it. Nobody watches ESPN and then feels compelled to go bet on who Phil Simms's pick is. Nobody feels a responsibility to be right on every game. It's commentary. It's background. It's context. It's information. Take it for what it's worth and then be a grown-up. Some of it may have nothing to do with you at all, but you are just interested in the topic. Or it might have everything to do with you. People have to make those decisions for themselves just like they would in any other media. But, for some reason, finance is the only area where opinions get construed as advice.
If you generally prefer passive ETFs over actively managed mutual funds, how do you view smart beta ETFs, which sort of fall in the middle of those two?
There’s nothing wrong with smart beta. It’s more about the marketing. In real life, there is something called the small-cap premium. There is something called the value premium. These things have been proven to exist. But, as my friend Meb Faber says, factors [attributes of stocks that are associated with higher returns, such as dividend yield, quality and momentum] are not static. [Faber is a portfolio manager at Cambria Investment Management.] And when so many people allocate to a factor it will definitely hurt its efficacy going forward.
Dividends are the example Meb uses. I would also use the small-cap example. If too many people tilt towards small cap, that premium is then arbitraged away and you don’t get it back again until everyone is disgusted with it and sells out. Then what was really popular becomes really unpopular and then it’s a good bet it will start working again.
I think the various [factors] in the market are cyclical, just like every other investment style or strategy. If we are using a smart-beta ETF it's probably because it is something we think has legs for decades. In some cases we will use a plain vanilla market cap-weighted index and in some cases a fundamental-weighted index, maybe an equal-weighted, maybe a dividend-weighted. We are agnostic as far as ‘Is smart-beta good or bad?’ We just recognize the cyclicality inherent anytime an investment idea becomes really popular.
I read that your firm just launched an automated advisory service called Liftoff to cater to younger people or people just getting started. Is it an all-ETF portfolio?
It is. It goes with the lowest-cost ETFs on the market and they trade commission-free at our custodian. So literally costs have been driven down to almost nothing. This product allows us to serve a portion of the public who wouldn’t normally use a wealth manager.
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