Morningstar ETF conference: Momentum, Bitcoin and Selena Gomez

And millennials' love of ETFs continues to grow

Sep 8, 2017 @ 4:38 pm

By John Waggoner

Richard Thaler is the Nobel prize-winning Charles R. Walgreen distinguished service professor of behavioral sciences and economics at the University of Chicago Booth School of Business. He's also a principal with Fuller & Thaler Asset Management, a boutique investment shop that uses tenets of behavioral finance. And he had a scene in "The Big Short" with singer Selena Gomez. So when he sat down to talk with reporters at Morningstar's ETF conference on Wednesday, it seemed like a good idea to take notes.

Two topics most of interest to advisers: Momentum investing and bubbles.

"Momentum investing is a puzzle," Mr. Thaler said. "The first finance paper I wrote was titled, 'Does the stock market overreact?' If you just ranked stocks on three- and five-year performance and followed them going forward, the stocks that had done best underperformed, and the stocks that had done worst had overperformed. We concluded that, yes, the stock market overreacts."

If you use a six to 12-month time period, however, you got the opposite result, he said. Leaders continued to outperform, and laggards continued to lag.

"This was an academic point, rather than an investment strategy, he said. And it didn't fit well with a paper titled, "Does the stock market overreact?"

At Fuller & Thaler Asset Management, where Mr. Thaler is a principal, they take a different strategy with their small-cap value fund, looking for the end of a losing streak rather than riding a winning streak.

(More: In the ETF world, spoils still go to the biggest and cheapest)

"We start with the losers and then find the ones that aren't going to be losers anymore," he said. "We're looking for positive signals the market will underreact to. The theory is, if the stock is bad long enough, then good news tends not to get the attention it deserves."

Given all the talk of bubbles these days, does he think there are any bubbles in the markets now?

"It's possible to say the government bond market is a bubble," Mr. Thaler said. "We have negative interest rates around the world, and economists have written forever that that's not possible. Does that mean it's a bubble? I don't know. Like everyone else, I've been predicting interest rates would go up for the past decade. I've been wrong so far, so it's a good thing I don't run a bond hedge fund."

What about stocks, now in the eighth year of a bull market?

"You see some signs of a bubble, but not like what we saw during the tech bubble of 2000," Mr. Thaler said. "You had companies [then] with no earnings but hopes and prayers. Of course, one of those turned out to be Amazon. All we needed were a few more Amazons, and things would have all been fine."

During the tech bubble, the NASDAQ composite fell from 15,000 to 1,400, Mr. Thaler said.

"I don't expect anything like that. But the stock market is up 15% since the election. Is that all based on tax reform? If so, what's the probability that we get tax reform? If the odds are 50-50, is that enough to justify the substantial increase in stock prices? I don't know. It doesn't mean that I'm confident that prices are too high, it just means that I'm puzzled."

What about Bitcoin? Is that a bubble?

"I'm even more puzzled about Bitcoin," Mr. Thaler said. "If I were a drug dealer and could buy and sell Bitcoin, I'm pretty sure I would. Other than that, as a currency, we tend not to want currencies that are volatile. If you want a volatile currency, go to Venezuela. I don't claim to understand how the Bitcoin algorithms work, and I wouldn't want Bitcoin in my portfolio."

What about Bitcoin futures?

"We need Selena Gomez to explain betting on future Bitcoin prices," he said.

Zero to $5.6 billion in two years

Goldman Sachs Asset Management launched its first ETF two years ago; today assets in its nine ETFs stand at $5.6 billion. Insurance companies have been one secret to their success.

"Insurance companies are one of the fastest-growing segments of our customers," Steve Sachs, managing director of the firm's ETF division, said.

Normally, one thinks of insurance investors as bond buyers, clipping coupons and matching long-term investments with long-term liabilities, he said.

But ETFs have certain charms for insurers, one of which is the ability to invest – or sell – big positions quickly. It's generally easier to buy or sell an ETF than several individual bonds, for instance, and they can choose among ETFs with constant durations.

Another benefit: They can use the ETF conversion feature to swap cash for the ETF's underlying bonds.

"That's become more prevalent, and it's a very sophisticated strategy," Mr. Sachs said.

An insurer redeeming creation units in the Goldman Sachs Investment Grade Corporate Bond ETF (GIGB), for instance, would get some 200 bonds with maturities of one to 10 years.

The company also announced the launch of Goldman Sachs Access High Yield Corporate Bond ETF (GHYB) on Wednesday.

Advisers are another big part of Goldman Sachs' success in the ETF market, as is its outsized footprint in the investment landscape.

"At end of the day, Goldman Sachs is a $1.4 trillion asset manager, and that has really resonated with financial advisers who have been using Goldman Sachs products for many years," said Mr. Sachs, who is no relation to the company's founder.

Does he get that question often?

"Every single day," he said.

(More: What is the best way to construct a portfolio with ETFs?)

Millennials and ETFs: The love story continues

Millennials love ETFs more than anyone, according to a study by Charles Schwab.

The San Francisco-based ETF powerhouse released a study on Thursday of 1,264 ETF investors with at least $25,000 in investible assets. Respondents had to be between 25 and 75 years old, and have purchased an ETF in the past two years.

Fully 63% of millennials expected ETFs to be their primary investment in the future, as opposed to 23% of baby boomers and 45% of those in Generation X.

"ETFs have been part of the option set for millennials since day one," said Heather Fischer, vice president of ETF & Mutual Fund Platforms at Charles Schwab. "Boomers didn't have it on that table."

ETFs also are becoming far more accepted as a vehicle for long-term goals, rather than for short-term trading, Ms. Fischer said.

"When we asked how investors viewed ETFs in their portfolio, 56% said they were using them for long-term goals, and just 12% said for short-term only," she said.

At the moment, only one in 10 ETF investors are currently invested in socially responsible ETFs, according to the Schwab survey, but interest appears to be growing.

"There's heavy buzz, but not a lot of assets," Ms. Fischer said. "It's worth paying attention to."

Here again, interest is greatest among millennials. About 48% of them said they actively seek out funds that use SRI techniques, as opposed to just 14% of baby boomers.

Almost two-thirds of millennials said they thought SRI funds could help them meet their investment goals, as opposed to about one-third of boomers.


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