ETF Edge - 2020 Rotation, Net Asset Value vs. Market Price

Episode Date: June 22, 2020

CNBC’s Bob Pisani spoke with Dan Egan, managing director of behavioral finance and investing at Betterment, and John Davi, founder and chief investment officer of Astoria Portfolio Advisors. They discussed retail investors’ rush to the stock market, social media, and their top picks for the second half of 2020. In the 'Markets 102' section, Bob discusses the different types of ETF trades and how they generate returns. Hosted by Simplecast, an AdsWizz company. See pcm.adswizz.com for information about our collection and use of personal data for advertising.

Welcome to ETF Edge, the podcast. If you're looking to learn the latest insights and all things, exchange traded funds, while you're in the right place, every week we're bringing you interviews and market analysis, and we're breaking down what it all means for investors. I'm your host, Bob Bizani. Today on the show, we'll dive into the return of the retail investor and explain the psychology behind the sudden investor frenzy. Plus, we'll talk about why value might outperform growth in the second half of the year.

We'll show you what ETFs to own and write out that wave. Here's my conversation with John Dobby, the founder and CIO of Astoria Portfolio Advisors. And Dan Egan, he's the managing director of behavioral finance and investment at Betterment. Dan, let me start with you. We heard a lot about the Robin Hood crowd and the surge in interest in retail trading recently. Those metrics were fairly easy to see because Robin Hood post them. Tell us what Betterman investors have been doing the last three or four months. Have they also been trading a little bit more?

What were they trading if they were? It's an interesting time to sort of be able to see this going live. I don't think I've ever seen a market quite like this one in terms of what's driving each person's specific actions and what's happening. So just to set it back, this started, say, back in March. In March and April, we were definitely seeing people getting a little bit more conservative,

especially around having cash positions or emergency funds and wanting those to be available at shorter notice. We actually saw a greater activity around our cash savings accounts at that point in time. Since then, as things have stabilized and people have ended up staying home a lot more, I think there's been a depression of how much people would spend, no going out to restaurants, not a lot of activities, indoor activities they used to do, and people are either voluntarily or involuntarily saving a lot of that money and they need something to do to it.

And, you know, I've definitely hit the end of everything that I can watch in my Netflix queue. We're starting to see what I would call entertainment investing, where there's no professional sports going on. There's not a lot that you can talk about that's sort of like a communal thing for us to all focus on and understand what's been happening. But the stock market is in the news. People talk about it. It's more accessible than it's ever been. So we are definitely seeing people treating it a little bit like a form of entertainment, where they want to come in and be able to talk about, like, what they have and haven't invested in, how it's been doing. So I think across the board,

both from a sort of budget point of view, but also from a what else are you going to do with your time point of view, it's been a good time to be somebody who helps clients manage their money. John, I love this phrase from Dan, entertainment investing. We always have Dan on to talk about behavioral psychology, but that's a new line, entertainment investing. I think that makes a lot of sense. From your point of view, as a professional investment advisor, what do you make of this recent retail frenzy, or are we making too much of it? Is it just limited to really just a few bankrupt companies and a few airlines? What's your take on all this? I do think that it is limited to like a specific cohort of stocks, so either stocks that have very low price. I think a lot of retail

investors that kind of come into the market, not really for a long-term strategic allocation, tend to buy very low-price stocks, penny stocks. You know, it is concerning. I, I think investing you should have a very long time, or as I've said on your show many times, Bob. So I am worried about it. I do think that as the economy opens up, sports opens up, you know, a lot of these investors that would typically trade, you know, for a quick day trade,

I think they will go and find other ways to kind of utilize their efforts and their time and their money. Yeah. John, I want to go back to this. I love this line, entertainment, investing. You shared some stats with us for Betterment up through, March, more customers making deposits than withdrawals, call and email volumes 50% higher average in March compared to January. Do we have any updated stats at all? Do we have anything

what's going on in April and May and parts of June? I presume you're seeing the same elevated levels. Yeah, I think they continue to be slightly elevated. Nothing that sort of makes us anxious. We definitely, like every advisor, think that when there are kind of scary events in the news, especially around tax time, that's the point in the year where most people are thinking about these things anyway, that that's sort of when we need to step up and be able to talk to our customers and more communicate exactly what's going on with them. I think that things have been elevated throughout this, both because people are trying to wrap their heads around what is the right thing for them to do financially. We had a whole bunch of legislation passed that was meant to help with people's finances specifically in regards to COVID, withdrawals from retirement accounts and understanding exactly what the consequences of those were.

So I think that for a while, we are going to be on a slightly higher plateau of thinking about, worrying about looking at your investments and kind of being aware of it, not necessarily only from the entertainment investing point of view, but also from the like, am I making the right moves for me and my family based upon the opportunities that are out there right now. Yeah. And again, I want to let everyone remind everyone, Dan is the director of behavioral finance for betterment. So he's sort of our market psychologist whenever we have questions about behavioral psychology or behavioral investing. And then just to summarize why you think all of this retail trading happen, I know you use the word entertainment investing, but you use the word more accessibility.

The market is more accessible. And I think that's true. It's certainly easier to trade on your cell phone now than it was 11 or 12 years ago. Was there other factors involved? It's zero dollar commission. Some people feel zero dollar commissions was a factor. Some people obviously feels just staying at home. Some people feel willingness of people to bet penny stocks. But, you know, I don't recall having the same frenzy in penny stocks in 2008 that we saw today. I'm trying to think of something is different now or whether people are just naturally who have a little money in our board willing to throw out, you know, a little risk money and play the field here. I'd say there's one kind of like real amplifier that's the elephant in the room that we don't

talk about as much, which is basically like social media and social networks. And there's a key thing here, which is that we don't tend to brag about the fact that we lost $15,000 last week, where we made a really bad mistake or something went awry. When you talk to and hear from people, you know, like if you go on to forums like Reddit, where people are talking about how much money they made and how easy it was, we all tend to brag about how easy it is to beat the market. And there's a real sample bias in what most people are going to understand goes into that investing. And I think a lot of brokerages, a lot of places like are very happy putting out figures that reinforce the idea

This is fun, it's fast, it's easy, you should be doing it too. But there's some real sample bias there. People can easily get the idea that this is really easy. I think there are some other interesting narratives out there right now that make you feel like a dummy in terms of the supportiveness of policy. The idea, and I want to be clear, I'm not sort of endorsing this, but there are narratives out there that say, like, the Fed's going to come in and buy no matter what. They are not going to let companies actually go bankrupt. They are in such a sort of like protection point of view that you are a fool if you don't buy the company, that are losing in money. And amongst sort of novice retail investors, these narratives make you feel

like it's an easy win for you to go in, trade a couple of low-value stocks that have recently fallen, and that you're guaranteed to make more money and beat the stock market and be able to brag to your friends about it. Yeah, that makes a lot of sense to me. I mean, we saw this with Hertz. We were really scratching our heads trying to figure out, Hertz is in bankruptcy. Normally a bankruptcy company, normally, the common stock will be worthless. And when it's trading, the bonds were trading at 40 cents on the dollar, that tells you, even the bondholders that are ahead of this common stockholders don't think they're going to be made whole at all. And yet the stock went from 40 cents to $2 really quickly. It's hard to like understand the psychology there because it seems like investors either

are day trading just in and out or they don't quite understand the mechanism involved in bankruptcy. I mean, at what point does the cleverness become just ignorance? Yeah, I mean, I think ignorance is a good way of putting it. In a very benign way. Like, when Zoom, the video conferencing company was obviously going to do well because of all of the work from homelessness, a different company who had a similar ticker was the one that was going through the roof. So I think there's a lot of shooting from the hip, a lot of people not really doing a lot of research and understanding even which company is which that contributes to this.

I think you also have to factor in that the Fed has anchored interest rates near zero. So it's kind of forced people out the risk curve. So people, if they can't make any, you know, make any interest on their, you know, on their cash at the bank. I mean, I started my career in 1999. I remember Texcox going up 1,000 percent in a year. But, you know, Fed funds, you know, two-year, they were north of 5, 6 percent, right? And that was risk-free, whereas now it's zero. So I think that's also a big catalyst to get a lot of people, you know, not, you know, taking their money out of the bank and going on the side.

market. Yeah. Yeah. John, you're the markets guy here. You have to recommend investments all the time. I know you have said for a while now that you think value slash cyclical names would be doing better in the second half of the year. And you also like small caps over big cap, particularly big cap growth stocks like the mega cap stocks. You still believe that. You did last time I chatted with you. And what ETFs do you like for the second half of the year? Can you give us some names that you think will outperform. Sure. So, you know, we run some long-date of retirement money where our time horizon is in five, ten years. So I think, you know, small caps, you know, if you look at EES, the Wizzintree, earnings, weighted small-cap ETF, you have a nine PE ratio. That's versus

the Russell 2000 ETF, the IWM, which is 14 PE ratio. So that, Bob, to me, looks very attractive if you believe that there's a cyclical upswing in the economy and that were past, you know, the recession period. You know, U.S. large cap index is, you know, north of 20. So, you know, the entire U.S. market, I would say, looks, you know, interesting once you strip out, you know, things like spy, you know, SPLV, UFMV, you know, all the defenses like XLP, XLU, you know, Cape Shoe ratio is in the high 20. So I just think that if I look at the macro economic data, the earnings, you know, everything looks like it has, you know, troughs. So with the Fed anchor in interest rate at zero and they provided the floor to financial assets, you know,

they're going on buying individual bonds and ETS. You know, I just think that, you know, now it's time to strategically revounce your portfolio. Yeah, it's a nice in theory. The problem I have with the whole thing is I don't like value versus growth in general. I think it's an outdated investment ideology, but it's a loser, John. It's been a loser for 10 years. can argue on mean reversion, I guess. But, you know, even our friend in Omaha is having a lot of problems around the whole, it's time to buy value story. Is it, is your call to buy value, by the way,

value in case you're wondering, folks, right now is generally energy stocks, a lot of bank stocks, some retail stocks? Is your call, John, to buy value really an idea that the economy is recovering? And so instead of a late cycle play, we've already gone through the recession, and now we're in an early cycle, and so you should buy cyclicals in an early cycle play? Is that the rationale here? Yeah, and it's all how you construct the portfolio, Bob, and how much risk you put in one particular factor.

We tend to be more diversified across factors because we don't want to make a big value bet. As you just said, you know, 10-year trade, it's gone wrong. So we've been on your show many times, and we've been fortunate. We've said tilt towards, you know, quality, tilt towards high quality growth. So what we're saying now is that

now it's time to take profits. You know, the idea is to buy low and sell high and buy, you know, when valuations are on the low end. And I do think that if I look at emerging markets, if I look at, you know, things like MCHI, China, you know, 12 PE ratio,

you know, the broader merge market tip that we use DGRE as also like an 11.5 P.E ratio. So to me, I take comfort in that U.S. large cap index. You know, like I said, the forward P ratio in the low 20s, that's, you know, very, very high in my eyes.

It doesn't mean that it can't stay high forever, but, you know, as somebody that strategically thinks very long time, you know, I do think that it does make sense. And the banks that you mentioned, you know, we have the KBWB large cap banks. I mean, to me, that feels like, you know, a regulated

entity. You've got very strong balance sheets. You know, I think banks are well positioned. So it has the yield curve, you know, moves steepens, and as rates go up, I think, you know, banks should be a pretty interesting five, ten-year trade. Dan, how do you explain to betterment investors all of this? I guess you'd call it factor investing, you know, quality versus low quality or value versus growth or low volatility versus high volatility or momentum versus low volatility.

Does any of that as an investment category, I guess you call it factors broadly, make any sense to you? And does it fit anywhere in the betterment universe? Yeah, absolutely. One of the things that we've really focused on is positioning the investments and the investments that we put forth for clients as being about them achieving their goals. And over the past two or three years, outside of our sort of vanilla market cap-ish, globally diversified portfolio, the fastest growing and the most sustainably growing strategy that we've been put out there is our social responsibility strategy. And I think that, you know, like it's something we offer. It's not something that we market dramatically,

but we make it available to our clients. And without that marketing, without a tremendous amount of trying to push it in front of people, it's done very well. And the events of the past few months have driven more interest in that, more interest in the value of what you invest in from a values point of view. And I think that there are big opportunities now to say, how can we more refine and reflect the values of our clients in the investments that we provide for them? And that not only allows them to sort of feel like their money is going to places that they, you know, feel, I don't know, but responsible with, but also when you are invested in a portfolio for ethical or moral or any kind of like more fundamental reason than money, you tend to be

a better investor in it. You're less likely to panic during downturns. You're more likely to stay the course, save reliably. So I think that when we tend to talk to clients about value and values, it's just a very different conversation about what do you want your money to achieve. Yeah, that's a very good way of looking at it. And when you say socially responsible, are you just talking about ESG, like plain vanilla EST? What does socially responsible mean to you? What are they actually investing in when you say they're interested in social responsibility? ESG is definitely the broadest framework. It's also the one that sort of right now has the most assets and therefore the lowest costs associated with the funds in it. I think one of the opportunities that we're looking at now is that different people have different values and the ability to let each person reflect themselves in their portfolio in some sort of a scalable fashion. There are funds out there. There is a fund NACP that specifically looks at the advancement of colored people. I think that there are more opportunities to refine the niches that people really want to see reflective. in their portfolio. I'm not sure if that's going to be a fund in the end of it. It might require

something that's more like personalized indexing solutions at the individual stock level. But I definitely see that being a growing, a real growth area for any advisor who wants to have conversations with clients about their investments that aren't just what did it do last quarter. Yeah, I think that's a very good point. And we had the head of the NACP ETF on last week. And I think you're right, Dan. What we're going to see is, ESG is a very broad area for socially responsible investing, environmental, social, and governance. And I think you'll see the emergence of, I wouldn't call them niche, more niche oriented, but stuff that's a little more geared towards trying to attain a specific goal,

whether it's clean energy or whether it's social justice. I think you're going to see much more interested in that. This has been a very fascinating conversation. I know we've sort of veered off into philosophy a little bit. and we often have Dan on to try to explain investor psychology and unusual trends in investor psychology. And this is certainly the right time to have him on. So thanks very much. Now it's time to round out the conversation with some analysis and some perspective to help you better understand ETFs.

This is our Markets 102 portion of the podcast. Today we'll be answering some of the most frequently asked questions about ETFs and how they generate returns. Once again, here's my producer, Kirsten Chang. Bob, just going back to basics for a minute, we get a lot of questions about the types of ETF trades out there. So what types of ETF trades can investor place? Can they do market orders as well as limit orders? Yeah, you know, you're right, Kirsten.

When you buy or sell an ETF, you have the option of placing an open market order or setting the price that you'll pay with a limit order. And a limit order, that allows you to specify the maximum price that you'll pay when you're buying securities or the minimum that you'll accept when you're selling them. So if you're dealing with a very liquid ETF that has a very tight bid and ask spread, most people say it's fine to put in a market order. But most investor sites will recommend you put in a limit order just to protect yourself. And just pivoting a bit, how is the market price of an ETF determined overall?

Why is that sometimes different from the net asset value of an ETF? Well, you know, Kirsten, the market price of an ETF is not always the same as the net asset value. An exchange-traded funds market price is the price at which the shares in the ETF can be bought or sold during trading hours. The net asset value is a little bit different. It represents the value of each share's portion of the funds' assets and the cash they have at the end of the trading day. Now, the net asset value and the market price theoretically should be very close, and in fact, most of the time they are. Now, if they get very far out of whack, what happens is the market makers can arbitrage. You can buy the lower priced one and sell the higher price one. That's an arbitrage. And the redemption mechanism is what we call it essentially helps keep the market price and the net asset values in line. Now, there's some very interesting questions of what happens when the underlying market is closed, when the stocks are closed, for example, and the ETF stays open. This happened, for example, several times in this

2020, China was closed for days on end, and yet the China ETFs in the United States kept trading. Well, how do you know the price of the ETF when the underlying stocks aren't trading? And the answer is, investors guess. That's literally what it is. And it turns out that the wisdom of the marketplace, the wisdom of the crowd is very good at this. When China was closed, investors got the price of the China stocks quite accurate by guessing the value. of the ETFs, of course, is a guess is the value of the underlying stocks. Now, what's interesting is that you can have a certain mass psychology here that actually tends to work and guess correctly,

directionally, at which and which way the stocks are going. Obviously, you need a certain mass of people who are making a guess. You need a statistically valid sample. I'm not sure what that would be, but I don't watching this for years now, that ETFs are very accurate in guessing direction of prices. We had another example earlier this year when the corporate bond market was going virtually crazy, and investors were buying corporate bonds like crazy, and the net asset value was deviating from the underlying prices

of the corporate bonds themselves, and it was a little bit of an odd situation, And what was going on here was there was so much trading going on that the people who were, the bonds underneath weren't trading often enough. And so there was a slight disconnect. And the question is who was right? The answer is by and large, if the bond market was more liquid, it would have more accurately reflected the ETF prices rather than the other way around. So this was another vindication for ETFs where people essentially said, geez, you know, you've got some stickiness in the bond market in trading the underlying stocks, but the ETF market kind of accurately figured out where they should have been. So it's a very interesting question about net asset value in market prices. And again, if you get a sufficiently large crowd there, they're pretty good at figuring out what the right prices are. That's it for today. I'm Bob Bizani. Thank you for listening. And make sure you tune in next week. And in the meantime, you can tweet us your questions or topic ideas at ETF Edge, CNBC.