In my last post, I discussed what baseball batting averages can teach us about exchange-traded funds (ETFs). But alas, my dream of a strong season for the Oakland A’s has met the reality of a 0.20 winning percentage and an apparent franchise move to Las Vegas. What is happening here?! With my baseball interest now at an all-time low, I’ve shifted to one of my other summer pleasures—gardening. I suppose it took a move to California for me to find my green thumb, but now I love the entire process that ideally leads to an abundant harvest toward the middle of summer.
Recently, within our ETF organization, “product development and strategy” has been added to my capital markets plate. Specifically, I now need to contemplate the viability of both our current and future ETFs as well how they trade.
As I was tending to my garden last weekend, it occurred to me that many of the lessons I have learned from gardening through the years have some clear analogies to our ETF lineup. (Yes, I have a work/life balance problem). For your enjoyment:
- Vegetables, like ETFs, both start from seed.
Sorry, this one was too easy.
- Even very similar vegetables grow at their own pace.
My wife loves tomatoes, whether picking them from the vine for her salads or making giant batches of gazpacho. I typically plant around 20 vegetables each April, with approximately half of those being different varieties of tomatoes. I plant them all on the same day and give each plant the same amount of water. The soil is uniform with equal amounts of fertilizer and chicken manure (very important). Somehow, six weeks into the season, some of the tomato plants are already humongous and producing fruit while others have barely grown at all.
ETFs are often punished for not having asset growth during their first year. Historically, I have approached writing about this issue from the lens of trading and liquidity with examples that highlight the ease of buying and selling even the newest and smallest ETFs. There are simpler explanations as well as to why an ETF might not have initial success. A new ETF can offer exposure to an asset class that is out of favor. For active ETFs, some investors need at least a one-year track record to consider investing in them. Sometimes, it just takes time for roots to take hold.
Sometimes my best-producing tomato plants are the ones that started slowly in May. I see that with our ETF lineup as well. One of our single-country ETFs had only US$50 million of assets when it hit its five-year anniversary—and then added almost US$200 million over the next three months.
- Variety is important.
I mentioned earlier that almost half of our vegetables this year were tomatoes. The rest of the garden includes cucumbers, squash, eggplant, zucchini, shishito peppers, bell peppers and four different herbs. Whether for dinner or snacks, different vegetables will be in demand on different days in our household.
I see the same with our ETF lineup. Some investors simply want passive exposure to a specific market at a very low cost. Others want low tracking error and low cost but with a slight factor tilt. Others want a specific outcome that could be obtained via rules-based indexing or active management. Multiple ETF options can be a great benefit to investors, and I believe it is important to offer a variety of options to meet different investor needs.
- Watch out for unexpected external factors
Last year was the first one in which I saw the aftermath of some unnamed animals that had eaten several of my budding vegetables. I have yet to detect a pattern for their preference beyond their love of cucumbers. This year, I am going on the offensive, led by a motion-activated plastic owl stationed by the cucumbers and Irish Spring soap shavings to confuse their sense of smell. I have netting on standby. I want to make sure I’m prepared if the local squirrels post my home address on their backyard message boards.
“Expect the unexpected” seems to be par for the course in ETF land as well. ETFs can experience massive inflows and outflows out of the blue. Rare market structure events (flash crashes) can cause liquidity to evaporate in the blink of an eye. Global pandemics, wars and financial crises can severely impact the behavior of global markets, including ETFs. I constantly speak with investors about which funds to consider and what trading best practices can handle even the most extreme market conditions.
Franklin Templeton just crossed US$15 billion in global ETF assets, so it seems as though plenty of investors are interested in our offerings. Still, we continue to innovate and stay nimble to the currents of change while keeping a constant pulse on demand. Don’t be surprised if another great ETF product idea sprouts up while I tend to my garden!
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Generally, those offering potential for higher returns are accompanied by a higher degree of risk.
For actively managed ETFs, there is no guarantee that the manager’s investment decisions will produce the desired results.
ETFs trade like stocks, fluctuate in market value and may trade above or below the ETF’s net asset value. Brokerage commissions and ETF expenses will reduce returns. ETF shares may be bought or sold throughout the day at their market price on the exchange on which they are listed. However, there can be no guarantee that an active trading market for ETF shares will be developed or maintained or that their listing will continue or remain unchanged. While the shares of ETFs are tradable on secondary markets, they may not readily trade in all market conditions and may trade at significant discounts in periods of market stress.
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