In my opinion, however, the key attribute that has led to ETFs' success is its liquidity/transparency. Like a shiny new machine in the casino, ETFs (such as DXJ) promised even faster trades and up to date pricing that make (or break) entire companies. With this in mind, will the next generation of active etfs allow for investors/speculators to hedge their managers?
The prototypical active etf is PIMCO's Total Return etf (BOND), which has done well:
(Source: http://seekingalpha.com/article/578491-pimco-total-return-etf-off-to-a-fast-start)
Notice that the etf (top-most line) is not just being compared to its benchmark (which it handily beat), but also PIMCO's own Total Return Fund. In a very real sense, Bill Gross has beaten himself. Similar to the cash-futures basis, could there be an etf-mutual fund basis?
Now let's take this a few steps further:
- Execution-hedging: If xyz investor has a large holding in a mutual fund that he wants to liquidate intraday (wanting, perhaps erroneously, to catch the top), he can short the etf until the close.
- Manager-hedging: xyz investor likes abc strategy and has invested in a top tier manager. There is another manager doing the same abc strategy but the investor believes this other manager will do significantly worse than the top tier. He/she can short the etf while still invested in the top tier manager
- "Basis" trading: If one believes that a particular manager's etf version is going to do worse or is mispriced relative to the mutual fund version, he/she can short the etf and buy the mutual fund. This is admittedly incomplete, as one cannot "short" a mutual fund easily.
The issue is though that for big funds like that the minimum investment is so high that retail investors are unlikely to have capital with them. I do think it'd be great to be able to bet against certain fund managers. I think most pension funds, high net worth individuals, etc, hedge away the risk in exposure to those funds through diversification and only allocating a small amount to such "alternative" investments.
ReplyDeleteIndeed, this would be a highly illiquid/niche strategy at best. I do think, though, there is a way for retail investors to hedge/bet similar exposures. E.g. retail person holds a portfolio of bonds and think he/she will outperform BOND etf given its size. This is probably not a profitable strategy for most investors, but it does given them the choice.
ReplyDeleteSure, it definitely does. There are a lot of limits to what you can do as a retail investor. What I think is interesting is that it's hard, if not impossible for retail investors to buy CDs in order to buy insurance on bonds and things of that nature. I bring this up because I'm in real estate and re-reading The Big Short I noticed that Phillip Green wanted to hedge against his vast residential real estate holdings and really had to work to find a bank that would let him make that type of bet.
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