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Rational Reminder

Episode 392: The Rise of ETF Slop

75 min episode · 2 min read

Episode

75 min

Read time

2 min

Topics

Investing, Fundraising & VC, Leadership

AI-Generated Summary

Key Takeaways

  • Thematic ETF Performance: Morningstar data shows only 10% of thematic funds outperform global equities at ten years, with 100% of Canadian thematic funds either closing or underperforming. These funds launch after themes peak, capturing investor excitement but delivering 6% annual underperformance post-launch.
  • Buffer ETF Costs: Buffer funds charge 0.73% versus 0.09% for underlying index funds while offering inconsistent downside protection. AQR research demonstrates simple equity-cash combinations outperform buffer funds on average and during drawdowns, making traditional asset allocation more effective and transparent.
  • Covered Call Trade-offs: Covered call ETFs market high distribution yields but mechanically trail underlying equity total returns. Analysis across multiple funds shows investors needing portfolio income fare better combining regular dividends with occasional equity sales rather than accepting capped upside for income distributions.
  • Leveraged Single-Stock Risks: Hendrik Bessembinder research finds three-times leveraged single-stock ETFs underperform frictionless benchmarks by 9.4 percentage points annually, with 61% trailing unlevered market returns and 56% producing negative absolute returns at one-year horizons due to daily rebalancing costs.
  • ETF Market Transformation: US markets now contain more ETFs than individual stocks and more actively-managed than index-tracking ETFs. Average management fees for 2025 ETF launches reached 0.7%, with 166 funds charging above 1%, reversing the low-cost index fund revolution.

What It Covers

Benjamin Felix, Dan Bortolotti, and Ben Wilson examine the proliferation of complex, high-fee ETFs in 2025, including thematic funds, buffer ETFs, covered call products, and leveraged single-stock ETFs that underperform simple index strategies.

Key Questions Answered

  • Thematic ETF Performance: Morningstar data shows only 10% of thematic funds outperform global equities at ten years, with 100% of Canadian thematic funds either closing or underperforming. These funds launch after themes peak, capturing investor excitement but delivering 6% annual underperformance post-launch.
  • Buffer ETF Costs: Buffer funds charge 0.73% versus 0.09% for underlying index funds while offering inconsistent downside protection. AQR research demonstrates simple equity-cash combinations outperform buffer funds on average and during drawdowns, making traditional asset allocation more effective and transparent.
  • Covered Call Trade-offs: Covered call ETFs market high distribution yields but mechanically trail underlying equity total returns. Analysis across multiple funds shows investors needing portfolio income fare better combining regular dividends with occasional equity sales rather than accepting capped upside for income distributions.
  • Leveraged Single-Stock Risks: Hendrik Bessembinder research finds three-times leveraged single-stock ETFs underperform frictionless benchmarks by 9.4 percentage points annually, with 61% trailing unlevered market returns and 56% producing negative absolute returns at one-year horizons due to daily rebalancing costs.
  • ETF Market Transformation: US markets now contain more ETFs than individual stocks and more actively-managed than index-tracking ETFs. Average management fees for 2025 ETF launches reached 0.7%, with 166 funds charging above 1%, reversing the low-cost index fund revolution.

Notable Moment

Bessembinder simulated leveraged single-stock ETF returns back to 1974 and found that over half would have lost money within one year, with results worsening at longer horizons before accounting for actual fees and financing costs embedded in swap contracts.

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Episode Transcript

This is the Rational Reminder podcast, a weekly reality check on sensible investing and financial decision making from three Canadians. We're hosted by me, Benjamin Felix, chief investment officer, Dan Bortolotti, portfolio manager, and Ben Wilson, head of m and a and portfolio manager at PWL Capital. Happy New Year, everyone. Yes. Happy New Year. Good to be back. It's episode three ninety two. Three ninety two coming up on 400 here. Can't say that I ever thought we would get there when we started the podcast but here we are. It's what? Eight years? Around there. Yep. Been going for a while. A long journey. Every week. So we have a topic today that I've been thinking about for a while. Realized that it needed a name. I don't know if I'm the first person to call it this, I'm sure other people have written about it or something. But what I'm calling it is the rise of ETF slop. So we're gonna talk about that. I think it's actually a real problem for investors. Let's get into it. ETFs are no longer synonymous with sensible investing. Dan, when you started your blog, ETFs were, like, a big part of it is why anybody could go and build an index fund portfolio. And back then, most, but not all, ETFs were low cost index funds. You could kind of stick your hand into a bag of random ETFs, and you're gonna pull out probably something pretty good. But more recently, the fund management industry is launching literally hundreds of new actively managed ETFs every year. And in The US, this is an interesting little statistic. For the first time in US market history, there are more ETFs than there are individual stocks. So we've known for a while there were more indexes than individual stocks, which is always an interesting data point to pull out. There are now more ETFs than there are individual stocks in The US stock market, which I think is pretty crazy. Yeah. I think that's been the case for a little while in Canada, but of course we have so many fewer publicly traded companies to think of ETFs having eclipsed the number of individual stocks on The US exchanges is remarkable. The other data point that's interesting is, again speaking to The US market, there are now more actively managed ETFs than there are index tracking ETFs. So again, ETFs used to be synonymous almost with index funds. I think that's a mistake that a lot of people still make where people refer to ETFs as if that meant the same thing as index funds. And even if that were true on average, because there were more index ETFs than active ETFs, it is no longer the case. There are more actively managed ETFs than index tracking in The US. I think the big issue for investors is that a lot of the ETFs being launched today have really been engineered to attract …

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