• Tue. Jul 23rd, 2024

A Collective ETF Trading Mentality


Jul 28, 2022
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By David Mann, Head of Global Exchange-Traded Funds (ETFs) Capital Markets, Franklin Templeton

What do sports cards have in common with exchange-traded funds? David Mann, Head of Global Exchange Traded Funds (ETFs) Capital Markets, explains why a collective mentality may be beneficial for traders of both.

Thanks to my son, the latest craze to hit my household is the collecting and trading of sports cards. He scours the internet as well as local card shows to find what he thinks are undervalued cards. I have been reluctantly supportive of this hobby as I do think there are some solid life skills around the art of negotiating and ideally making a profit. (Side note: he says he is bringing in tons of money, but I am dubious!).

There seem to be two key factors that drive the value of these cards and interestingly, the actual player on the card is not necessarily one of them. The first factor: rookie card. That seems to be the only card game in town. The second factor is the condition of the card. Not surprisingly, a mint condition card will be worth more than one with frayed edges.

There are grading companies that my son and his friends send their best cards to, in order to see if they will be rated a nine or a 10, as their rating would materially impact the value of that card. Upon researching the cost of rating a card, my son was initially puzzled by the fact that the cost per card drops significantly when you send in more cards—call it a bulk discount. He then rightfully understood that if he and his friends sent their cards together, the individual cost per card to them would be lower. “Pretty smart for us to work together, right dad?”

I will come back to card grading in a second, but first, I should probably discuss ETFs given the theme of this piece. Over the past couple months, I have seen two ETF trends start getting some real traction. The first one, given the market selloff, is tax-loss harvesting into ETFs that provide a similar exposure. As I have discussed before (usually toward the end of the year), tax-loss harvesting is the silver lining for ETFs that have losses. Our previous blog on this topic highlighted single-country ETFs, almost all of which are in the red this year. Investors can utilize alternate single-country ETFs that provide access to the same markets to harvest losses while simultaneously keeping their exposure. With most countries deeply in the red year-to-date, it’s not surprising we’ve seen a lot of investor interest in these sorts of trades.

The second trend is an uptick in more nuanced investor questions about using smaller funds given the potential restrictions over percent ownership or assets under management (AUM). Concerns about fund size are often intertwined with questions about ETF liquidity. That is a point I discussed in one of my first blogs back in 2016. Most of my recent content has focused on ETF liquidity, so I trust that investors now have a better understanding of trading ETFs of all sizes.

To clarify any issues over percent ownership based on the small fund size and the amount they want to invest let’s take a page from sports card grading. We can glean some real-world lessons from my son’s approach to savings via teaming up on the rating fee. Collectively, if all existing shareholders of one large fund decided to move into a smaller equivalent fund at the same time, the percent ownership issue should go away.

The key element is there needs to be some awareness of the collective interest in making this switch for the timing to work. One of the positive aspects of sitting on the ETF Capital Markets desk is that we get to talk to almost all parts of the ETF ecosystem—authorized participants, market makers, internal distribution teams and end investors. Every so often, our desk will hear enough chatter about a smaller fund to try to connect the dots with the existing shareholders of a larger equivalent fund.

We have seen several examples over the past year, the most recent of which was in one of our single country funds. The fund was below $50 million at the start of June when the chatter started; multiple investors needed a specific AUM at which point they could invest. The initial client inflow triggered a domino effect, with each investor following one another as soon as the fund was large enough to allow for their investment. In less than two months, the fund increased its assets sixfold, and now has hauled in more than $300 million.

The takeaway for investors with percent ownership restrictions who are interested in a smaller fund—whether for tax-loss harvesting or as a new investment—is that there might be options available, especially when there is strong collective interest. The idea of working together is nice—just don’t think that my son is giving up his mint condition Ja Morant rookie card anytime soon!

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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