Holly Cook: We are here at the Morningstar Investment Conference and joining me is Scott Burns. He is Director of ETF Research at Morningstar. Scott, thanks for joining me.
Scott Burns: Holly, thanks for having me.
Cook: So you just gave us a very interesting presentation covering kind of all areas of ETFs, but one of the things that you pointed out is, in the U.S. in particular, the huge growth in ETFs. I think you said it was around 40% of daily trade volume on the New York Stock Exchange is now in ETFs.
Burns: Yeah. That's correct.
Cook: Even more so in Canada. So, what are some of the key benefits of these products?
Burns: Well, I think if you want to focus on the share of trading volume that’s out there, I mean, really it's the liquidity of the ETFs and the ability for investors—large and small—to trade baskets of securities in this very cost-effective liquid manner. So, you see all sorts of uses going on whether it's core portfolio building blocks or tactical investing or even in the more sophisticated hedge fund, investment banking, pair trades and other risk management tools. You can go long and short in ETFs and I think that's a nuance that gets missed by people a lot. So, that's really, I think, what's driving the asset flow from that side of the ETF equation.
Cook: And yet Jack Bogle, as you pointed out to us earlier, has famously come out against ETFs, and various regulators have also made noise, saying they’re looking at them too. So, what are some of the key risks as well?
Burns: Yeah. Well, I think, for Jack, who says “I don’t like ETFs because you can trade them all day”, at the core of Jack's message—and it's been the same for 40, 50 years—is that he hates trading, right? Jack says stop trading. So, whether you're trading, day trading stocks or bonds or ETFs, Jack dislikes that. He actually likes ETFs that they are more tax efficient, but I think he is a little concerned about the ability to trade will mean that people will trade.
I think the biggest disadvantage for ETFs—it's not really a disadvantage, but more an awareness—is that they do trade and that is challenging, I think, for a lot of investors to understand. You know, how do you get in to making a market order, and a limit order, and understand things like bid-ask spreads, and underlying liquidity? And something our research team in the U.K. spends a lot of time focusing: having the right investment idea can be completely ruined by a bad execution of that idea. So, making sure that you understand those nuts and bolts of trading; there are more complexities than to a traditional mutual fund, but it’s not such that even the most novice investor couldn't eventually pick it up.
Cook: So, given some of those complexities, what are some of things that maybe an investor might look for when thinking about investing in ETFs?
Burns: Well our mantra on ETF research, and this is true globally, is “know what you own”. And that's especially important in the European market where you have physical replication and synthetic replication and, I think, as you were mentioning earlier, that's what a lot of the regulatory boards have kind of come out with.
You know it's really understanding the embedded credit risks, especially in some of these synthetic products there. We've been calling for more disclosure, more transparency as to collateral and counterparty risk ever since we started ETF research in the U.K. So, it's definitely in line with what we think; although, we definitely don’t believe in the scare tactics that this is the end of the world.
I mean, really what we're witnessing, especially in the synthetics and really more on the Continent than probably per se in the U.K., is this on-exchanging of structured product and European institutional investors have been using structured product with less transparency and definitely less liquidity for decades, right? So, it's actually a good thing that we're bringing this on the exchange. It will be a better thing when we have more transparency as to what's happening in the background.
Cook: And so to help out with the investor trying to find out, to sift through all of that information, Morningstar recently launched the ETF Research as well. I mean, could you tell us a little bit about that?
Burns: Yeah. We're very proud of the research team. We've had it actually going in the U.K. and Europe more broadly since early 2010. The research came live in March actually 2011 and investors can find it on Morningstar.co.uk.
I believe it’s still the only individual fund analyst, analyst-driven individual ETF and ETP research that's available out there. We focus on suitability. We think about ETFs as tools. So, making sure that people understand how they work in the portfolio, what they do, what they don't do, as well as some of those structural issues that we discuss.
So, if you do have questions about who the backing bank is and what the collateral policies are in, say, synthetic, these reports are designed to help address that. So we're very excited. We're covering 150 of the largest ETFs in Europe right now, always looking to grow that. We're also producing a lot of great commentary and thought leadership pieces as well.
Cook: Well, thanks very much for joining me Scott and thanks for your presentation as well.
Burns: Holly, thanks for having me.
