Author Q&A With Bloomberg TV’s ETF Expert Eric Balchunas by Gavekal Capital Blog

In our most recent book club selection — The Institutional ETF Toolbox — Author Eric Balchunas outlines what investors need to know about the changing landscape of investment products in a fast-moving format that makes this book well worth any investor’s valuable time. Balchunas quotes early adopters and power users of ETFs to illustrate how investors helped to create this class of products and share how the best of the best are using them.

We wanted to know what’s new in ETFs since the release of the book, so we sat down with Eric last week in New York after he finished his fourth TV segment of the day. He shared what’s next for ETFs, how investors will find performance in the future, and how he became Bloomberg’s go-to guy for ETFs.

Q&A: Bloomberg TV’s Eric Balchunas on ETFs

Gavekal Capital: How did you become an ETF expert?

Eric Balchunas: After college I was a financial reporter for Institutional Investor. I made the move to PR because I wanted to see the other side of the keyhole of all these press releases I was receiving. When I started at Bloomberg I was blown away by the place. It looked like an electric beehive. After spending a few years in PR at Bloomberg, I decided to drastically switch things up, and I went to work for the Bloomberg’s Princeton data office. This was a move from a talking profession to a data-oriented profession. Now I was looking at mutual fund data and not using my communication skills at all. Gradually, as I got used to working with the Bloomberg terminal I began to combine the data analysis and communication skills together. ETFs were beginning to gain a lot of steam –remember this is back in 2006 so ETF AUM was not nearly as large as it is now –and I quickly realized that I could become Bloomberg’s go-to guy on ETFs. So I combined all of my skills and tried to get in front of the oncoming ETF wave. Initially I worked with a team to build out ETF functions on the Bloomberg terminal. If you have a Bloomberg Terminal and type ETF <GO>, that is a function that I helped to create. ETF <GO> is invaluable for understanding an ETF and figuring out why it performs the way it does. In the book I compare ETFs with like names to show how each one performs differently and how differently they are constructed. ETF <GO> is the culmination of all of that work.

Gavekal Capital: Did the idea for the book come from working on ETF <GO>?

Eric Balchunas: It definitely played a part. While working on the ETF function, I was going on TV more and more during Bloomberg’s ETF segments. People kept telling me I should write a book on ETFs. Gradually, I began to think about writing a pamphlet, something I could hand out to friends and family at dinner parties to help them lower their investment costs. So the genesis of the book was my sitting down to draft this little pamphlet. When my editor heard about it, he introduced me to Bloomberg Press. The first pitch for the book was actually directed at retail investors. The publisher declined because there are more retail-oriented books in the marketplace. They wanted a book directed at institutions, so I set to figure out how the bigger institutions in the financial world were using ETFs.
The book is about 60% what I was going to say about the retail side and 40% new research on how institutions use ETFs. For parts of the book, I was writing and learning at the same time. I interviewed investors of endowments, foundations, retirement plans, big ETF providers, Jack Bogle, ETF strategists and early adopters. The interviews allowed me to use expert quotes to explain some of the more complicated aspects of ETFs. I interviewed about 60 people and included about 300 quotes in the book. Readers have told me they really enjoy the first-hand stories from practitioners about how to use ETFs.

Gavekal Capital: Your book came out in August 2015, what’s changed since it was released?

Eric Balchunas: The biggest change is there have been roughly another 100 ETF launches since last August. In terms of major trends in the ETF world, I don’t believe much as changed … yet. In a couple of years, we will see some of the more exotic ETFs take hold. For example, in the book I discuss interest rate-hedged ETFs and liquid alt ETFs, which have still yet to have their day. I did this on purpose because smaller ETFs and asset classes will eventually become more important as time goes on.

Gavekal Capital: What’s the next big ETF trend investors should be watching?

Eric Balchunas: Smart beta is going to be a very big deal. Smart beta is where all the new products are coming from, and that’s where managers can find some interesting ways to try to beat their benchmark. We are already seeing large institutions wade into this space. Since the release of the book, Goldman Sachs and JP Morgan have launched smart beta ETFs.

Perhaps the biggest industry shift on this front has been from Fidelity, who announced they are going to be releasing smart beta ETFs based on their own indices. This is huge! They are taking their secret sauce, turning it into a rules-based index and tracking their own index. That way, even though they will be earning less money, they are still in the game and their profits aren’t transferring to a competitor.

Gavekal Capital: Looking out over the next 5-10 years, do you expect ETFs to continue on the current trajectory and take a larger share of the pie?

Eric Balchunas: Without a doubt. Right now there is about $2T in ETFs and another $2T in index mutual funds. The active mutual fund marketplace is much larger at around $13T. If we look back at recent history and conservatively project trends into the future, I expect about $250B per year to bleed out of the active money management world into passive management. ETFs will get the majority of it.

Gavekal Capital: So in 4-5 years, index investing will reach parity with active from an AUM standpoint?

Eric Balchunas: Yes, that sounds about right.

Gavekal Capital: Why will ETFs take the larger share of flows?

Eric Balchunas: Because there are so many new, interesting products being launched every day. Right now, the mutual fund industry dominates the ETF industry in terms of number of products. There are roughly 16,000 mutual funds when you consider all the various share classes. Currently, the number of ETFs is only about 2%-3% of that amount. Right now, when people go looking for ETF investments, there are only one or two options per benchmark index. This means investors who prefer more options tend to focus on mutual funds. And typically, the analysis on that side of the business starts with who has been performing best recently. The funds that have performed the best get hyped up by the media as well. This helps drive mutual fund flows and ironically, it is usually the case that an active

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