Episode 392: The Rise of ETF Slop

27:05And then as reality unfolds, expectations tend to settle down and stock prices tend to follow to drop a little bit or a lot of it. Cannabis was an extreme example. That was a crazy one that we watched here in Canada. Canada legalized cannabis. Global investors saw the potential for this massive market to open up in Canada and in other countries that we're potentially going to legalize. Investors just piled dollars into cannabis stocks in Canada, but also thematic funds in Canada built around cannabis stocks. At the peak of the cannabis frenzy, cannabis funds made up more than 60 % of the Canadian thematic market by assets, I believe.

27:45Today, they make up 1.4%. Pretty crazy. The hot themes today based on fund flows in Morningstar's report are security and AI, unsurprisingly. Cannabis is like an extreme bad outcome. I'm not saying we should expect security and AI to follow that extreme of a pattern. Those are just bigger things that are much more consequential to the broader economy than cannabis. But I do think it's important for investors to step back and consider the long-term data on thematic investing. That has been out there, that paper from Zahi Ben-David's published in 2021, we know this, but investors continue to be attracted to these products, probably because of attentional bias.

28:24Investors are basically attracted to shiny objects and fund managers know which objects are shiny, or at least the good ones do, the good ones from a marketing perspective. There's also optimism bias. Investors overestimate the probability of a good outcome. Extrapolation bias. Investors assume that recent trends like, oh, these stocks have done well recently are going to continue indefinitely, which doesn't tend to be what happens. In general, thematic funds belong in the pile of ETF slop, which should be avoided by most investors most of the time. I think out of the four categories you've identified, this particular category can even be tempting for disciplined index investors.

29:04We've seen that with investors regularly like, well, I'll invest 90 % of my portfolio in a broad market index portfolio, but maybe I'll kind of YOLO and invest a portion in this because it's exciting. As you've said, it preys on the attentional bias of investors. If you're doing it responsibly with a small portion of your net worth, it's probably not the end of the world. You can see how it's tempting for investors, even if it's something that rationally or intuitively is probably not the best choice. Especially now, if you want to talk about AI, just look at the broad market, especially in the US, and how much of just a plain vanilla index fund is dominated by companies in that industry.

29:52You want to get even more concentrated than that? That requires a bit of naivete, I think. And I think this is where the thematic ETFs have the appeal is that there's a narrative there. This is a business that is going to be hugely influential, all of which is true, no doubt, but all of which is already reflected in the prices of those stocks. Somebody needs to come up with a trend ETF that tracks stocks that everybody else hates, not stocks that everyone already loves. That's extreme value investing, I suppose. Even that, of course, is wrought with difficulty because as we always remind people, if people are sour on a lot of stocks, it might be for very good reason.

30:37It might not just be that they're underappreciated. It always comes back to the same thing. Stop thinking that your hunches and your compelling narratives are true insight into what will outperform in the future because in the vast majority of cases, you're just fooling yourself. I think you make a good point, Dan. And when people get attracted to these thematic ETFs, they're not necessarily looking at their composition in their broad market portfolio. I've had a couple clients recently express, like, I want a higher allocation to tech. And we actually look at the underlying holdings of their diversified portfolio, and they're like, oh, wow, I've already got between 10 % and 15 % in the large-cap growth stocks that I want and overweight in.

31:23That's probably enough. I don't know if I agree, Ben. I know this is the one that comes up with clients a lot. I think all of these are equally tempting to investors. I think in our client base specifically, the thematic one comes up quite a bit. But when I look at other places around the internet and the comments in my videos and the Roush Reminded community and stuff like that, or just online more generally, all of these ideas are very, very appealing to investors. And that's why I think they're so dangerous, potentially harmful, and profitable. The companies that launch these products are brilliant because they've identified things that investors are really going to want because they appeal so strongly to the biases they have.

32:03If thematic ETFs play on investors' optimism and extrapolative beliefs, buffer ETFs play on their pessimism. Investors tend to overestimate the probability of negative events and loss aversion. Investors feel the pain of losses more acutely then they feel the joy of gains. Buffer ETFs are funds that are marketed as providing exposure to the stock market with some level of downside protection to smooth out the ride. I'm only picking on BMO here because they had really, really nice marketing on these funds. They did a really, really good job showing graphically how these products work. Great job, BMO, for the communications and I apologize for picking on you.

32:41I bring that up because I mentioned BMO a lot when we were talking about covered calls because BMO has some of the oldest, longest running covered call funds in Canada. I don't think BMO loved being picked on. They did a great job keeping these products alive for a long time and managing them well, then I'm using them as an example. Here again, BMO has launched these buffer ETF products, which is fine. They're obviously allowed to innovate and they've done a great job illustrating and explaining how the products work, which is very cool to see. And then I'm picking on them because they did all the right things.

33:12so I just feel the need to apologize. If we take the BMO US equity buffer hedged to Canadian dollars ETF January, and that January is part of a fund name. As an example, this is an ETF that's designed to offer the return of a US large cap equity index up to a cap of 8.1 % for the period January 20th, 2025 through January 5th, 2026. That's why the January is in the fund name. and they've got these for like staggered for a bunch of different months, while providing a buffer against the first 15 % of a decrease in the market price of the index. So that structure with a capped upside and a partial cap on the downside, so you're protected from the first 15 % of a decrease, but not after that.

33:58That structure is one of the most common structures for buffer funds. We'll put a chart up in the video that the BMO fund I mentioned compared to the BMO ETF of the underlying equities over its current target outcome period. It's very clearly done its job. If you can see the video of capping downside up to a 15 % loss and capping upside at around 8%. It's cool to see. I'm kind of in awe of all these products. It's incredible that we can create these things. And if the end user of this product really wants that very specific payoff profile, it's very cool that you can go and buy that. I'm impressed.

34:36But I think the setup comes with some problems. There is a paper on this in the Journal of Portfolio Management from some of the folks at AQR, a 2025 paper titled Rebuffed, an Empirical Review of Buffer Funds. So the BMO fund I just used as an example would not be in the sample in this paper because they looked at US funds. They highlight the potential problems as the options used to structure the payoff may be naturally too expensive. The transaction costs of trading options may be high and the fees managers charge may be meaningfully higher than they would alternatively charge in a passive allocation to the underlying reference asset.

35:15So they do show data in the paper that this buffer ETF or buffer fund category has become a huge category measured by assets in the category and number of funds that have launched in the category. They also show consistent with my ETF slop thesis that the fees in this category tend to be quite high. Using that BMO fund as an example, the fund has an MER of 0.73 % compared to 0.09 % for the reference asset for just BMO's version of the US equity index fund that that fund is tracking or related to. So in the rebuffed paper, they show that the vast majority of the buffer funds in their sample, which includes all US listed defined outcome funds in the Morningstar database with at least 24 months of history at the time that they did the study, offer inconsistent downside protection with realized losses frequently exceeding what investors might expect based on option payoff diagrams like what we showed in the video for the BMO fund, especially outside of a narrowly defined target outcome periods.

36:20And probably the most important finding in this paper is that simple low-cost alternatives like mixing equities with cash generally outperform buffer funds on average and even in drawdowns. So I think the findings in that paper really raise the question of whether buffer ETFs are truly designed to serve investors' goals or just to cater to their behavioral biases and sell relatively high-fee products. So the authors conclude that their analysis adds to a growing body of evidence that much of the innovation in this space is superficial, engineered more for sales than for substance. I don't think they mentioned ETF slop in the paper, but that's basically what they were writing about there.

37:00I really do think that the buffer ETFs are an interesting piece of financial engineering. I really am in awe at a lot of these products. It's very cool what we can do. They're absolutely brilliant from a marketing perspective, a lot like structured products, which have been around for much longer. You can have market participation with capped downside. How cool is that? It does seem really cool. So these products cater to very strong investor biases that make that seem cool. And again, this is where I got the shock absorbers. They mentioned that these products are like shock absorbers for your portfolio.

37:32Who doesn't want that? You don't want a bumpy ride. So as cool as they are, I don't think that these things improve expected outcomes for investors. When you take into account the relatively high fees, the implementation costs, they're unfortunately probably detrimental to long-term investors in most cases. And then the other thing I would think about with this, if someone came to me and said, I really want to invest in a buffer ETF or a buffer fund, and I can only sleep at night with my portfolio if I have this product, it's probably a sign that you need to review your asset allocation, which could alternatively be expressed with a simple combination of low cost index funds, or even better, a risk appropriate asset allocation index fund rather than these complex high fee products.

38:16That's just it though, isn't it? people I think who would be attracted to a product like this they understand that their upside is capped they're not foolish they don't think they're getting exposure to the market with no risk they understand I want protection from losses and I'm willing to give up a bit of the upside that's great we all want to do that or most people who aren't 100 % equities that's exactly what you want to do it's just that they're cheaper more transparent and more effective ways to do that. And that is just add some fixed income component to your equities. We can come up with expected returns and expected maximum losses in a balanced portfolio, and they're not going to be guaranteed.

38:58But long term, we have a pretty decent idea of the range of possible outcomes for various asset mixes. And it just seems to me that even though it's not as sexy, that's the best way to cap your upside and also control your downside. That's what any diversified, balanced investor wants to do. You don't need financial innovation to do that. I agree with you. The funds are fascinating, the way they work under the hood. I just don't think it really fills a true need other than perhaps satisfies some behavioral bias. I don't think it's just end investors that are subject to this risk or behavioral bias.

39:41More and more conversations I'm having with advisors in my role, advisors, there's so much ETF slop out there that they're tempted by the narratives that the wholesalers or their parent company is pitching to them. Well, this sounds good. They do their own cursory level of diligence. Don't dive deep. Do a bit of research on their own and checks these boxes. I think this is good for my clients without actually looking deeper under the hood and understanding maybe this isn't the best option doing some data analysis comparison. Not every advisor out there is going to the depths to understand one product from another.

40:22It's a good point. It would be interesting to see what percentage of these ETFs that we're lumping together as slop are purchased by DIY investors versus recommended by advisors. I have no idea whether that data exists. But Ben, I think you raise a good point. Advisors are not immune to the same behavioral biases as individual investors are. So they can often use those narratives themselves and not because they're trying to be deceptive. They genuinely believe them, I think for the most part. They're just probably deceiving themselves. Absolutely. Definitely. I've seen some extreme cases of this in my compliance years of experience.

41:02I don't think they were intentionally deceiving investors. I think they truly believed that what they were recommending was in the best interest of their clients. I've seen books that were 95 % of their entire book was invested in bullion funds because the advisor truly thought, this is great for my clients. I believe this is a safe asset. This is where we should have our money. That would have worked out pretty well in 2025. five. Yeah. Yeah. That would have worked out pretty well since then, Ben, since you were in that role. Those guys are probably killing it right now. If they're still in business.

41:36I think most advisors are good people, even if they're misinformed. There's academic research on that too, that shows that advisors making recommendations into products that we would call suboptimal are doing it because they believe that that is the right thing to do. And that research evidences that by showing that those advisors continue to invest in the exact same products, both while they're working, which you could argue while they're just doing that to show their clients so they can sell product, show their clients they're doing the same thing. But then after those advisors retire, they keep investing in the same high fee, actively managed funds.

42:10Conflicts of interest are a problem in financial services, but they're not the only problem. I agree with both of you guys. I would bet that a lot of these products are being used. I know of recovered calls. We did our episode and I did a few videos on that. I did hear from some pretty pissed off advisors who are using that strategy and didn't like what I had to say about it. But they were probably being honest. 100%. They probably weren't talking their own book. They were being honest and I respect that, but it's certainly better than the cynical view, which is deep down they all know that their advice is terrible, but they're recommending it because it's better for their bottom line.

42:47As you say, I think that is the case in a very, very small number of cases. Yeah, I think that's right. Undercovered call ETFs, unlike a buffer fund, covered call funds and covered calls more generally, they cap upside returns without offering meaningful downside protection. These are both strategies that are going to use derivatives to give you some type of payoff. Covered calls are doing a little bit differently and you're getting a different payoff stream. The way covered calls do it is by selling call options on stocks that are held by the fund, or if it's not a fund, you sell a call option on the stock that you own.

43:22If the underlying stock performs well, the upside is capped. And if it does poorly, there's limited downside protection because you do get the option premium, but downside is mostly unprotected. If you get a huge drop, you're going to get a little tiny bit of protection from the option premium, but you're going to eat most of that downside. So you get this really asymmetric expected return profile with covered calls. So as many people listening will know, I did a series of three videos on covered calls last year. I'm not going to reiterate all of that here, but the important points are that these funds, covered call funds, are designed to attract investors with their ridiculously high distribution yields, which are often enormous and are a huge focus of the marketing and fund webpages and all that stuff for these products.

44:06The branding names also often include the word yield or income. But I think the big problem with these products and the reason that I felt the need to make videos about them is that I don't think investors understand that the high distribution yields on these products comes with a huge trade-off on the upside of returns. You're giving up a lot of potential upside in exchange for this high cash distribution. And the overall effect is that the total returns of covered calls should be expected mechanically to trail behind the total returns of their underlying equities. They should be expected to do that and that is what they have done when you go and look at the data on these products.

44:45In those videos I did last year, I compared covered call funds to their underlying equities and found that they underperform most of the time, including for investors who need income from the portfolio, which was a big pushback that I got when I initially started talking about them. I looked at a few covered call funds in one video and then a bunch of people came and said, well, you picked bad ones. You picked ones that of course they're going to underperform. If you look at this one, you'd see that covered calls are amazing. And so I got like, I don't know, 20 comments like that or more, or 20 fund tickers like that from probably hundreds of comments that people say, well, no, you should have looked at this ticker.

45:20It's like, okay. So I went and looked at all the tickers. I was curious. I ended up making another video to go through all of those tickers and show that the exact same thing that I talked about with covered calls in general applies to all of these tickers as well. In some cases, I think what was going on there is that they were not super easy to benchmark. I think one of them had a whole bunch of US equity in the fund, but it was being benchmarked to the Canadian index. That's why it had done well over that period. And you go and benchmark it properly, it just looked a lot different. I think that reinforces what we were just saying, that advisors think they're doing the right thing.

45:53They look at some level of data. This looks great. over these periods compared to this benchmark, but they're not going to the depth of research that you did, for example. And we always encourage advisors, if you feel strongly, show me the data. We're just looking at numbers. We're not trying to shut down a product because we don't like it. We're just actually analyzing the numbers. And this is what we're seeing in the data. If you see something differently, we're always open to different perspectives. The other thing I did in those videos was modeled an investor who needs income from their portfolio.

46:27Because that was another one of the big pushbacks that I got is that, well, these make sense if you need income. I said, okay, let's test that. I modeled it out and asked if covered calls provide an advantage over a combination of regular portfolio dividends and occasional sales from the portfolio to fund income. I took the covered call fund, took how much income you're getting from that. Then I looked at the underlying equities from that fund and just said, okay, if we pulled the same amount of income out of the underlying, are you better or worse off than the covered call? In all cases, you're worse off rather than better with the covered call, even if you need that amount of income from the portfolio.

47:04The other thing I did is I showed that a simple combination of stocks and cash can closely match the returns of the covered call fund without putting a hard cap on upside returns. I really came away from that being like, okay, there's probably a case for these products somewhere other than just the psychological case. There's got to be. I hope. I can't find it. That's not totally true. Maybe they give you access to something called the volatility risk premium. That's theoretically one of the reasons that these products could make sense, but it sure isn't showing up in the data that I looked at.

47:33And it sure isn't the reason that people give for buying them. That is the point right there. No one is buying their covered call fund saying, yep, I need access to the volatility risk premium. They're saying, I want a 12 % yield. That's a great point, Dan. And I don't want to dig into capital. Ben, you're saying you're going to sell some of the equities from time to time. That's digging into capital. Can't touch the principle. You have to keep the capital intact and live off the 12 % income. Now, one of the things that I did learn from making those three videos on covered calls is that it's got more of a cult-like following than dividend investing, I think.

48:05I don't know. Maybe it's a close one, but covered call folks are very passionate about their 12 % yields. The idea that this is not free money that they're just getting for being good people or something, they just don't want to hear it. The cult-like following, I think it's a good distinction because I would say that there's a lot more willful blindness among people who follow a strategy like this compared with dividend investing for, and we've had this discussion many times, it may be suboptimal, but it's not crazy talk. There are a number of worse investment strategies than buying a diversified portfolio of blue chip dividend paying stocks and holding them for the long term.

48:45That's not magic. Occasionally you will hear people talk about dividends being free money. But I think those are a very small minority. Most people understand dividend investing for what it is, which is a perfectly legitimate strategy that doesn't involve hand-waving and magic thoughts like 12 % yields. I agree with that. I think this is one of the biggest wins for the ETF industry from a marketing perspective. Covered Call has been huge. They've seen tons of inflows. They're one of the biggest, fastest growing ETF categories and people just eat them up. They love them. Good for the industry for coming up with those products.

49:24It's too bad that it's coming at the expense of a lot of the people who are using them without realizing it. I saw there were a lot of comments on my videos on covered calls. A lot of people were angry that I was saying this stuff about covered calls. A lot of people agreed with what I was saying. Then a handful of people, particularly on the second and third video, came and said, I commented a really angry comment in your first video, but it actually made me go and look at this and consider if what you're saying was actually true. And I've completely changed my mind now. You were right. That was interesting to see.

49:55And humble to admit. Good on them. Totally. But it shows the power of the story with covered calls, where it takes someone seeing a video of some dude saying that this is not a good strategy for them to go and think, huh, maybe this isn't what I thought. To cap this off here, the sloppiest version of ETF slop is single stock ETFs. These things are being issued in huge numbers, which makes sense because they're issued on individual stocks. If someone's like, I'm going to come out with single stock ETFs, they're not going to come out with one. They're going to come up with a whole bunch, often on the popular stocks.

50:31They have high fees. They are complex tools for speculation wrapped up in an easy to use vehicle. And they're being marketed, maybe not technically, because I don't think they're supposed to be marketed to retail in batches. But you look at the website for these things and the titles of the products, come on. It's like making flavored nicotine vape juice and saying they're not being marketed to kids. Okay. Okay, sure. That's a pretty good analogy, actually. Proud of myself on that one. So there are two main types of single stock ETFs. One focuses on positive or negative leveraged exposure to the individual stock, daily leverage, which as you mentioned earlier, Dan, that's an important point.

51:12And then others offer income through covered calls. And then some combine these two attributes, leverage and covered calls. Single stock covered call ETFs come with the same issues as covered calls more generally with the added risks and volatility of individual stocks. They are marketed with names like yield maximizer, yield shares, high income shares, I believe to appeal to the mental accounting bias where investors separate income and capital into different mental accounts. And so they want to go and buy yield. The idea that you can get a stock that you heard about or whatever that you know and get a 10 % yield, that's pretty exciting.

51:50But the problem as with covered calls more generally is that the income yield comes at a cost of upside returns. So you end up with high income, lower expected total returns, not a great combo. Some providers, not just in the single stock ETF market, but in covered call funds more generally, attempt to address this by adding in leverage. So I found in one of those videos I mentioned earlier, that it was somewhere around 70 % equity and 30 % cash is kind of like what covered calls look like. So some of these products are applying the covered call and then levering the whole thing up 25%. So you've got 25 % leverage on a single stock covered call strategy.

52:32So that does increase your expected returns, maybe back close to what it was before the covered call. You've still got a capped upside though, due to the covered call. You get the more extreme downside of a leverage position, which you do see if you look at the returns of these products. And you only get a little bit of cushion from the option premium on the downside. and you're paying for the cost of leverage. I just don't get why somebody would want to do this. If you want to get your expected return back, just don't write the covered call in the first place. Some of these funds have expense ratios.

53:03Now, this does include the cost of leverage, important to mention, well above 1%. I saw some close to 2 % as a total all-in cost of ownership. Of course, you're still exposed to the risk of an individual stock. We know from looking at the long-term data, most individual stocks have long-term returns that trail the market. Many individual stocks suffer from large losses, which the covered call is not going to protect you from, that they do not recover from in their lifetimes. Those issues become more extreme when leverage is employed. If we move past the covered call slash lightly levered covered call funds, the leveraged single stock ETFs, those are going to magnify the already high volatility of single stocks and they come with their own weird characteristics and unique risks.

53:49Jeff Tack from Morningstar looked at 2X single stock ETFs, which these are designed to produce 2X of the return on a single day. If you look over time, you probably won't get 2X of the long-term return of the individual stock. A 2X leveraged ETF is probably not going to give you 2X the 10-year return of its underlying equity. Same for a leveraged index. It's actually interesting. It's partially due to the fact they're rebalancing daily, but it's also just due to the fact that the leverage makes the thing more volatile. And so the compound returns of a more volatile thing are going to trail the less volatile thing, which is why you don't get exactly two X return.

54:33So that aside, Jeff Tack looked at the daily returns and found that even then, in a lot of cases, you're not getting two times the daily return with these products. On the upside, you're getting less than two times the daily return. On the downside, you're getting more. Why is that happening? It's pretty interesting. It's because of the cost of leverage inside the funds. I mentioned the covered call leveraged fund. The cost of leverage in that case showed up in the expense ratio. In a lot of these single stock, multiple leveraged products, those costs are not going to show up in the expense ratio because the leverage is coming from swap contracts.

55:11You're not paying interest, which is going to show up as an expense in the expense ratio. The financing cost is baked into the price of the swap. It doesn't show up in fees. Man, just evaluating that is over a lot of people's heads. The financing cost built into these swap contracts has resulted in a pretty significant shortfall in returns of many of these leveraged single stock ETFs relative to their target daily returns. Again, we expect a divergence over longer periods of time. Jeff Tack in his blog post is showing that over daily periods, you're getting pretty meaningful tracking error. Between high costs, high volatility, and the skewness in individual stock returns, I really think these leveraged individual stock ETFs face a lot of headwinds.

55:52Hendrik Bessembinder, who's been on this podcast, We've talked about his research lots. He has a 2025 paper on leveraged single stock ETFs, which is super interesting. He sent it to me a while ago and basically said, given the research that I've done on individual stocks and on long-term returns, this was a natural fit for me. The paper is super cool. He finds that long levered single stock ETFs issued since 2022, so these are live funds, underperform a simple frictionless leveraged benchmark by an average of 0.79 % per month. So that's more than nine percentage points per year relative to his frictionless benchmark with 0.26 percentage points of that attributable to the daily cost of rebalancing.

56:34So that's the thing that you were talking about, Dan, and 0.53 percentage points attributable to frictions like fees, the actual cost of leverage in the swap contracts over a risk-free borrowing rate, which is what he uses in the simple benchmark. So underperform by a lot. And then inverse funds trail a simple benchmark by 1.01 % on average. That's more than 12 percentage points annually. More of that is coming from daily rebalancing and a little bit less from frictions, but still coming from the same places. Those are the live funds that he looked at. But then he said, okay, we've got a pretty small sample and a pretty short history of leveraged single stock ETFs.

57:10What if we simulate the returns of leveraged single stock ETFs going back in history. He uses the CRISP database. I think he started at a market cap of a billion plus, so he wasn't looking at small caps and super small micro caps and stuff like that. He starts in 1974. He does tons and tons of simulations over this period. He finds that at a one-year horizon, a little more than two-thirds of hypothetical 3X leveraged single stock funds underperform a simple benchmark of just borrowing the money yourself to buy the stock. This is probably my favorite data point from this paper. 61 % of the 3X leveraged single stock ETFs underperform the unlevered total market index return at the one-year horizon.

57:57And 56 % of single stock 3X hypothetical ETFs have negative absolute returns. And if we go into 2X, the numbers are a little bit better, but still not great. In both cases, there's a non-trivial occurrence of total losses over a one-year period. And then inverse funds, unsurprisingly, if we compare them to the market, they've done quite poorly. 62 % of negative 1x funds and 68 % of negative 2x funds would have trailed the market at the one-year horizon. I suspect based on, so he looks at shorter horizons and then longer up to a year, and the results get worse and worse up to the one-year horizon, I don't know.

58:38I'd have to ask him why he didn't look at longer horizons, but I would expect that these numbers would get worse and worse as we go out past a one-year horizon. These simulated results don't even capture the frictional costs observed in live funds, the fees and the financing costs. I think of all of the categories that we've touched on today, this one is furthest into the Looney Tunes land because some of the others cater to some behavioral bias and they might lead to some disappointing underperformance. But this stuff is just driving a car into a brick wall. If you continue to use a strategy like this repeatedly, it just seems to me that the most likely outcome is$0.

59:27This doesn't make any sense as a long-term strategy in almost any context. The thing I find fascinating with these structures is that people can hide or ignore the complexity that's in these funds using a leveraged ETF. There's leverage being employed through the swap contracts, but if that same person, let's say they're investing$100 ,000, they're unlikely to go and buy that individual stock, borrow an extra 200 grand and invest full amount in that stock. But effectively, that's what's happening. But it doesn't feel like they're borrowing money because they're just buying this ETF on the stock market.

1:00:05It might even be better, Ben, to do what you've described because you don't have that daily reset. It's that volatility that erodes these things. Of all these hypothetical funds that underperformed or had negative returns, my guess is some of those stocks probably had positive returns over that period. It was the mechanism of the fund and the erosion caused by the volatility that resulted in the negative return, not the stock itself. Exactly. And the majority of investors would probably take my example and think that that's crazy and way too risky to consider. But someone might consider doing this leave an ETF and take a gamble basically.

1:00:48And think it was safer. In fact, it's probably more risky. On the other hand, and again, this is speaking of the perspective of, hey, this is pretty cool. You can't really get that kind of leverage in many cases as an individual investor. That's fair. And now you can go and get it. You probably shouldn't, but the fact that you can is kind of neat. Many of these are theoretically interesting. And from a detached intellectual perspective, you're right. It's cool engineering, but that doesn't mean I would buy them or recommend them in almost any circumstance. These products started to hit the market.

1:01:23And when they started to hit the market, the SEC issued a warning to investors, which most individual investors probably didn't read, but they were worried about it. Picking individual stocks is plenty risky without 2X or 3X leverage on the positive or negative side. I think the last thing investors need is a tool that makes betting on or against individual stocks easier to do while charging a premium for the privilege. We don't need more of that. Even though I said it's cool that we have it and it is, but we didn't need that. Just like we don't need all of the gambling sites that exist now. You can't even watch a basketball game, try and sit down and watch an NBA game and I'm inundated with gambling ads.

1:02:06What is happening? It's really become very difficult to watch any sporting event without being inundated with that. And I worry about it a little bit. Once you start gamifying these sorts of things, it just becomes normalized. The reason to watch sports is so you can bet on it. And I think that there's some knock-on effects with investing. There's always been an element of that. I just think these kinds of speculative products, the more normal they become, the more it sends a message to investors that investing equals speculation. That has always been part of investing and part of the appeal that people seem to have.

1:02:46They think of the stock market as a casino. But I think this just compounds the problem. It's condoning, supporting that behavior. And it's easy. That's the thing is you could have gone and shorted or gone leverage long and individual stock before these products existed, but now it's a lot easier. and you can do it on your Robinhood account or whatever. Well, yeah, I was going to say you needed to know how to do it. Or Ben, to your earlier point about borrowing the money, you could have gone to the bank, borrowed 200 grand and bought a stock in theory, but probably no one would have done that because there would have been obstacles.

1:03:22They probably wouldn't have got approved. They probably wouldn't have ever tried to do such a thing. Now you can do it on your phone. it just normalizes what used to seem like extreme behavior. One other point on this is that in general, complexity in investment products has not been a good thing. There's a 2021 paper that looks at the allowance and use of derivatives, leverage, and illiquid assets by mutual funds and finds that those complex instruments are associated with poor performance and higher risk. That paper is by some Canadian professors published in the Critical Finance Review. We did have Paul Caluzzo, one of the co-authors on this podcast, talk about that paper a while ago.

1:04:06Simple low-cost products are likely the best tools for most investors most of the time. As John Bogle, the late founder of Vanguard said, you get what you don't pay for. I mentioned earlier, I've got a quote from Bogle. Here it is. He called what we're seeing in the ETF market today back in 2015. He wrote this piece for the Financial Times about ETFs and about his skepticism of the structure. He says, I freely concede that the ETF is the greatest marketing innovation of the 21st century, but is the ETF a great innovation that serves investors? I strongly doubt it. In my experience, almost 64 years in the fund industry, I've learned to be aware of investment products, especially when they are new and even more when they are hot.

1:04:48So Bogle has gotten some criticism for his skepticism about ETFs because ETFs have been in many ways very, very good for investors. In this article, Bogle actually says that index ETFs, as long as they're not used for speculation, are perfectly good vehicles. He was more concerned about how the ETF wrapper was being used to create, at the time he was writing, there were, I think 1 ,700 ETFs. And he was like, that's way too many. But he was talking about sector ETFs, things like that, that could be used for speculation. And obviously, based on what we've talked about in this episode, it's gone much, much further than that, where tools that are very explicitly and really only useful for speculation have now been shoved into the ETF wrapper, which is great for the ETF issuer because they can charge higher fees for that product and the fees are much higher.

1:05:43But for the end investor and to Bogle's point, I don't know if it's a net good thing, the way that the structure is being used now. So I would say that Bogle was right back in 2015 and we have now entered the age of ETF slop. Bogle was right about a lot of things. He had so much wisdom and I think you could take what he's saying here to an extreme. As an advisor who almost exclusively uses ETFs for his clients, obviously, I don't agree that they're problematic in that way, but you understand what he's saying. And in 2015, if that was true, it is so much more true today. The temptation to go down the wrong road with ETFs is just so present right now.

1:06:29Now, I think it's fair to say the vast majority of people who have ETFs in their portfolio are probably not using them in the way that you or I would say is the right way to use them, which is just as a way to get long-term exposure to an asset class at the lowest possible cost. to link this back to the comment we made earlier that advisors themselves are not immune to this especially if you're an independent advisor in a smaller shop who's running their business there's a lot of demands on advisors they're planning they're fulfilling compliance requirements they're doing client service they're dealing with all the things that are involved with running a business so they only have a finite amount of time to dedicate to researching products themselves like they have an obligation requirement to do that but they tend to rely on other experts to help them with their research and often the people that they're relying on to do their research are the people in their company in their research department which tends to be also the product manufacturers so they're relying on the product manufacturers to feed them the information to help them make decisions for clients which is not always in the best interest of clients and the best interest of the company and the marketing tools, marketing engine that exists.

1:07:50One analogy that I think is worthwhile to kind of think of, when you're buying a car, you kind of do some of your own research, do enough to understand what you're looking for, maybe focus on some of the key features that are important to you, like horsepower or cargo space or color or some of the key features that matter. And then you go on a test drive, but then you're relying on the expert, the sales guy to share the key features. And then obviously they're trying to make a sale. So they give you the positive features. But if an advisor is part of a larger independent firm that has a dedicated, unbiased research team, they can go into depth and provide research.

1:08:33So comparing that back to the car analogy, like if you had a dedicated mechanic to help you make that decision and go through and say like, okay, what are the actual implications of car? Like, what's the expected life on these types of vehicles? Is there any things that we should be aware of over the long term rather than just the things that you care about as an investor? When you're an advisor working with an independent firm that has a research team, you have access to unbiased advice that you may not have on your own in a small shop or even a bigger firm that's led or owned by a bank or one of the larger institutions that are manufacturing the products themselves.

1:09:11It's like you wouldn't go to a butcher to get dietary advice unless you're really sure that meat is the best thing for you, in which case you should only get advice from the butcher. That's it. Any other comments for you guys on ETF slop? No. Ready to go to the after show?

1:09:32Not much in there. We got one review, nothing else. The RashleMinder community has been popping. It's pretty neat over there. Lots of folks having lots of good discussions. We have a really good moderation team. I don't have much to say about it other than the RashleMinder community continues to be a pretty neat place on the internet. We do have one review from Apple Podcasts. Under SEC regulations, we are required to disclose whether a review which may be interpreted as a testimonial was left by a client, whether any direct or indirect compensation was paid for the review or whether there are any other conflicts of interest related to the review.

1:10:04As reviews are generally anonymous, including this one to an extreme extent, we are unable to identify if the reviewer is a client or disclose any such conflicts of interest. Now this name, I'm pretty sure is just a keyboard mashing. A few J's in there, an H and I, a W, B, U, C. there's no rhyme or reason to those letters the way they're assembled. But they did say that this podcast is fantastic. And they said, I haven't found anything like this out there for anyone with an intermediate level of investing knowledge. This is a great podcast. Thank you very much to the anonymous reviewer that we did not pay.

1:10:40I am told with some confidence that we will in this episode have the funny disclaimer that Dan wrote. There was quite an uproar in the Rational Reminder community over the holidays because we said that we would be playing the new funny disclaimer. I thought that we would have it recorded and that it would go into one of those episodes. And some people who really, really don't like the disclaimer actually listened to the disclaimer because they were expecting it to be Dan's comical version. And when they were met with the normal disclaimer that they had already sworn off of listening to, they were quite frustrated.

1:11:23I'm pretty sure that at the end of this episode, Dan's comical disclaimer will be played. I have to be honest and say when I didn't hear it myself, I thought, oh, maybe they decided they weren't going to go through with this. It got squashed, but apparently not. It's going. My understanding is that it will be coming out at the end of this episode. There was one edit that Ross, people who listened to our year-end episode, or that How the Podcast is Made episode will know who Ross is. There's one edit from him, but overall, Dan, your disclaimer lived on pretty much as you wrote it. We should all get to hear it at the end of this episode.

1:12:02Well, I think we're obligated to do it now, aren't we, Ben, after that preamble? No, you're right. We'd have some very angry listeners. Get the pitchforks out. Well, enjoy. All right. Anything else? I just want to mention that I'm planning to be in Vancouver, BC, the second week of February, February 9th. For any advisors that are interested in meeting up and just chatting, sharing notes, always happy to talk, reach out by email, LinkedIn, happy to talk. Every advisor listening should take Ben Wilson up on that offer if they're in Vancouver. I've had lunch with Ben before. It's an experience. All right.

1:12:37Thanks, everybody, for listening. Thanks, guys.

1:12:44Hey, everyone. It's producer Matt. Thank you so much for tuning in to this week's episode. Before we sign off, here's the disclaimer you've been waiting for. Portfolio management and brokerage services in Canada are offered exclusively by PWL Capital, which is regulated by the Canadian Investment Regulatory Organization and is a member of the Canadian Investor Protection Fund. Investment advisory services in the United States of America are offered exclusively by One Digital Investment Advisors, LLC. One Digital and PWL Capital are affiliated entities, and they mostly get on really well with each other.

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