Mid - February Update

Zero – Fee ETFs (or negative) are on the horizon says Wall Street Journal

Do zero fee exchange traded funds appear on the horizon in the US?  The Wall Street Journal thinks so, as reported on 2/7/18.  Between the low overhead costs possible through economies of scale and the additional income that fund managers can generate by lending securities to short term borrowers, the barrier can be broken in the next year or two.

Even a negative fee ETF, where the fund pays investors to invest, might be possible.  Lee Kranefuss, one of the founders of iShares, has been quoted as saying “There isn’t a Zero lower bound to expenses”.  A negative management fee is certainly conceivable.  Steady growth in ETF assets has resulted in a steady reduction of operating expenses, with numerous brokerage houses now offering annual fees of just 0.03% on US market index funds.  That’s $3 on $10,000 investment.  So, what could spark the final push past the zero-free barrier?

More assets, lower costs

One of the most salient features of the ETF and index mutual – fund industry is that as more money flows into a fund, the costs of operating the fund decrease.  Over the past 17 years, trends show that a $290 billion increase in inflows into index funds drives the expense ratio down by 0.01%.  This implies that one of the current low fee ETFs could drop its 0.03% expense ratio to zero with as little as an additional $870 billion in new flows.  If the current trend continues this could happen hypothetically within the year. (Conservative estimates assume it will take $1.5 million in more ETF assets – or approximately 2 1/2 years)

Share-loan Revenue

ETFs also can generate revenue by lending the shares they hold (or shares of the ETFs themselves) to borrowers who want to sell them short in a bet they will fall in price.  The funds can make money by charging lending fees, as well as on the collateral that borrowers have to pay for the shares they short.

All things considered it appears entirely plausible that a sustainable zero fee ETF will be offered within two years.  But whether it’s Vanguard, Schwab or BlackRock taking that first victory lap remains to be seen.  Stay tuned!

Sources: The Wall Street Journal

Mid - February Update

Mortgage Rates Starting To Rise 

Optimism about economic growth has led to higher inflationary expectations, which eventually translate into higher interest rates. Over the past few months, the yield on the 10-year U.S. Treasury has increased from a historical low of 1.35% in 2016 to 2.72% at the end of January. As a gauge for mortgage rates nationally, the increase in the 10-year Treasury has also led to an overall increase in mortgage rates. According to data made available by Freddie Mac, the average rate on a 30-year fixed mortgage loan increased to 4.15% at the end of January. The concern economists have is that as mortgage rates continue to increase, home sales and affordability may begin to falter.

Thirty-year mortgage rates have surged to the highest levels in nearly a year, increasing borrowing costs at a time when the housing market is strengthening and prices have been rising. The 4.15% rate at the end of January was the highest rate since March 2017 and above 4 percent for the first time since May 2017. The average 15-year mortgage rate climbed to 3.62 percent from 3.39 percent over the same period of time.

Even with the recent rise in mortgage rates, rates are still low on a historical basis. As of this past month, the average mortgage rate since 1971 has been 8.16%. Over the past 46 years, mortgage rates have transitioned from the 5% range in the early 70s to over 14% in the late 70s and early 80s, with the 30-year conforming rate hitting a record high of 16.63% in 1981.

Sources: Freddie Mac, Bloomberg, U.S. Treasury



Bitcoin & The Greater Fool Theory 

A Bitcoin exchange in South Korea went out of business in December after it was hacked by cyber thieves that stole roughly 20% of it’s clients holdings, validating that cyber currency exchanges are still extremely susceptible to losses. Unlike a bond, stock or real estate, a crytocurrency offers no intrinsic value, such as cash flow and earnings. Instead, the value is solely based on what the next buyer is willing to pay leading to speculation, also known as the greater fool theory.

The greater fool theory states that the price of an item is determined by unreasonable expectations and ideals about that item. As speculation inflates prices, sellers profit as there will always be a bigger fool willing to pay a higher price.

Many believe that the price of Bitcoin in the final weeks of 2017 exemplified behavior relative to the greater fool theory. Volatility in December alone was considered irrational and speculative in nature, as the cyber currency value skyrocketed over 40% in early December, then tumbled over 30% later in the month.

Sources: coindesk.com/price, cointelegraph.com