This transcript has been automatically generated.

Kathryn Toope: Welcome to Barenaked Money, the podcast where we strip down the complex complex world world of of finance to its its bare essentials essentials with your hosts, Josh Josh Shelik and Colin White, portfolio portfolio managers managers with Barenaked Capital Management Inc.

Josh Sheluk: There is a fairly common belief but the distinction remains important. ETFs and mutual funds are just structures. They’re just vehicles. What matters more than the structure or the vehicle is what you put inside it, what it owns, why it owns it, what it costs, and what the intention is for that vehicle within your overall portfolio.

Colin White: Welcome to the next episode of Barenaked Money with only a shower curtain between us. Josh and Colin here, and Josh is let me lead this one off because this is this is Josh’s podcast. Josh has got more bullet points for this podcast than maybe the last 10 podcasts combined. So he wants to cover a lot of ground today, Josh. So why don’t you set the stage for our listeners and explain to them why you’re so passionately excited and use different shapes for your your your the indentations are all different shapes, and I’m not sure what that means on your list.

So maybe you could share that with the listeners.

Josh Sheluk: Well, today we are going to explain why mutual funds are the worst thing that has ever existed and ETFs are the greatest thing that’s ever existed.

Colin White: Well, is great because I’ve been waiting for someone to explain this to me in a way that made sense. So if today’s the day it’s going to be explained to me, this is great, Josh.

Josh Sheluk: Well, I’m sorry to disappoint right off the bat, Colin, because that’s not exactly what we’re going to do today. The reason I position it like that is because it seems like that’s the common belief amongst maybe some media runners or people that have a cursory understanding of this stuff. And what we’re going to do is debunk or refute some of the common misconceptions and some of the common portrayals of this whole mutual fund versus ETF. ETF stands for exchange traded fund, just for the record. This whole mutual fund ETF conversation.

So hopefully, we’re gonna rip down this curtain that’s between us and shed some light on it for everybody.

Colin White: Yeah. We better be careful with that metaphor, Josh. It’s just gonna it’s getting out of hand in a hurry. But listen, I’ll I’ll I can tell you what the difference is between an ETF and a mutual fund right now. Why one is better than the other?

All got to do with the marketing budget, baby. The amount of money that’s spent telling us that ETFs are better is way more than the amount of money that’s spent telling us mutual funds are better.

Josh Sheluk: Well, the mutual funds had the run of it for a good couple decades there telling us about why they were so great. So now they’re just the, the conversation, the narrative has shifted a little bit. So New

Colin White: kid on the block. New kid on the block.

Josh Sheluk: You got it.

Colin White: Alright. So, Josh, I’m gonna challenge you. I want you to define a mutual fund in, five words or less.

Josh Sheluk: That’s, not a lot of words. Five words or less. Okay.

Colin White: Just just as simple as you can make it. What’s a mutual fund?

Josh Sheluk: It’s a collection of investments.

Colin White: There you go. What’s an investment?

Josh Sheluk: Something that you put money into that is hopefully gonna grow over time.

Colin White: Well, that’s that’s good. All right. So a mutual fund is a collection of things you think you hope it could grow over time. Yep. So what what’s the exchange traded fund?

Josh Sheluk: A collection of investments

Colin White: that you hope is going to grow over time. Correct.

Josh Sheluk: Correct. Yeah. So this is the crux of our argument. These are just vehicles and the vehicles are structured in slightly different ways. But in both of these vehicles, you can have very similar or exactly the same types of investments.

Exactly the same investment strategies, exactly the same philosophies, exactly the same stocks, bonds, whatever else, cash you want to put into them. So this idea that one is inherently better than the other is just false. Categorically false.

Colin White: Categorically false. That’s rather certain.

Josh Sheluk: Well, they, they both have pros and cons. So let’s, let’s not say that they’re absolutely identical in every way, shape and form. They both have pros and cons. But to say that again, to say that one is inherently better than the other is again false. So just to take a step back, some of the common misconceptions I think arise from the ways that the two vehicles are commonly used.

And this is mostly a legacy thing, in my opinion. Mutual Funds have decades and decades, maybe a century now, of track record as being a vehicle in which you pay a manager, you pay a portfolio manager of that mutual fund to make decisions to buy and sell stocks or bonds or whatever other investments that are in there to hopefully outperform or grow more than the market. We call that active management. So mutual funds have historically been associated with active management. They don’t need to be actively managed.

They can be passively managed. They can be managed in any way, shape or form that you want. But historically, they’ve been actively managed, which comes with the cost associated with that mutual fund or that active manager. Whereas ETFs now this is becoming the lines are becoming a bit blurred on the ETF side because as they proliferate, they’re going to more and more different directions. But they sort of started as what we would call a passive management vehicle.

So all that they were doing is trying to match an index or benchmark specifically. So you don’t have a portfolio manager making active buy and sell decisions, trying to outperform the market as we call it. They’re just simply trying to match the market, which is a lot simpler philosophically and typically comes with lower costs. So pull ETFs being better than mutual funds thing has arisen from, in my opinion, two things, active versus passive with mutual funds traditionally being actively managed and ETFs being traditionally passively managed. And with the discourse out there that’s against active management, people have opted more towards this narrative that ETFs are amazing.

And secondly, I’ll just finish here. The idea of high cost versus low cost. Actively managed products, whether they’re mutual funds or ETFs or anything tend to cost more than passively managed products. So this whole idea of, well, I can save costs if I go to an ETF because it’s passively managed and then you kind of snowballed the argument from there.

Colin White: Well, And I think that it’s some of it, I think you hit it on the head with legacy, but just taking it back a little bit further, when mutual funds first came to the market, there was no internet. So people walked around with briefcases full of paper. Things were pretty opaque. You could get away with a lot and the costs were very, very high. Now there’s some legendary money managers from back in the day who did put together very good returns for investors, which really helped the industry for sure.

But there was also a lot of greed and there was a lot of opacity. Like it was difficult to see what was going on. So when the ETF people showed up and again, I think initially it was, it was actually a very pure competition. Like they were saying, we’re going to give you cheap access to dead simple investing. You know what?

There’s a place in the world for cheap access to dead simple investing. But what’s happened is that the ETFs, of a sudden, it was like, Hey, they got popular. And the ETF, like there’s ETF mutual funds now. So I was like, So, you know, what happens if something gets popular, then supply increases. And when supply increases, you have to have a differentiator.

So it’s ended up with, we have ETF versions of mutual funds. So they’ve actually kind of morphed together in a lot of ways. So it’s no longer the homogeneous batch of ETFs are all one thing or mutual funds are all the other thing. They they’re kind of eating each other’s lunch a little bit. And that’s where it gets a little bit tougher to have this conversation and say, one is better than the other.

I think as with many things in the financial world, these are solid products that have a place. And depending on your objectives and depending on what you’re trying to accomplish, either one can work. I mean, we internally flip back and forth between using an ETF or fund in any given circumstance based on what we’re trying to accomplish at a portfolio level. Because again, the conversation about cost is actually, for me, it’s a red herring. It’s what was, what’s the net return to the client.

So that’s, that’s what you should be focused on. And if your net return to the client’s not good, then we’ll, yeah, you’re going to talk about costs. It’s funny to watch quest rate pivot away from retire 30% more when the year later, the competitors are poking fun at them. It’s like, well, you know, you’re not 30% better off if your performance is worse. So even Questrade has kind of gone full circle and they had all kinds of success with, with attracting people with, Hey, we’re this much cheaper and this much cheaper over thirty years means that you’re like a billion percent better off.

That’s it’s a misnomer. It’s just not accurate. Just because it’s cheaper doesn’t make us better. If it’s better, it’s better. Better is, does it give a better risk adjusted return for the client?

Josh Sheluk: Yeah. After considering costs, after considering costs. Yes. Yeah. So, so, and all of these things are exactly my point.

You can have an ETF that is actively managed that is high cost. You can have a mutual fund that is passively managed that’s low cost. So these things are just wrappers and you can put anything in these two different wrappers. The fact that they’ve gravitated towards one thing or the other over time is somewhat true, but now mostly a media narrative. And so now this whole push, I think for mutual funds first knee jerk, bad ETFs, good is just wrong.

So that’s where we need to start, start moving away from that. You use the example of you have mutual funds of ETFs and ETFs of mutual funds now. So funny example of where this whole narrative can be so powerful. One of the active managers that we use historically has been mutual fund based. This is going back decades now.

And one of their sales guys, I was talking to him. This must be six or seven years ago now. He understand why people want an ETF version of what we do because it’s going to be exactly the same product. We’re going to make exactly the same investments in that ETF versus that mutual fund. So just buy the mutual fund.

But they launched an ETF that invested in the mutual fund. So truly identical performance you’re going to get from these two things. But the ETF sold like hotcakes when it first launched. That’s because this narrative clients are driving this narrative where I don’t want to buy mutual funds. I’d much rather have an ETF.

And so it’s something sometimes it’s easier to go along with the narrative than to push back against it like we’re doing here.

Colin White: We can go conspiracy theory here for a minute. It’s not really conspiracy theory because this is part of what how ETFs work. One of the reasons the industry is so happy about ETFs is some of the ways that they, they profit from them. Cause there’s all the, disclosed fees and there’s proper disclosures done and everything. And there’s trading expense ratios over MERs.

There’s other things that get disclosed, but the market makers on an ETF, they have a bid ask spread And that bid ask spread isn’t really totaled up anywhere. And they just take a little few shillings every time something goes across the desk, they take a little bit of it. It’s not disclosed as a fee. It’s just a bid ask spread. And depending on how lit the market is that they’re trading on or whether or not they’re trading on an internal market, they can make some good coin.

And I gotta, I go back to, and forgive the listeners I’m repeating stories too. I went back when ETFs first came out. I went to an ETF university, Josh. It was held at a university for two days explaining this wondrous new product they were bringing out to us. And they had a market maker in the room.

Again, the ETFs trade on the market. So they trade in real time and the underlyings may or may not be as liquid. There’s a whole bunch that goes into making markets on these things. And I said, well, that’s fantastic. You gave a great explanation.

What do you charge to make the market? He goes, oh, we don’t charge. You don’t charge to make the market. No. Okay.

Did you make money last year? Yeah. Okay. How did you make money last year? And then he kind of grinned leaned back his chair.

He goes, oh, that’s bid ask. Oh, see. The smile on your face when you when you when I made you say that out loud. I I get it now. So you could say, and the industry has created demand for these things.

And, again, I don’t wanna I’m not painting this all with a dark brush. There is a place for ETFs. They do some stuff really, really well. We use them all the time, but they’re not lily white perfect, the the answer to every question.

Josh Sheluk: Yep. So the bid ask actually is reported now on ETFs in Canada. If you go to the ETF fact sheet, you can see what the bid ask is. So you can see the this is kind of for for investors in these things. It’s kind of like your execution cost to get interrupted, but this is important because it is one distinction between ETFs and mutual funds.

I think an important one. The main difference between the two is that an ETF trades on an exchange all day every day at whatever market price the market is is determining. And a mutual fund trades not on an exchange at end of day at what’s called the net asset value or NAV. So there’s a whole bunch of stuff that goes into all of this, and we’re not going to get into it all on this podcast, but if, so I’m going to use an example of, I have a wallet, there’s $520 bills in this wallet. So the net asset value or the value of this wallet is a $100.

If I bought a mutual fund or sold the mutual fund, at the end of the day, I’m always going to get my $100 in or my $100 out. It’s always going to cost me a $100 or give me a $100 when I buy or sell. The ETF, it trades all day at whatever the market price is. Typically that market price is going to be very close to that $100 NAV because I have $520 bills in there. But sometimes it might be a penny higher or penny lower depending throughout the day.

That again, that’s not inherently a bad thing. It’s just something to be aware of. There’s some nuances there that at times it can be more effective to use the mutual fund or at times it can be more effective to use the ETF.

Colin White: The other thing about ETFs is the complexity that’s not obvious to the end investor, right? Because if you’re trading an ETF that is based on the Asian markets and you know, you’re buying a selling in Canada during the day, there may or may not be liquidity of the underlying. So it’s a little less efficient. I was like buying a gold ETF late in the day after the commodity exchange has shut down. Like there’s there’s inefficiencies in trading ETFs that you have to kind of be aware of.

And there’s also, I don’t know, Josh, did you catch on your radar when it went by when they had the double bear and double bull ETFs out there? Yeah. Had these product. They had these products out there that they could go double bear or double bull. So if you thought things were going up, you could bet things were gonna go up and get paid double.

It says that right in the name or things are gonna go down. Yeah. You could profit off that too and get paid double. So you just had to pick a side. It was just so people invested in both these things and then we’re just gobsmacked that they were both down like 40 to 60% in one year at the same time.

Yeah. And the investors are going, how can they both go down? Well, you have to understand how the underlying works and options contracts and things of that nature. So some of the stuff gets launched with, like, really sexy, catchy titles, but you really gotta be careful. It’s in my opinion, unless you’re buying a very basic ETF, you should only do so with, with some guidance from somebody who can point these things out.

Josh Sheluk: Yeah. Okay. But this is a good example because you could do that exact same thing in a mutual fund. Yep. It doesn’t need to be an ETF.

So that that’s an issue with the strategy. That’s not an issue with the ETF wrapper itself.

Colin White: Yeah. Oh, no true. But I think those particular ones are getting closer to, oh, foreshadowing, getting closer to hedge fund strategies and mutual fund strategies, Right. Course. Because again, mutual funds are designed to be safe and they have checks and balances in the future.

Hold on,

Josh Sheluk: hold on. Funds are designed to be safe?

Colin White: I didn’t say they were. I said they were designed to be compared to What these do

Josh Sheluk: you mean by that? How are they designed to be safe? Again, I’m making the argument that you can put whatever you want in a mutual fund just like you can in ETF. So why are they safer than

Colin White: There’s limits on leveraging, there’s limits on short selling, there’s limits. You have The to be

Josh Sheluk: same limits exist on ETFs. They follow the same prospectus rules. So again, there’s, there’s not that much of a distinction.

Colin White: Well, okay. Well, okay. Now, let’s just, I’m about to be educated. So Josh, you’re telling me that we could have a double bear and a double bull mutual fund that replicated that ETF strategy and it would be on-site of eighty one thousand one hundred two.

Josh Sheluk: Sure. Yep.

Colin White: Wow. Alright. Audience, I want you to mark this down. Josh just taught me something because I had always held the belief that was way too sophisticated. It would have to be in an OM or a hedge fund product.

So, Josh sincerely. You. I want to double check this after we get off the podcast.

Josh Sheluk: Please do. They follow the same rules. Eighty one one hundred two rules, which we’re talking Greek to everybody on the podcast now. Got ETFs and Mutual Funds. So yes, they they can follow the same rules.

Now, lot of these double bear and double bull products are designed to be traded intraday. And you can’t do that in the mutual fund. So this is one example of when the vehicle maybe makes a difference for the execution of the strategy. But in theory, the strategies can exist the same.

Colin White: There you go. What’s the difference with the hedge fund? So what’s the difference to the hedge fund, Josh?

Josh Sheluk: Yeah. So a hedge fund again, this is sort of a vague term. A hedge fund is, I would refer to it as a loosely regulated, either a mutual fund or an ETF, and one where the investment strategy is typically a bit more unconventional. So you might have short selling of investments, which is sort of a bet that it’s gonna go down, if you wanna call it that. You could have something like an arbitrage strategy, which we’ll get into on another podcast.

You could have something that invests in futures contracts or options contracts, like a global macro type approach. So the investment approach typically a little bit more outside of the box. And the goal is, again, you’re typically getting a little bit looser regulation because you’re following under a different set of guidelines or rules. That’s a little bit brushing the same sort of stroke on everything. It’s not exactly like that for every what we would call a hedge fund out there, but in a nutshell, that’s the key difference.

Colin White: Yeah, think there’s a lot more trust and a lot less disclosure when it comes to the hedge funds on a regular basis.

Josh Sheluk: When you say more trust, the person that’s investing needs to provide more trust because they have a little bit less transparency. Right?

Colin White: Yeah. Yeah. So you have to trust the manager. Like, you’re taking a look at the management team and saying, like what they’re saying. I like the story or I like what they’ve done, and I’m gonna close my eyes and here’s my money.

And, hopefully, it’s it’s it’s something good at the end, but but they tend to be way, way more aggressive. I mean, for those who wanna see how a real hedge fund operates, just watch billions. I mean, that that that that’s that’s pretty much exactly how it operates.

Josh Sheluk: Is that a real hedge fund call on your

Colin White: show business, Josh is show business.

Josh Sheluk: So that’s probably not what a real hedge fund operates. Like if I just for the record, of them might, but again, a lot of them aren’t aren’t really that different from a traditional mutual fund or ETF necessarily. Again, the hedge fund is not an inherently good or bad thing. There is, as Colin said, maybe some less transparency around what they’re doing. And because the investment strategies can be a bit more unconventional, you either need to have a really good understanding of what the manager’s doing.

Or again, you’re providing a certain level of trust to the manager there. So there can be a greater disparity in the results from a hedge fund than you would get from a more conventional mutual fund or ETF. And another thing that tends to be associated with hedge funds, which again is is why I think there’s a negative perception on the moat there, is they tend to be higher cost.

Colin White: Yep. Well, the two two and twenty is kind of the thing. Know, 2% fee plus a 20 management fee or performance Yeah. So I mean, they do tend to be more expensive. They are shooting for the stars.

If somebody talks to you about mutual funds, it’d be very hard pressed for me to look at a mutual fund and say the downside of this mutual fund is zero. In the hedge fund world, you can look at something and say, you know what? The downside here could be zero. Like it’s, includes, Yeah, exactly. It includes that end of the spectrum.

I’m not saying all of them, but you can get that far with them for sure. One of the other pretty consistent characteristics of a hedge fund is liquidity. One of the reasons to get into alternative strategies is that there’s some truth to this. By giving up liquidity on your investment, like daily or weekly or monthly liquidity, you can participate in different kinds of investments and it can be a diversifier if it’s properly used. That’s something that was less common in the mutual fund world.

So the hedge fund world does contain that aspect of things as well. So again, it’s like everything else. It has maybe a bad reputation or some people’s got too good of a reputation.

Josh Sheluk: Coming back to one of the things we’ve we’ve touched on a couple times is the high cost versus low cost thing. And to your point, value matters more than cost in a vacuum. And I’m reminded of a TED talk that I saw with Jim Simons, who’s maybe one of the most I don’t know if we can call him famous, but respected, maybe. Hedge fund managers out there, certainly his company has one of the best track records that we think are out there for any investment manager ever. Their TED Talk was them asking him about the cost of his funds.

I’m going to paraphrase a little bit. So sorry to Jim Simons if I’ve misquoted him, but one of his clients came to him and said, your costs are too high. And he said, why is that? He said, well, typical in the industry is this, or I don’t want to pay two and twenty or whatever it is. And he said, well, I’m going to surprise you because we’re going to increase our costs.

Do you want to sell your investment? And they said, no, we actually want to buy more even at the higher cost. So because the investment results were so astronomical. Now I’m not saying you should pay any price if you think the investment results are going to be good because there’s a limit to everything, but value matters more than cost in a vacuum. Sometimes paying as low cost as possible is the right thing to do.

And sometimes not always and more often, and it’s not the case, but sometimes paying a little bit more can get you better value with better investment results.

Colin White: Part of it is is the human condition. Like trying to project or believe in future returns on something is gray and difficult. It’s it’s not easy to say that this is a better investment going forward because it’s just harder to do that. Much easier to walk in the room and say I’m cheaper. That’s definitive.

I can see that cheaper is always better. Well, all the other stuff’s kinda messy, and I can’t really make sense of it. So I’m gonna I’m just gonna stick with cheaper and I’ll be better off. And it’s that’s just way more comfortable. Like, if I I just spent ten hours in my workday and I come home at the end of the day and I’ve gotta make my RSP contribution and I’ve got, like, ninety seconds to pay attention to this.

Yeah. I mean, that that’s a nice simple way that you can feel comfortable that you think you’ve made a good decision. It’s way messier. And I think we’re evidence of that, Josh, is how much time we spend trying to to sift through all of the data to find where we feel the value really is. Finding value is not a simple or easy thing, and it’s it takes a lot of effort and a lot of a lot of experience, but it is there.

That doesn’t mean it doesn’t exist. It doesn’t mean it’s not worth it, but it it is tougher for people to see, therefore, not as successful in the marketing side. So

Josh Sheluk: Speaking of value, we have created and launched our own mutual funds. Why have we done this call? What is the value in doing such a thing?

Colin White: As you told me it was a good idea.

Josh Sheluk: Do you do everything that I tell you?

Colin White: Sure point. Sure point. I always go back from an evolutionary standpoint, from original mutual funds with front end loads and deferred sales charges to just straight being paid trailer fees to getting to fee accounts and all these things. These have all been progress ions that we’ve gone through over the last number of years to get better and better for our investors. So we got to a point where, you know, the strategies we were employing, we were holding multiple positions in everybody’s account.

And that was great. That was, was far better than what came before it. But we got to a point where we could actually roll this into a single investment and simplify things, simplify things from a tax reporting perspective to clients to get away from the avalanche of tax slips that come out at the end of the year to get some more efficiencies on the investment side so that we could reduce the costs of some kinds of investments and also have all of our investment ideas actually in every client account, regardless of size, because now there was, there was no barrier to doing that. But Josh, I want you to comment on one specific aspect that’s right in your wheelhouse. What, what has this done to our ability to execute on different investment ideas?

Does that, has this changed the water on the beans with, with how we’re actually able to execute things?

Josh Sheluk: Not massively so. At, at the edges, maybe a little bit. When you’re trying to put in just to make up some numbers here, one investment across a thousand different investment accounts, it’s a little bit tedious to make that happen. So it can take some time to execute. It takes some time to get everything lined up so you’re ready to execute.

The actual execution’s usually the easier part. Lining everything up taking us a little bit more time. But the fact that we’ve launched a mutual fund or a pooled fund, as we would call it, which essentially all we’ve done is taken clients’ existing investments, put them in a nice tidy box and delivered it to them in this nice tidy box with a nice wrapper and a bow on it. It has made some things a little bit easier to deal with in that one box rather than in a thousand boxes for a thousand clients.

Colin White: Well, again, is put in place. We’re not charging an additional management fee on this, So it’s, it’s not an additional profit center for us because we’re doing the same work and picking the same group of investments. We’re just executing it in a more efficient, effective way for our clients. So we expect over time that this is actually going to be a less expensive way to do things for our clients. We have been able to execute better on some trades because we’re, we’re doing things more efficiently and effectively.

And it’s something that we want to keep working towards even doing better and better on. And we’re going to keep reporting on all the underlying, because again, we we keep control over what’s in there. We haven’t outsourced this to to somebody else to run. This is still our group doing the same kind of work that we’ve done in the past. So it was it was really put forward as a way to simplify and improve and reduce the costs to the clients.

And, this is kind of the next iteration. I think this is the next thing, and and I haven’t seen a whole lot of people doing this. So this is pretty exciting, and I’m pretty proud actually that we got to this point and are able to bring this bring this out into the world and watch as other people come down the same road with us and start doing some of the same stuff. Are you proud, Josh?

Josh Sheluk: Very proud. And for the record, we could have launched this through a mutual fund or an ETF.

Colin White: Oh, wait. Should we launch an ETF of our mutual fund? Josh

Josh Sheluk: is the same thing. Tomatoes. Yeah.

Colin White: Well, I learned something today. So, you know, the fact that I’ve learned something, I’m very proud of myself. So I’m going to take the rest of the day off and go, go and just reflect and double check what Josh has told me because there’s probably more in there for me to learn.

Josh Sheluk: Check everything. The first time I’ve ever taught you something in your life Collins pretty miraculous. Think

Colin White: and it’s gonna be recorded it here live for for people to hear on a podcast forever. Can you believe it? Wow. Thanks, Colin. Thanks, Josh.

Kathryn Toope: Have you ever wondered why your financial adviser is making a recommendation? In an industry where conflicts of interest are everywhere, it’s important to understand how they affect you. For more info, contact us at Verecan. You can find us at annoyingthecompetition.com. For more information on the subject of today’s podcast or any other financial topic, please visit us online at verecan.com.

That’s verecan.com. There’s plenty of information there, or you can reach out to someone on the team. Thanks for listening. Please note, the information provided in this podcast is for general information purposes only. It is not intended as financial investment, legal tax, accounting, or other professional advice.

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