On the latest episode of The Long View, our guest was Jeff Ptak, managing director for Morningstar Research Services. We talked about why investors can benefit from simpler portfolios, less trading, and avoiding the temptation to chase performance. And how extrapolating trips them up.
Here are a few excerpts from our conversation with Jeff, the author of Morningstar’s Mind the Gap research.
Amy Arnott:You’ve written extensively about some of the vehicles that have SpaceX-related exposure and some of the challenges of packaging private assets into a vehicle that has daily liquidity. What are some of the key takeaways for investors from those examples?
Jeff Ptak:I would say it’s a careful what you wish for situation. As we have this conversation, I think SpaceX SPCX maybe traded up a little bit this morning, but as of the close yesterday, it was trading meaningfully below the IPO price. As a result, some of the products that took a stake in it pre-IPO were underwater on the position. That’s certainly not true of every one of those. I think for investors who are clamoring for exposure pre-IPO, that probably seems like a pretty foreign situation that they now find themselves in given the sheer amount of hype. And you’re right, there is a fundamental incompatibility, in my opinion, between the daily liquidity structure. This is an ETF, an open-end fund, though I think it’s more acute for ETFs, and something that doesn’t trade. I mean, ETFs are built for assets that one can readily value and transact in, and that is not how you would describe a pre-IPO name like SpaceX, or anything else for that matter.
Personally, at the risk of this sounding like a scold or a worrywart, it is a trend that concerns me just because I think you can basically have some real sort of complications that arise once you take a stake in one of these names in that type of wrapper.
Christine Benz:I think I know what you’re going to say, Jeff, but I’d like to hear your take on adding private-market exposure as an investment option for 401(k) plans, either separately or as part of a diversified target-date fund. It seems like private equity and credit are creeping closer to the retail channel. I’d like to get your take on that broad question and then 401(k) specifically.
Ptak:Were you going to predict I’d say I hate it? Because if so, you’re correct. I hate it. To me, it seems totally unnecessary. To be fair, target-data allocations have evolved over time. More has come into the fold. Retirement plan lineups have evolved. There are maybe more options that are available to investors. I could have taken that position 20 years ago and been like, “Oh, all you need is US stocks and investment-grade bonds, and you’re good to go, and we don’t need this other stuff.” But I think there’s a crucial difference here. We’re talking about liquid and illiquid, and you’re also talking about a retirement plan. This is a linchpin part of our system and ensuring that when people reach their retirement years, they’re able to enjoy them bountifully. I do worry about introducing something illiquid in the context of a retirement plan.
I think the least worst way to do it is through a target-date fund. It does not seem advisable at all for it to be a stand-alone option on a menu. That seems like a recipe for disaster. If they’re going to do it, one would hope that they do it tucked away within a target-date fund.
In general, it seems like a solution in search of a problem. I think by every indication I’ve seen, while there’s plenty of work to do on our retirement system, expanding access and the like, it seems like investors are faring pretty well. They’re doing well on target-date funds, they’re capturing their returns, we’re getting them auto-enrolled, they’re even auto-escalating. To me, that’s a picture of success that we can build on. It doesn’t seem like they’ve been deprived of anything, let alone private equity and credit. So, I’m not a fan.
Arnott:You’ve also written extensively about thematic portfolios and some of the risks involved in products like an AI-themed ETF. Why do you think investors are still so attracted to these types of thematic products, even though we have pretty strong evidence that investor results have been pretty poor?
Ptak:It’s a great question. It’s the power of stories, I think, to a degree. People love stories. I think they find them especially compelling when maybe they confirm some of their priors. It’s intoxicating when the story that maybe taps into their confirmation bias is being validated in the market at that time. There’s some theme, and it squares with your intuition. You’re like, “Oh yes, absolutely, this is going to be huge.”
Furthermore, you see a vehicle that purports to tap into that theme is doing really, really well at the time. I mean, that’s like ding, ding, ding. Those are three things that I think just really speak to a segment of investors. I think it explains sort of the enduring power of thematic strategies, drawing assets, notwithstanding the results, which, as I mentioned earlier, I found on a dollar-weighted basis have been really poor.
Benz:You’ve argued that investors should be cautious about products tied to the prediction markets. How do you distinguish between useful financial innovation and innovation that primarily serves speculative demand?
Ptak:Yeah, so I think it comes down to two things: time horizon and cash flows. The shorter the time horizon, like a single day, which is what leverage ETFs and the like are built for, the more dubious the proposition. I mean, that’s pure speculation because none of us know what’s going to happen in a given day. If there are no cash flows associated with a security, then I think that veers toward speculation too.
I have to say, I’d lump crypto in with that, just given the fact that I haven’t really seen somebody convincingly demonstrate its financial utility. It certainly seems to have a kind of utility for trading and speculation and perhaps illicit purposes, but I haven’t really seen somebody identify what it’s really good for, in advancing certain sort of economic objectives of various kinds, or just sort of commerce as it were transacting.
Yeah, crypto, I would lump in there too. I think most dubious of all are, and they’re just a proposal at this point, though I did write about them, are prediction-market ETFs, which would basically use what are called event contracts and allow people—I think the initial batch were tied to the outcomes of various elections, the presidential election, control of either house of Congress. And they’re binary; they’re zero-sum. They serve no economic purpose whatsoever. They’re really the antithesis, I think, of what people should be trying to do with their investments. Hopefully those never see the light of day.
Arnott:For people who are excited about innovations in a given sector like technology or healthcare, do you think there’s any merit in setting aside a small percentage of their portfolio, maybe 5% or so, as play money? Or does that just play into the type of behavioral issues that can lead to bad outcomes?
Ptak:No, I think that’s fine. I realize for most of this conversation I sound like the world’s biggest scold, but I think it’s fine to do that. It’s like you say, you want to make sure that it’s in the margins. One of the tricks here is just ensuring that it remains on the margins of your portfolio and it doesn’t come to overwhelm the other, what ought to be core parts. The other piece of it is I think that you would want to make sure that you establish your core portfolio first. Let’s get that working. Secondarily, if you want a “fun-money” portfolio on the side, then that’s fine. You’ve got your priorities in order at that point, and that ensures that you’re continuing to strike a healthy balance.
Valentina Djeljosevic contributed to this article.
The author or authors do not own shares in any securities mentioned in this article.
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