I Just Don’t Understand ETFs

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Northern Flicker
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Re: I Just Don’t Understand ETFs

Post by Northern Flicker »

livesoft wrote: Tue Nov 23, 2021 6:55 pm
Northern Flicker wrote: Tue Nov 23, 2021 6:51 pm My last tax loss harvest was a move from mutual fund A to mutual fund B. The exchange happened at market close. There was not even a millisecond of being uninvested while the markets were open. I cannot achieve that with ETFs without a cash position or the shady idea of overcommitting assets by depending on a settlement succeeding to fund a purchase, which I don't try to do.
And my last TLH with an ETF allowed me to wait until the ETF I used as a replacement had dropped about 1% further from an instantaneous exchange time, thus saving me some money.

We should all be able to find examples where a mutual fund is at a disadvantage/advantage and where an ETF is at a disadvantage/advantage.
True, if you want to do intraday market timing and speculation on price moves, ETFs enable that. I'm sure you are aware that it also could have turned the other way and cost you 1% instead.
My postings are my opinion, and never should be construed as a recommendation to buy, sell, or hold any particular investment.
Northern Flicker
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Re: I Just Don’t Understand ETFs

Post by Northern Flicker »

KyleAAA wrote: You don't need a cash position at most brokers. Just sell and immediately buy. Yeah, you might be out of the market for a few milliseconds but it's difficult to imagine a scenario where that would make any difference at all.
That is what I described as overcommitting of assets. You are depending on the sell order completing successfully or the buy will fail (or maybe only partially fail if you have some cash sitting in the settlement account).
My postings are my opinion, and never should be construed as a recommendation to buy, sell, or hold any particular investment.
Northern Flicker
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Re: I Just Don’t Understand ETFs

Post by Northern Flicker »

alex_686 wrote: Tue Nov 23, 2021 7:04 pm
Northern Flicker wrote: Tue Nov 23, 2021 6:53 pm I also will mention the following ETF risk that I am describing with a quote from a Vanguard Statement of Additional Information.
Mutual funds face the same identical risk, except even more so. ETFs have a broader range of options when dealing with this situation.
The quote is from pages 71 & 72 of the following SAI, which covers both some mutual funds and some ETFs. The risk is not mentioned for mutual funds covered by the document.

https://personal.vanguard.com/pub/Pdf/s ... 2210179000

I think the corresponding risk for a mutual fund is a run on the fund to redeem by a large number of individual investors. This leads to the following risk for mutual funds articulated on page 38 of the same document.
Each Fund can postpone payment of redemption proceeds for up to seven calendar days.
Last edited by Northern Flicker on Tue Nov 23, 2021 11:57 pm, edited 2 times in total.
My postings are my opinion, and never should be construed as a recommendation to buy, sell, or hold any particular investment.
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Re: I Just Don’t Understand ETFs

Post by BF3000 »

https://twitter.com/danielsotiroff/stat ... 54209?s=21

I would like to modify my previous post. Even if you are sticking to market cap weighting, you better choose wisely when it comes to mutual funds in taxable acct (eg vanguard). I just saw this post on Twitter.

I still believe that the ETF tax advantage is even bigger with “smart beta” type strategies.
Northern Flicker
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Re: I Just Don’t Understand ETFs

Post by Northern Flicker »

BF3000 wrote: Tue Nov 23, 2021 7:34 pm https://twitter.com/danielsotiroff/stat ... 54209?s=21

I would like to modify my previous post. Even if you are sticking to market cap weighting, you better choose wisely when it comes to mutual funds in taxable acct (eg vanguard). I just saw this post on Twitter.
That does not apply to most Vanguard index mutual funds because they and their ETF counterparts are share classes of the same fund.

And ETFs typically have to pay the transaction cost of heartbeat trades to avoid distributing capital gains.
My postings are my opinion, and never should be construed as a recommendation to buy, sell, or hold any particular investment.
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Re: I Just Don’t Understand ETFs

Post by KyleAAA »

Northern Flicker wrote: Tue Nov 23, 2021 7:18 pm
KyleAAA wrote: You don't need a cash position at most brokers. Just sell and immediately buy. Yeah, you might be out of the market for a few milliseconds but it's difficult to imagine a scenario where that would make any difference at all.
That is what I described as overcommitting of assets. You are depending on the sell order completing successfully or the buy will fail (or maybe only partially fail if you have some cash sitting in the settlement account).
Can you describe a situation where the sell order wouldn't complete successfully?
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Re: I Just Don’t Understand ETFs

Post by Northern Flicker »

There are various ways a failure to deliver event can happen. The frequency goes up significantly at times of acute market stress. There was a significant increase right after the Lehmann Bros. insolvency and bankruptcy. Say the market maker on the other side of your sale has some adverse event and a major liquidity squeeze. They may not be able to marshall the cash to complete the purchase of the shares you are selling.
My postings are my opinion, and never should be construed as a recommendation to buy, sell, or hold any particular investment.
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HanSolo
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Re: I Just Don’t Understand ETFs

Post by HanSolo »

KyleAAA wrote: Tue Nov 23, 2021 8:00 pm Can you describe a situation where the sell order wouldn't complete successfully?
Northern Flicker wrote: Tue Nov 23, 2021 11:56 pm There are various ways a failure to deliver event can happen. The frequency goes up significantly at times of acute market stress. There was a significant increase right after the Lehmann Bros. insolvency and bankruptcy. Say the market maker on the other side of your sale has some adverse event and a major liquidity squeeze. They may not be able to marshall the cash to complete the purchase of the shares you are selling.
Although I don't know the technical details, the fact that an ETF (or stock) trade doesn't settle the same day seems to mean that the broker isn't sure it will settle (for whatever reasons). The fact that a mutual fund exchange does settle the same day seems to mean that the mutual fund company is sure that there will be no settlement issue (because there's no outside counterparty, it's just you and that company).

Whenever there's an outside counterparty, you are counting on the counterparty making good on their end of the deal. Usually, it comes out OK, but you're not sure until you're sure.

So perhaps this is an advantage of mutual funds. You can be certain of settlement at the end of the same day.
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KyleAAA
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Re: I Just Don’t Understand ETFs

Post by KyleAAA »

Northern Flicker wrote: Tue Nov 23, 2021 11:56 pm There are various ways a failure to deliver event can happen. The frequency goes up significantly at times of acute market stress. There was a significant increase right after the Lehmann Bros. insolvency and bankruptcy. Say the market maker on the other side of your sale has some adverse event and a major liquidity squeeze. They may not be able to marshall the cash to complete the purchase of the shares you are selling.
That isn't a real concern.
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HanSolo
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Re: I Just Don’t Understand ETFs

Post by HanSolo »

KyleAAA wrote: Wed Nov 24, 2021 2:59 am
Northern Flicker wrote: Tue Nov 23, 2021 11:56 pm There are various ways a failure to deliver event can happen. The frequency goes up significantly at times of acute market stress. There was a significant increase right after the Lehmann Bros. insolvency and bankruptcy. Say the market maker on the other side of your sale has some adverse event and a major liquidity squeeze. They may not be able to marshall the cash to complete the purchase of the shares you are selling.
That isn't a real concern.
There are some sources that agree with you, as long as you insert words like "usually":

"Settlement risk is usually nearly nonexistent in securities markets."

https://www.investopedia.com/terms/s/settlementrisk.asp

Some people prefer to assume that things that don't usually happen will never happen. Some don't.

It's all good.
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Regal 56
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Re: I Just Don’t Understand ETFs

Post by Regal 56 »

Okay, I want to be clear about the question I asked yesterday. Say I bought a share of VTI in 2016. Flash forward to today. One of the stocks in VTI has dropped precipitously. The company still exists and still issues stock. VTI management, however, no longer regards this company as representative of the total US market. So in current and future offerings of VTI, this particular stock is omitted.

Does this mean the newly omitted stock is no longer part of the VTI share I bought in 2016?
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Re: I Just Don’t Understand ETFs

Post by drjd »

Regal 56 wrote: Wed Nov 24, 2021 6:33 am Okay, I want to be clear about the question I asked yesterday. Say I bought a share of VTI in 2016. Flash forward to today. One of the stocks in VTI has dropped precipitously. The company still exists and still issues stock. VTI management, however, no longer regards this company as representative of the total US market. So in current and future offerings of VTI, this particular stock is omitted.

Does this mean the newly omitted stock is no longer part of the VTI share I bought in 2016?
That is exactly what it means. You own what the fund owns at that time. Your share of VTI is like being an owner of a company, and you own whatever that "company" owns that day, not what it owned 5 years ago. Conversely, your share of VTI is worth the value of 1 share of the "company" today, not 5 years ago, so win win.
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Re: I Just Don’t Understand ETFs

Post by sycamore »

drjd wrote: Wed Nov 24, 2021 6:38 am
Regal 56 wrote: Wed Nov 24, 2021 6:33 am Okay, I want to be clear about the question I asked yesterday. Say I bought a share of VTI in 2016. Flash forward to today. One of the stocks in VTI has dropped precipitously. The company still exists and still issues stock. VTI management, however, no longer regards this company as representative of the total US market. So in current and future offerings of VTI, this particular stock is omitted.

Does this mean the newly omitted stock is no longer part of the VTI share I bought in 2016?
That is exactly what it means. You own what the fund owns at that time. Your share of VTI is like being an owner of a company, and you own whatever that "company" owns that day, not what it owned 5 years ago. Conversely, your share of VTI is worth the value of 1 share of the "company" today, not 5 years ago, so win win.
And note nothing special about the ETF in that regard. The above applies not just to VTI but also to the VTSAX mutual fund. That's because the "company" in question is the Vanguard Total Stock Market fund -- not a mutual fund, not an ETF, but a company. It aims to track the CRSP US Total Market Index by sampling the stocks in that index. The index changes over time (per the index's methodology) so the assets held by the company also change over time. There are times when it has to remove a stock from its assets or add a new stock to its assets.

The company offers multiple share classes: Investor/VTSMX, Admiral/VTSAX, ETF/VTI, etc. And so the VTI ETF shareholder owns the same underlying assets as the VTSAX mutual fund shareholder.
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Re: I Just Don’t Understand ETFs

Post by UpperNwGuy »

Regal 56 wrote: Wed Nov 24, 2021 6:33 am Okay, I want to be clear about the question I asked yesterday. Say I bought a share of VTI in 2016. Flash forward to today. One of the stocks in VTI has dropped precipitously. The company still exists and still issues stock. VTI management, however, no longer regards this company as representative of the total US market. So in current and future offerings of VTI, this particular stock is omitted.

Does this mean the newly omitted stock is no longer part of the VTI share I bought in 2016?
Correct. Your ETF share is a living, breathing, changing, evolving asset. It is not static. The content of your ETF share today is not the same as what it was in 2016. This is no different from mutual funds.

You still haven't told us where you got the mistaken idea that it was static.
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Regal 56
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Re: I Just Don’t Understand ETFs

Post by Regal 56 »

Thanks. One misconception down—many more to go.
UpperNwGuy wrote:You still haven't told us where you got the mistaken idea that [an ETF] was static.
Where did my mistaken idea originate? From right inside my pointy little head. My ignorance is home grown.

Bear in mind that I’m operating under the assumption that because ETFs are differentiated from mutual funds, they’re somehow fundamentally different. Further, since I’ve never bought an ETF, I’ve never studied them in detail. Ignorance is fertile ground for misconceptions.

Somehow I got the idea that buying an ETF is like buying a bag full of canned soup from a grocery store. Once you leave the grocery store and stack the soup cans in your home pantry, no one from the grocery store comes to your house and removes a can of chicken noodle to replace it with a can of French onion. My thought was that each individual ETF share was “one and done,” and this was one reason for the lower cost of ETFs.

You may ask: “Hey Regal, if you thought each ETF share was ‘one and done,’ then why do ETFs have an ongoing expense ratio?” Well, that was going to be my next question. Fortunately, that question is now gone with the wind. (In my defense, let’s not overlook the financial industry’s willingness to charge fees for doing nothing.)

Further demonstrations of my vast ignorance will arrive anon. But the balance of today will be devoted to slapping my forehead and chanting: “Stupid! Stupid!”
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Re: I Just Don’t Understand ETFs

Post by alex_686 »

Northern Flicker wrote: Tue Nov 23, 2021 7:40 pm And ETFs typically have to pay the transaction cost of heartbeat trades to avoid distributing capital gains.
What do you mean "pay"? How is this different than what a mutual fund does?

When you have to reconstitute the fund due to cash flows, dividends, changes in the index you need to trade. For mutual funds the fund has to execute these trades and thus bear the cost - both the explicate and implicit. For ETFs it is the Authorized Participants (APs) that pay the costs, both implicit and explicate.

That the ETFs can avoid paying capital gains is a side effect of the heartbeat trades. The primary purpose of the trades is the standard reconstitution of the fund.
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Re: I Just Don’t Understand ETFs

Post by BrooklynInvest »

Personally I think a great deal of noise is made over what are very small structural and accounting differences. For me whatever broad index has the lowest fee is what I went with when I set up my asset allocation and implemented across taxable and tax-aware accounts.

My average holding period for my passive funds (95% of holdings) is measured in decades... plural. I care not one whit about intra-day trading and microscopic - and often theoretical - differences in tax efficiency. Frequent traders or more opportunistic investors may have different experiences and opinions for good reason.
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Re: I Just Don’t Understand ETFs

Post by alex_686 »

Regal 56 wrote: Wed Nov 24, 2021 8:28 am Further demonstrations of my vast ignorance will arrive anon. But the balance of today will be devoted to slapping my forehead and chanting: “Stupid! Stupid!”
While it may have been a stupid idea, it is a common one, one that I have been asked about for both ETFs and mutual funds. It is one of those items that you don't know what you don't know. You have to ask questions.
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Re: I Just Don’t Understand ETFs

Post by AlohaJoe »

Regal 56 wrote: Wed Nov 24, 2021 6:33 am VTI management, however, no longer regards this company as representative of the total US market.
VTI management doesn't make those decisions. The index provider does. VTI just follows whatever the index says. In the case of VTI that means they do whatever CRSP (The Center for Research in Security Prices) decides.
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Re: I Just Don’t Understand ETFs

Post by KyleAAA »

HanSolo wrote: Wed Nov 24, 2021 5:11 am
KyleAAA wrote: Wed Nov 24, 2021 2:59 am
Northern Flicker wrote: Tue Nov 23, 2021 11:56 pm There are various ways a failure to deliver event can happen. The frequency goes up significantly at times of acute market stress. There was a significant increase right after the Lehmann Bros. insolvency and bankruptcy. Say the market maker on the other side of your sale has some adverse event and a major liquidity squeeze. They may not be able to marshall the cash to complete the purchase of the shares you are selling.
That isn't a real concern.
There are some sources that agree with you, as long as you insert words like "usually":

"Settlement risk is usually nearly nonexistent in securities markets."

https://www.investopedia.com/terms/s/settlementrisk.asp

Some people prefer to assume that things that don't usually happen will never happen. Some don't.

It's all good.
I'm not assuming it will never happen. I'm saying it's not a real concern even if it does.
alex_686
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Re: I Just Don’t Understand ETFs

Post by alex_686 »

Northern Flicker wrote: Tue Nov 23, 2021 11:56 pm There are various ways a failure to deliver event can happen. The frequency goes up significantly at times of acute market stress. There was a significant increase right after the Lehmann Bros. insolvency and bankruptcy. Say the market maker on the other side of your sale has some adverse event and a major liquidity squeeze. They may not be able to marshall the cash to complete the purchase of the shares you are selling.
You know that they reformed the system since then? Brokers have to post collateral to ensure trade completion. You can see how well that worked during the GameStop/Robinhood situation earlier this year.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
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Re: I Just Don’t Understand ETFs

Post by lazynovice »

HanSolo wrote: Wed Nov 24, 2021 2:35 am
KyleAAA wrote: Tue Nov 23, 2021 8:00 pm Can you describe a situation where the sell order wouldn't complete successfully?
Northern Flicker wrote: Tue Nov 23, 2021 11:56 pm There are various ways a failure to deliver event can happen. The frequency goes up significantly at times of acute market stress. There was a significant increase right after the Lehmann Bros. insolvency and bankruptcy. Say the market maker on the other side of your sale has some adverse event and a major liquidity squeeze. They may not be able to marshall the cash to complete the purchase of the shares you are selling.
Although I don't know the technical details, the fact that an ETF (or stock) trade doesn't settle the same day seems to mean that the broker isn't sure it will settle (for whatever reasons). The fact that a mutual fund exchange does settle the same day seems to mean that the mutual fund company is sure that there will be no settlement issue (because there's no outside counterparty, it's just you and that company).

Whenever there's an outside counterparty, you are counting on the counterparty making good on their end of the deal. Usually, it comes out OK, but you're not sure until you're sure.

So perhaps this is an advantage of mutual funds. You can be certain of settlement at the end of the same day.
T+2 is the industry requirement. It isn’t a measure of the broker’s certainty. It used to be T+3.
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Northern Flicker
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Re: I Just Don’t Understand ETFs

Post by Northern Flicker »

alex_686 wrote: Wed Nov 24, 2021 9:06 am
Northern Flicker wrote: Tue Nov 23, 2021 7:40 pm And ETFs typically have to pay the transaction cost of heartbeat trades to avoid distributing capital gains.
What do you mean "pay"? How is this different than what a mutual fund does?

When you have to reconstitute the fund due to cash flows, dividends, changes in the index you need to trade. For mutual funds the fund has to execute these trades and thus bear the cost - both the explicate and implicit. For ETFs it is the Authorized Participants (APs) that pay the costs, both implicit and explicate.

That the ETFs can avoid paying capital gains is a side effect of the heartbeat trades. The primary purpose of the trades is the standard reconstitution of the fund.
It limits the "buyers" of disposed of securities to those able to do the heartbeat trade method, so I have to assume the transaction cost and/or execution is not optimal.

I'm not sure why mutual funds generally don't do them, but maybe they do now or have been doing them as well anyway.
My postings are my opinion, and never should be construed as a recommendation to buy, sell, or hold any particular investment.
Northern Flicker
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Re: I Just Don’t Understand ETFs

Post by Northern Flicker »

lazynovice wrote: T+2 is the industry requirement. It isn’t a measure of the broker’s certainty. It used to be T+3.
My understanding is that the change to T+2 was to reduce the frequency of failed trades-- narrower time window for an adverse event. If shaving off a day makes a material reduction in risk of a failed trade, then the risk for T+2 is probably at least as much as the incremental risk of the 3rd day when it was T+3.

In a TLH, the buy could also fail leaving you out of the market.
My postings are my opinion, and never should be construed as a recommendation to buy, sell, or hold any particular investment.
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Re: I Just Don’t Understand ETFs

Post by lazynovice »

Northern Flicker wrote: Wed Nov 24, 2021 4:43 pm
lazynovice wrote: T+2 is the industry requirement. It isn’t a measure of the broker’s certainty. It used to be T+3.
My understanding is that the change to T+2 was to reduce the frequency of failed trades-- narrower time window for an adverse event. If shaving off a day makes a material reduction in risk of a failed trade, then the risk for T+2 is probably at least as much as the incremental risk of the 3rd day when it was T+3.

In a TLH, the buy could also fail leaving you out of the market.
No. You sell, you buy back in. Time out of market 30 seconds. If your seller fails to deliver, the seller’s broker makes good on it and goes back to the seller with a violation.
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Northern Flicker
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Re: I Just Don’t Understand ETFs

Post by Northern Flicker »

The seller is a market maker not another individual doing a small trade with a retail broker. Failure to deliver events do happen, but probably are less common with small trades.
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Re: I Just Don’t Understand ETFs

Post by Northern Flicker »

alex_686 wrote: Wed Nov 24, 2021 11:48 am
Northern Flicker wrote: Tue Nov 23, 2021 11:56 pm There are various ways a failure to deliver event can happen. The frequency goes up significantly at times of acute market stress. There was a significant increase right after the Lehmann Bros. insolvency and bankruptcy. Say the market maker on the other side of your sale has some adverse event and a major liquidity squeeze. They may not be able to marshall the cash to complete the purchase of the shares you are selling.
You know that they reformed the system since then? Brokers have to post collateral to ensure trade completion. You can see how well that worked during the GameStop/Robinhood situation earlier this year.
Were there any retail trades submitted through Robinhood that were in the pipeline and got cancelled when Robinhood had to stop accepting GME trades?
My postings are my opinion, and never should be construed as a recommendation to buy, sell, or hold any particular investment.
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Re: I Just Don’t Understand ETFs

Post by Northern Flicker »

Another possible anomaly-- you submit sell on A and moments later submit a buy on B but a trading pause/halt is implemented on A leading to the execution order inverting.
My postings are my opinion, and never should be construed as a recommendation to buy, sell, or hold any particular investment.
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Re: I Just Don’t Understand ETFs

Post by alex_686 »

Northern Flicker wrote: Wed Nov 24, 2021 4:36 pm It limits the "buyers" of disposed of securities to those able to do the heartbeat trade method, so I have to assume the transaction cost and/or execution is not optimal.
I am not sure what you are trying to say. I think you are literally trying to say is that ETFs would have to engage in their normal redemption process, where the costs are born by the APs.
Northern Flicker wrote: Wed Nov 24, 2021 4:36 pm I'm not sure why mutual funds generally don't do them, but maybe they do now or have been doing them as well anyway.
The short answer is that because mutual funds have to trade at the end of day NAV. They just have less flexialbity. I think in the 10 years I was in mutual fund accounting I saw less than a dozen tax-free exchanges in my fund complex. And we all knew that they were coming a week in advance.

ETFs and mutual funds are a little like Ginger Rogers and Fred Astaire. Sure, Fred was a good dancer, but Ginger could do everything that Fred could do backwards and in high heels.

So it might help that instead of looking at things piecemeal you try taking a holistic approach. Start with the big picture and zoom to the small. You posts are showing lots of inaccuracies, but common inaccuracies. If you are going to criticize the nuts and bolts of a process it helps if you know how the nuts and bolts go together. I am not trying to be mean but rather I am trying to be constructive as somebody who has worked with the nuts and bolts.

For example, you are correct that if there was a mass outflow of cash this could trigger capital gains distributions. Worse thing possible. With a mutual fund you could have capital gains distributions, but the worse thing that could happen would be the nuclear option of closing the fund for 30 days.

I might suggesting reading this book:A Comprehensive Guide to Exchange-Traded Funds by Joanne M. Hill et. al. You should be able to find PDFs out on the internet and the Kindle version is free.

Elisabeth Kashner is one of the contributors, who coined the phrase "heartbeat trade". I really enjoyed her insight on how ETFs worked when I talked to her. Here is her atricule

https://insight.factset.com/the-heartbe ... efficiency


Start with thinking through about a portfolio that has a sudden outflow of cash. How does that work? What are the impacts? What are the options? What are the mechanics?
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Re: I Just Don’t Understand ETFs

Post by lazynovice »

Northern Flicker wrote: Wed Nov 24, 2021 5:13 pm Another possible anomaly-- you submit sell on A and moments later submit a buy on B but a trading pause/halt is implemented on A leading to the execution order inverting.
A trading halt on VTI or VXUS or ITOT?
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Re: I Just Don’t Understand ETFs

Post by alex_686 »

lazynovice wrote: Wed Nov 24, 2021 5:42 pm
Northern Flicker wrote: Wed Nov 24, 2021 5:13 pm Another possible anomaly-- you submit sell on A and moments later submit a buy on B but a trading pause/halt is implemented on A leading to the execution order inverting.
A trading halt on VTI or VXUS or ITOT?
I would counter with why are you trading during a time of extreme market stress? Because I can think of lots of bad fact cases for both mutual funds and ETFs.

And of what value is this discussion? I am more than willing to go into the weeds, but we need to identify the specific circumstance is.
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Re: I Just Don’t Understand ETFs

Post by lazynovice »

alex_686 wrote: Wed Nov 24, 2021 5:48 pm
lazynovice wrote: Wed Nov 24, 2021 5:42 pm
Northern Flicker wrote: Wed Nov 24, 2021 5:13 pm Another possible anomaly-- you submit sell on A and moments later submit a buy on B but a trading pause/halt is implemented on A leading to the execution order inverting.
A trading halt on VTI or VXUS or ITOT?
I would counter with why are you trading during a time of extreme market stress? Because I can think of lots of bad fact cases for both mutual funds and ETFs.

And of what value is this discussion? I am more than willing to go into the weeds, but we need to identify the specific circumstance is.
I traded on March 16, 2020 one of the circuit beaker days. I did it to tax loss harvest. Ironically, based on the discussion here, it was the day I exited every single international mutual fund position I had and moved to international ETFs. Combined with trades in US funds that same month, I didn’t quite get to a six figure loss carryforward but I got close.

The circuit breaker for the whole market triggered shortly after opening on the 16th. I don’t trade very close to open or close so it didn’t impact me.

The only mutual funds I hold are the ones in my 401(k) and those that were not in a loss position in March 2020.
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Regal 56
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Re: I Just Don’t Understand ETFs

Post by Regal 56 »

alex_686 wrote:I might suggesting reading this book: A Comprehensive Guide to Exchange-Traded Funds by Joanne M. Hill et. al. You should be able to find PDFs out on the internet and the Kindle version is free.
Started reading this, and understood what little I’ve read so far. Maybe this is just what the doctor ordered. I’ll let you know.
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Re: I Just Don’t Understand ETFs

Post by alex_686 »

Regal 56 wrote: Wed Nov 24, 2021 6:40 pm
alex_686 wrote:I might suggesting reading this book: A Comprehensive Guide to Exchange-Traded Funds by Joanne M. Hill et. al. You should be able to find PDFs out on the internet and the Kindle version is free.
Started reading this, and understood what little I’ve read so far. Maybe this is just what the doctor ordered. I’ll let you know.
Tell me how it goes or if you have any questions.

It is not the first book I would have recommended. It is a great book but it is a technical book aimed at the professional.

I would pick and choose my topics along my lines of interest.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
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Re: I Just Don’t Understand ETFs

Post by Northern Flicker »

alex_686 wrote: Wed Nov 24, 2021 5:21 pm
Northern Flicker wrote: Wed Nov 24, 2021 4:36 pm It limits the "buyers" of disposed of securities to those able to do the heartbeat trade method, so I have to assume the transaction cost and/or execution is not optimal.
I am not sure what you are trying to say. I think you are literally trying to say is that ETFs would have to engage in their normal redemption process, where the costs are born by the APs.
A law passed in the 1960's enables mutual funds (defined broadly so that most ETFs are included) not to have to realize capital gains for withdrawals processed by distributing shares in-kind. In a heartbeat trade, an institutional counterparty, presumably an AP, deposits cash into a fund and receives shares in-kind in return. I'm not sure if these are always even needed to manage the makeup of the fund, in which case the entire transaction cost is superfluous. If the transaction is needed, I do not assume it is at as favorable a cost (outside of tax gain considerations) as the best execution available for the shares.
Last edited by Northern Flicker on Thu Nov 25, 2021 12:40 am, edited 1 time in total.
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Re: I Just Don’t Understand ETFs

Post by Northern Flicker »

alex_686 wrote: Wed Nov 24, 2021 5:48 pm
lazynovice wrote: Wed Nov 24, 2021 5:42 pm
Northern Flicker wrote: Wed Nov 24, 2021 5:13 pm Another possible anomaly-- you submit sell on A and moments later submit a buy on B but a trading pause/halt is implemented on A leading to the execution order inverting.
A trading halt on VTI or VXUS or ITOT?
I would counter with why are you trading during a time of extreme market stress? Because I can think of lots of bad fact cases for both mutual funds and ETFs.

And of what value is this discussion? I am more than willing to go into the weeds, but we need to identify the specific circumstance is.
It is often when TLH opportunities are greatest. The whole point of depending on settlement for a subsequent trade was to do TLH. I did a TLH in 3/2020 when there was much market stress. I did a mutual fund exchange from a developed markets equity fund to a total int'l equity fund. No exposure to absence from the market. I then used the loss to offset a gain exchanging from a US equity fund to the total int'l fund, completing a rebalance from US to non-US equities as a non-taxable event. Mutual fund exchanges made it trivial without having to worry about market movements in between sells and buys.
My postings are my opinion, and never should be construed as a recommendation to buy, sell, or hold any particular investment.
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Re: I Just Don’t Understand ETFs

Post by Northern Flicker »

lazynovice wrote: Wed Nov 24, 2021 5:42 pm
Northern Flicker wrote: Wed Nov 24, 2021 5:13 pm Another possible anomaly-- you submit sell on A and moments later submit a buy on B but a trading pause/halt is implemented on A leading to the execution order inverting.
A trading halt on VTI or VXUS or ITOT?
Probably not for those funds. But very high volatility could make it harder to price the underlying stocks in a timely manner, creating a barrier to arbitrage by AP's of gaps between market value and NAV. This could lead to discounts to NAV persisting long enough to interfere with a smooth TLH process. If course the NAV's calculated for mutual funds at market close could have the same issue.

A TLH from a more liquid holding to a less liquid holding should be fine, even a win, but going from a less liquid holding to a more liquid holding would be an issue at times of market stress.
My postings are my opinion, and never should be construed as a recommendation to buy, sell, or hold any particular investment.
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Re: I Just Don’t Understand ETFs

Post by HanSolo »

KyleAAA wrote: Wed Nov 24, 2021 11:25 am
HanSolo wrote: Wed Nov 24, 2021 5:11 am There are some sources that agree with you, as long as you insert words like "usually":

"Settlement risk is usually nearly nonexistent in securities markets."

https://www.investopedia.com/terms/s/settlementrisk.asp

Some people prefer to assume that things that don't usually happen will never happen. Some don't.

It's all good.
I'm not assuming it will never happen. I'm saying it's not a real concern even if it does.
I get that if it happens (to you), then it's not a real concern (for you).

That's OK. It's your choice.
lazynovice wrote: Wed Nov 24, 2021 3:50 pm
HanSolo wrote: Wed Nov 24, 2021 2:35 am So perhaps this is an advantage of mutual funds. You can be certain of settlement at the end of the same day.
T+2 is the industry requirement. It isn’t a measure of the broker’s certainty. It used to be T+3.
If there were certainty, then they wouldn't call it "settlement risk".

My point stands, a person could prefer earlier settlement rather than later settlement. It's their choice.
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Re: I Just Don’t Understand ETFs

Post by lazynovice »

Northern Flicker wrote: Thu Nov 25, 2021 4:08 am
lazynovice wrote: Wed Nov 24, 2021 5:42 pm
Northern Flicker wrote: Wed Nov 24, 2021 5:13 pm Another possible anomaly-- you submit sell on A and moments later submit a buy on B but a trading pause/halt is implemented on A leading to the execution order inverting.
A trading halt on VTI or VXUS or ITOT?
Probably not for those funds. But very high volatility could make it harder to price the underlying stocks in a timely manner, creating a barrier to arbitrage by AP's of gaps between market value and NAV. This could lead to discounts to NAV persisting long enough to interfere with a smooth TLH process. If course the NAV's calculated for mutual funds at market close could have the same issue.

A TLH from a more liquid holding to a less liquid holding should be fine, even a win, but going from a less liquid holding to a more liquid holding would be an issue at times of market stress.
So all the things you are using to scare others away from ETFs are weird events that almost never happen and don’t happen at all in liquid ETFs that Boglehead’s buy?
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Re: I Just Don’t Understand ETFs

Post by lazynovice »

HanSolo wrote: Thu Nov 25, 2021 5:15 am
KyleAAA wrote: Wed Nov 24, 2021 11:25 am
HanSolo wrote: Wed Nov 24, 2021 5:11 am There are some sources that agree with you, as long as you insert words like "usually":

"Settlement risk is usually nearly nonexistent in securities markets."

https://www.investopedia.com/terms/s/settlementrisk.asp

Some people prefer to assume that things that don't usually happen will never happen. Some don't.

It's all good.
I'm not assuming it will never happen. I'm saying it's not a real concern even if it does.
I get that if it happens (to you), then it's not a real concern (for you).

That's OK. It's your choice.
lazynovice wrote: Wed Nov 24, 2021 3:50 pm
HanSolo wrote: Wed Nov 24, 2021 2:35 am So perhaps this is an advantage of mutual funds. You can be certain of settlement at the end of the same day.
T+2 is the industry requirement. It isn’t a measure of the broker’s certainty. It used to be T+3.
If there were certainty, then they wouldn't call it "settlement risk".

My point stands, a person could prefer earlier settlement rather than later settlement. It's their choice.
But there is certainty because the counterparty’s broker or the market maker keeps you whole. If your counter party fails to deliver, you don’t even know it. You got your shares or your money at the price you bought or sold at.
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Re: I Just Don’t Understand ETFs

Post by HanSolo »

lazynovice wrote: Thu Nov 25, 2021 11:12 am
HanSolo wrote: Thu Nov 25, 2021 5:15 am
lazynovice wrote: Wed Nov 24, 2021 3:50 pm
HanSolo wrote: Wed Nov 24, 2021 2:35 am So perhaps this is an advantage of mutual funds. You can be certain of settlement at the end of the same day.
T+2 is the industry requirement. It isn’t a measure of the broker’s certainty. It used to be T+3.
If there were certainty, then they wouldn't call it "settlement risk".

My point stands, a person could prefer earlier settlement rather than later settlement. It's their choice.
But there is certainty because the counterparty’s broker or the market maker keeps you whole. If your counter party fails to deliver, you don’t even know it. You got your shares or your money at the price you bought or sold at.
I didn't see that in the sources I read. It sounds like you're assuming that the broker or market maker is still solvent. In any case, if you're right, then someone needs to rewrite the books on counterparty risk... and the people who were worried about Lehman and systemic risk should've just taken a chill pill, eh?
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Re: I Just Don’t Understand ETFs

Post by Northern Flicker »

lazynovice wrote: Thu Nov 25, 2021 11:08 am
Northern Flicker wrote: Thu Nov 25, 2021 4:08 am
lazynovice wrote: Wed Nov 24, 2021 5:42 pm
Northern Flicker wrote: Wed Nov 24, 2021 5:13 pm Another possible anomaly-- you submit sell on A and moments later submit a buy on B but a trading pause/halt is implemented on A leading to the execution order inverting.
A trading halt on VTI or VXUS or ITOT?
Probably not for those funds. But very high volatility could make it harder to price the underlying stocks in a timely manner, creating a barrier to arbitrage by AP's of gaps between market value and NAV. This could lead to discounts to NAV persisting long enough to interfere with a smooth TLH process. If course the NAV's calculated for mutual funds at market close could have the same issue.

A TLH from a more liquid holding to a less liquid holding should be fine, even a win, but going from a less liquid holding to a more liquid holding would be an issue at times of market stress.
So all the things you are using to scare others away from ETFs are weird events that almost never happen and don’t happen at all in liquid ETFs that Boglehead’s buy?
I'm not trying to scare people away from ETFs. I have owned them going back 14 years and own one now.

Not everyone limits their ownership if ETFs to VTI, VXUS, and ITOT.

And yes, some undesirable things have happened with ETFs. Undesirable things also can happen with mutual funds. Having a trade not settle is uncommon but not unheard of. It does happen.

Buying shares with funds you don't yet have in your account is the type of activity that contributes to settlement failure.
My postings are my opinion, and never should be construed as a recommendation to buy, sell, or hold any particular investment.
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Re: I Just Don’t Understand ETFs

Post by lazynovice »

HanSolo wrote: Thu Nov 25, 2021 2:19 pm
lazynovice wrote: Thu Nov 25, 2021 11:12 am
HanSolo wrote: Thu Nov 25, 2021 5:15 am
lazynovice wrote: Wed Nov 24, 2021 3:50 pm
HanSolo wrote: Wed Nov 24, 2021 2:35 am So perhaps this is an advantage of mutual funds. You can be certain of settlement at the end of the same day.
T+2 is the industry requirement. It isn’t a measure of the broker’s certainty. It used to be T+3.
If there were certainty, then they wouldn't call it "settlement risk".

My point stands, a person could prefer earlier settlement rather than later settlement. It's their choice.
But there is certainty because the counterparty’s broker or the market maker keeps you whole. If your counter party fails to deliver, you don’t even know it. You got your shares or your money at the price you bought or sold at.
I didn't see that in the sources I read. It sounds like you're assuming that the broker or market maker is still solvent. In any case, if you're right, then someone needs to rewrite the books on counterparty risk... and the people who were worried about Lehman and systemic risk should've just taken a chill pill, eh?
Payment and settlement systems were reformed post-2008. See the DTCC deposit requirement that worked in January during the GameStop frenzy.

You’ve been in this forum a long time. Don’t you think you’d be seeing posts saying “I sold shares and never got my cash because the buyer failed to deliver!” Or “I bought shares and it’s three days later and they aren’t in my account.” But you don’t…

You do see posts that say “I got a good faith violation or a free riding violation” People get warnings from their broker and if they break the rules too much, their accounts get suspended.

All these comments are being made for the sake of scaring people who don’t know better. I’m not sure what the motivation is for that.
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Re: I Just Don’t Understand ETFs

Post by HanSolo »

lazynovice wrote: Thu Nov 25, 2021 3:18 pm You’ve been in this forum a long time. Don’t you think you’d be seeing posts saying “I sold shares and never got my cash because the buyer failed to deliver!” Or “I bought shares and it’s three days later and they aren’t in my account.” But you don’t…
Previously, you said "almost never happen". That means you're aware that there's at least a potential for tail risks (such as systemic issues). So far, so good.

If nobody on the forum has run into them, I'd say that's because they're tail risks (stuff that doesn't happen except in exceptional situations).
All these comments are being made for the sake of scaring people who don’t know better. I’m not sure what the motivation is for that.
Nobody said anything for the sake of scaring anyone. It's just information. Sure, some people don't care about tail risks, and that's fine. But it doesn't mean that those who want to be aware of that should not have the information.

I think you read something into the previous posts that wasn't there. Nobody said to be afraid. Just be aware, then do what you want.
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Re: I Just Don’t Understand ETFs

Post by Northern Flicker »

From 2011, ie post-2008:

https://www.morningstar.com/articles/37 ... -for-alarm

Not sure why my postings should be interpreted as trying to scare people away from ETFs. I just was pointing out that doing a TLH by doing a buy 30 seconds or 5 minutes after a sell takes settlement risk if you need the cash from the sell to settle the buy. If a back office delay causes a 20 minute delay in the sell settlement, the buy trade will fail.

I focus on the asset classes to which I want exposure. Whether I implement as a mutual fund, ETF, or some other vehicle is a decision I make on a case-by-case basis. There is no ETF or mutual fund for a stable value fund. There are pros and cons of ETFs and mutual funds.
My postings are my opinion, and never should be construed as a recommendation to buy, sell, or hold any particular investment.
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Re: I Just Don’t Understand ETFs

Post by lazynovice »

Northern Flicker wrote: Thu Nov 25, 2021 5:10 pm From 2011, ie post-2008:

https://www.morningstar.com/articles/37 ... -for-alarm

Not sure why my postings should be interpreted as trying to scare people away from ETFs. I just was pointing out that doing a TLH by doing a buy 30 seconds or 5 minutes after a sell takes settlement risk if you need the cash from the sell to settle the buy. If a back office delay causes a 20 minute delay in the sell settlement, the buy trade will fail.

I focus on the asset classes to which I want exposure. Whether I implement as a mutual fund, ETF, or some other vehicle is a decision I make on a case-by-case basis. There is no ETF or mutual fund for a stable value fund. There are pros and cons of ETFs and mutual funds.
From the link…

“Even in the case where either party truly fails to deliver either cash or securities, the counterparty to the transaction will still be made whole. In these instances, collateral posted by the parties in the transaction will be used to settle the transaction, whether by purchasing the relevant security for the buyer or delivering cash to a seller.
….
What are the implications of settlement failures for investors?
Let's ask a question: In all of the time that you have been investing, have you ever been adversely affected by a settlement failure? Odds are that most investors will respond "no" to this question. This is because the settlement process is something that goes largely unnoticed by investors. Investors gain (or cede) economic exposure to securities at the time a transaction is completed, at what we can describe as "T=0." Whether a trade ultimately settles at T+3 or T+4 will have no impact on an investor's returns or access to cash proceeds. And, in fact, investors virtually never even see in their accounts that any trade ever "failed" to settle.
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Re: I Just Don’t Understand ETFs

Post by HanSolo »

lazynovice wrote: Thu Nov 25, 2021 5:42 pm From the link…
It seems there are no points of disagreement in the discussion.
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Re: I Just Don’t Understand ETFs

Post by UpperNwGuy »

HanSolo wrote: Thu Nov 25, 2021 4:59 pm
All these comments are being made for the sake of scaring people who don’t know better. I’m not sure what the motivation is for that.
Nobody said anything for the sake of scaring anyone. It's just information. Sure, some people don't care about tail risks, and that's fine. But it doesn't mean that those who want to be aware of that should not have the information.

I think you read something into the previous posts that wasn't there. Nobody said to be afraid. Just be aware, then do what you want.
Sorry, but I don't buy that explanation. I read those posts as an intentional attempt to cast doubt on ETFs. This is simply not a normal risk and doesn't need to be mentioned in this kind of discussion.
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Re: I Just Don’t Understand ETFs

Post by lazynovice »

HanSolo wrote: Thu Nov 25, 2021 5:56 pm
lazynovice wrote: Thu Nov 25, 2021 5:42 pm From the link…
It seems there are no points of disagreement in the discussion.
You got it. Fail to delivers are taken care of by the market makers, neither party is “out of the market” and therefore not a reason to avoid ETFs.
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Re: I Just Don’t Understand ETFs

Post by HanSolo »

UpperNwGuy wrote: Thu Nov 25, 2021 6:48 pm Sorry, but I don't buy that explanation. I read those posts as an intentional attempt to cast doubt on ETFs. This is simply not a normal risk and doesn't need to be mentioned in this kind of discussion.
It's up to you to read it that way. Some are interested in the information and some are not.
lazynovice wrote: Thu Nov 25, 2021 6:50 pm
HanSolo wrote: Thu Nov 25, 2021 5:56 pm It seems there are no points of disagreement in the discussion.
You got it. Fail to delivers are taken care of by the market makers, neither party is “out of the market”
Yes. As the article said, sometimes "collateral posted by the parties in the transaction will be used to settle the transaction." Sometimes that's your collateral. If that's OK with you, then that's OK.
and therefore not a reason to avoid ETFs.
Nobody said to avoid ETFs. On that point, there's no disagreement.

Apparently, the only point of disagreement is that some people use unsettled funds for trading and some people avoid doing that. My opinion is that neither behavior is "wrong". Your opinion is that the latter is "wrong" (even after acknowledging that tail risks are non-zero).

If you want to think that, that's up to you. I like my opinion, and you like yours. That's OK.
Last edited by HanSolo on Thu Nov 25, 2021 7:49 pm, edited 1 time in total.
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