You may be aware that Vanguard and Fidelity have been locked in a price war now for a number of years that has driven the costs of many of their (and the entire financial industry’s) index funds down to nearly nothing.
In fact, last year, Fidelity broke new ground when it launched 4 new zero-cost index funds. That is, 4 index funds with a 0% expense ratio. You pay nothing to invest in these funds.
Why would Fidelity do that? In my view, they probably see these funds as a loss leader and marketing expense. In other words, they are a tool to:
- get new customers in the door by offering them an enticing product, even if it means a small loss for the company
- get those customers to invest or spend in other areas to become profitable customers
It’s not too dissimilar from grocery stores mailing you a weekly flyer of special sales on food staples that they are selling at or below cost in the hopes that when you get in the store you will buy a bunch of high margin items.
In light of these broader trends, I was not shocked when I saw the recent news that Salt Financial was launching an ETF that pays you to invest in it. The ETF, Salt lowTru Beta US Market Fund (Ticker: LSLT) is the first ETF that has a negative expense ratio (of -0.05%).
Perhaps this is just the next step in the natural progression towards lower costs in the financial investments industry?
I decided to dig deeper. Here’s what I found.
1. The Negative Expense Ratio is Only Temporary, and it’s Capped:
In Salt’s press release, they state:
The Adviser has contractually agreed to waive the Fund’s full unitary management fee of 0.29% on the first $100 million in net assets until at least May 31, 2020 and to contribute to the Fund’s assets an amount equal to an annual rate of 0.05% of the Fund’s average daily net assets on the first $100 million in net assets. This agreement may be terminated only by, or with the consent of, the Fund’s Board of Trustees.
Just in that statement alone, there are some red flags:
- If the fund goes above $100 million in assets and you invest (or re-invest) more, you will not only not get the 0.05% payout, but you will pay the 0.29% management fee. That fee is not horrible, but it’s also not cheap compared to industry-leading ETF’s/index funds these days.
- The agreement may be terminated by the Fund’s Board of Trustees. They’ve given themselves an out if things don’t work out to their liking.
- There is an end date: this promotion will likely end on May 31, 2020.
Contrast that with some of Fidelity and Vanguard’s offerings, which:
- Have no asset cap on lower costs.
- Have no end date. Expense ratios are always subject to change, but with these companies – they almost always go down.
2. I’m not Quite Sure what the ETF’s Underlying Strategy is
After reading about the ETF’s investment strategy, I’m not quite sure what to make of it. According to Salt, here is how their algorithm selects what to invest in:
1. Start with top 1000 stocks by market capitalization
2. Filter on 30-day average daily volume to keep the 500 most liquid stocks
3. Calculate truBeta™ scores for the remaining 500 stocks. Eliminate all stocks at or above a truBeta™ estimate of 1.0.
4. Calculate a Beta Variability score for each remaining stock. A lower score indicates more stability in beta over time.
5. Rank the top 100 stocks by Beta Variability, capping sector concentration at 30%.
6. Equal weight the portfolio and rebalance quarterly. Current index components remain in the index unless their truBeta™ estimate rises to 1.0 or above, helping reduce turnover.
Sounds complex! Too complex for me to want to invest in.
3. LSLT is Not Diversified
But don’t just take that from me, take it from the Salt website, which says,
The Fund is non-diversified and may invest more of its assets in a single issuer or smaller number of issuers than a diversified fund
And if you look at the fund’s current top 10 holdings, this plays out. Of the top 10, 6 are considered to be “consumer packaged goods” (think grocery store staples) companies: Kimberly Clark, Tyson Foods, Conagra, Hershey, General Mills, Church and Dwight.
Compare this to some of Vanguard’s and Fidelity’s low cost index funds that invest in the entire stock market, and you would be leaving yourself at a higher risk of sector-specific slumps, or missing the gains of the entire market.
4. Salt Financial is Not a Well Established Investment Firm
If a Vanguard or Fidelity launched a fund like this, I’d have to take a serious look. Both have assets under management in the trillions. Salt Financial, on the other hand, has fund assets in the millions. They have yet to really prove themselves.
Final Thoughts:
I’m all for passive ETF/index fund investing and low expense ratios. And should there ever be a diversified fund from an established player that tracks the broader stock market index and offers up a negative expense ratio – I’d probably be one of the first to get in. But LSLT is not it. Too risky, too gimmicky, and too unproven.
And the lesson here is a good reminder: before investing in anything, always do your homework and read the fine print.
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This is interesting – I wonder if it might pick up some steam and force Vanguard, Fidelity, etc. to offer negative loss-ratio products, at least to early investors (like a negative loss ratio on your first $20K then up to the normal rate). For that matter, I wonder how much longer Vanguard and Fidelity will continue their arms race of lower and lower prices. I realize their passive strategies mean they don’t have to pay armies of overpriced stock-pickers, but these companies must still be extremely costly to run with enormous amounts of employees working in customer support, IT, marketing, HR, legal, compliance, accounting, you name it.
Granted, a tiny fraction of a percent of trillions of dollars is still a tremendous amount of money. But it also costs a tremendous amount of money to compensate all these people, run the servers, pay rent and utilities for the office buildings, buy advertisements, etc. Vanguard was already pretty cheap before these price wars; how low can this go until the companies aren’t bringing in enough revenue to keep the lights on?