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TheManWhoHatesE.T.F.sTheNewYorkTimes

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TheManWhoHatesE.T.F.s
ByLANDONTHOMASJr. NOV.4,2015

Beardedandtanned,PeterS.Kraus,thechiefexecutiveofAllianceBernstein,strodewithassuranceintoaMidtown
Manhattanconferenceroomfulloffinancialadvisersfromalargeinvestmentbank.
HewastheretopitchthemonAlliancemutualfundsandpromotetheexpertiseofhisstockandbondexperts
whomanagetheseinvestmentpools.
Butthefinancialadvisershadbeendoinganicelittlebusinessignoringthesetypesofactivelymanagedfunds
andsteeringtheirclientsintocheaper,indextrackingexchangetradedfunds,thankyouverymuch.

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SoMr.KraushadagloomymessageforthosedazzledbytheascentofE.T.F.s.
Letmebringitdowntoreality,Mr.Kraussaid.YouguyswokeuponemorninginAugustandtheDowwas
down1,090points.Andonthatdaya$40billionE.T.F.tradedata30percentdiscount.
Mr.Kraus,whois63andspent22yearsatGoldmanSachs,woreadarkbluesuitandapinkshirtthathe
matchedwithasimilarlycoloredtieandapinkpolkadottedSwatch.Headdressedhisaudienceinacocksuremanner
thatisoftenseeninGoldmanexecutiveswho,failingtorisetothetopthere,moveontofirmswithalesserpedigree.
Thatshouldneverhappen,andifyourclienttradedonthatday,youwillnevergetthatback.Never.Thesefunds
mayhavelowfeesbuttheyarenotsafe,andyourclientsneedtounderstandthat.
Mr.Kraus,asanactiveinvestorlosingmarketsharetoE.T.F.s,hasanopenbiasinthisdebateashefreely
admits.
Itisalsotruethathehasnotbeentheonlypersonissuingsuchwarnings.
AstheE.T.F.industryhasgrown(withcloseto$3trillionundermanagementglobally,thereisasmuchmoneyis
investedinE.T.F.sasthereisinhedgefunds),sohaveconcernsthattoomuchmoneyhasbeenluredintohardto
tradeareasofthemarketandintoriskyinvestmentstrategies.
CriticshaveincludedStanleyFischer,vicechairmanattheFederalReserve,andinvestorslikeCarlC.Icahnand
HowardMarks.Andtheircomplainthasbeenconsistent:Whathappensifawaveofsellinghitsthesefunds,and
investorscantgettheirmoneyback?

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Theconcernstemsfromtheviewthatarushofmoneyintofundsthatpromiseinstantliquidityisfavoringthose
withashortterm,tradingdrivenmarketoutlookasopposedtothepatient,longertermperspectiveespousedby
buyandholdinvestors.
Thestockmarketswingsinrecentweekshaveheightenedthesefears.
Forexample,largeE.T.F.spromiseimmediateliquidityinilliquidareassuchasemergingmarketbonds,
leveragedloansandcreditdefaultswaps.
Alsoonofferarefundsthatborrowthreetimestheamountoftheirassetstobetonvariousmarketsgoingupor
downinvalue.
AllianceBernstein,orABasthefirmhasrecentlyrebrandeditself,representstheoppositeofthistrend:Itisan
oldschoolmoneymanagerthatoffers,forafee,arangeofstockandbondfundsthatpromisetobeatbenchmark
stockorbondindexes.
Theproblemisthatsince2010manyofthesocalledactivefundsofferedbyABanditspeershavetrailedtheir
benchmarks,notleastofferingsthatinvestinlargeAmericancompaniesintheStandard&Poors500stockindex.
Asaresult,assetshavesteadilyflowedfromfundcompanieswithanactiveorientationlikeFidelity,T.Rowe
PriceandFranklinTempletontolargerfirmslikeBlackRockandVanguardthatspecializeinpassiveinvestment
styles.
Forexample,thefirmsassetsundermanagementremainbroadlywheretheywerewhenMr.Krauswashiredto
revivethefirmsfortunesinDecember2008$463billion.Inabusinessthatprizesassetgrowthaboveallelse,that

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isnotnecessarilyatrackrecordtobragabout.
Ofcourse,activelymanagedmutualfundsstillmakeuptwothirdsofthemutualfundmarket.Butitsthe
increasingsizeandgrowthofthepassivefundmarketthatMr.Krausseesasathreat.
Ifyouabsorbtoomuchliquidity,thereisjustnotenoughgreasetomakethewheelwork,Mr.Kraussaidtothe
brokers.Wehaveseenmuchhighervolatilityandmuchfasterpricereactionsoverthepastfewyears,andthemain
reasonisthisshiftfromactivetopassiveinvesting.
Whilefinancechiefsoftencriticizetheirpeersbehindcloseddoors,itisrareforachiefexecutivetoraisepointed
questionsaboutarivalsbusinessmodelopenly.
WhenMr.KraussaysthatthedominanceofVanguardandBlackRock,whosepassivelymanagedfundsamount
tomorethan$4trillion,isariskforinvestors,peopleandthefirmstakenotice.
Vanguardathreattothemarket?
JoelM.Dickson,aseniorexecutivewithintheindexinggiantsstrategyunit,hasbeenonthereceivingendof
manycomplaintsandcriticismsfrombeatendownactivemanagers,buthesaidthisbrokenewground.
E.T.F.sreflectthemarketenvironmenttheydonotdictateit,Mr.Dicksonsaidinaninterviewata
MorningstarconferenceforE.T.F.slastmonth.Wearejustagentsforour20millioninvestorswhoaremakingtheir
owninvestmentdecisions.
AndLaurenceD.Fink,thechiefexecutiveofBlackRock,byfarthelargestE.T.F.provider,rejectsMr.Krauss

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contentionthatE.T.F.swillexperiencemoresharppricedropsastheydidinAugust.
Wedidnthavetheproblemthiswasamarketstructureproblem,Mr.Finksaid.Aug.24wasabigevent,
but90minuteslatereverythingwasfine.
SomeofBlackRockslargestE.T.F.splummetedfrom25to35percentonthatdaylargemovesforfunds
containingmorethan$60billionininvestorassets.
BlackRockhasissuedaresearchpaperthatconcludesthatthesharppricedropsweretheresultofpanicselling
byinvestorsandalackoftradinginformation,whichpreventedmarketmakersfromcominginasbuyerstosupport
prices.
ForalltheeyebrowsthatMr.KrausisraisingforhisantiE.T.F.crusade,hemaybebetterknownforhislucrative
jobhoppingspreein2008.
InMarchofthatyear,Mr.KrausretiredfromhispostascoheadofGoldmansassetmanagementdivision,not
longaftersomeofthefirmslargesthedgefundsexperiencedsharpfallsin2007.
InSeptember,Mr.KrausjoinedMerrillLynchatthebehestofhisgoodfriendfromGoldman,JohnA.Thain,
thenchiefexecutive.Mr.ThainsoldMerrilltoBankofAmericaafewdayslater.
ThemoreconservativeexecutivesatBankofAmericadidnotappreciateMr.Krausscolorfulwayshefavoreda
greenBlackBerryanddisplayedexpensiveartinhisofficeandbyDecemberofthatyearhehadmovedontothe
topjobatAB.

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Duringtheworstfinancialcrisisinageneration,Mr.Krauswaspaidcloseto$30millionbyMerrillandon
joiningABthreemonthslater,receivedanupfrontbonusof$6millionandrestrictedstockworth$50millionatthe
time.Underthetermsofhiscontract,hegetsnobonusanddoesnotreceivethestockuntil2018.
ABwasatroubledfirmwhenhejoinedit.Assetsundermanagementwerehalftheir$800billionpeakin2007,
andintheearlyyearsofhistenuremanyofthecompanysfundscontinuedtoloseinvestorsbecauseofshoddy
performance.
Inrecentyears,however,performancehasimproved,andmostABfundsinvestedintheUnitedStatesstock
marketarenowbeatingtheirindexes,accordingtotheassetmanagementtrackingfirmeVestment.
Nonetheless,inflowshavebeenmutedasinvestorcashkeepspouringintoVanguardandBlackRockE.T.F.s.
AndMr.Kraussadvicetoinvestorsnowistomoveoppositeoftheherd:Peoplearejustnotassessingtherisks
rightthesefundsarefreeridersandtheyarenotsafe.Youshouldbeshortthem.
AversionofthisarticleappearsinprintonNovember5,2015,onpageF2oftheNewYorkeditionwiththeheadline:TiltingatE.T.F.s.

2016TheNewYorkTimesCompany

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