The Dark Side of ETFs – The ETF P/E Magic Trick

Featuring Steven Bregman

Steven Bregman of Horizon Kinetics explains to Grant Williams that all is not what it seems in the ETF Market, in the first part of this incredible three-part interview. As you appreciate the magic tricks employed to reduce PE ratios and influence sector diversification, you begin to understand that investors are getting something diametrically different to what they expect. Filmed on June 29, 2017, in New York

Published on
19 August, 2017
Micro, ETF, Liquidity
42 minutes
Asset class
Bonds/Rates/Credit, Equities


  • RD

    Ryan D.

    8 7 2018 03:32

    0       0

    I’ve watched this series at least four times and will no doubt watch it again. I think this and Michael Green’s “Great Rotation” are the most important presentations for retail investors (like myself) to really understand. Many thanks for sharing; I have no doubt that this information will save me money over the course of my investing career.

  • JT

    Jayne T.

    20 10 2017 16:38

    0       0

    Hey Steve, excellent presentation and good to see you again -- I worked with you guys at BT.

  • JD

    Joe D.

    2 10 2017 22:48

    0       0

    Very key ideas at the very end.

  • TB

    Tad B.

    15 9 2017 22:53

    2       0

    I'm loving this. Frightening... but a must watch. This guy is great ! He should be looking after our dosh :)
    Market Cap weighted ETFs are a given; we all know how to spot those....... where 5 companies represent 30% of a fund comprised of 500. BUT, the PE calculations ARE UNREAL !!!!! Seriously ?!
    Buyer beware on the exotic junk rubbish but, the TRICKS to LIE being uncovered here are fascinating.

  • JM

    James M.

    11 9 2017 14:22

    1       0

    Great interview and who couldn't agree with what the fellas saying. But what the fuck does it matter, his first mistake is thinking like a rational logical money manager. We all know the whole thing as is a joke there is no market and there isn't likely to be until we get complete and utter collapse of the whole thing, which when that happens we will have bigger worries developing than 401ks. Obviously the only game in town is the Japanese QE infinite as explained by Jeremy Granthum in 2009 , where those ETFs come in really hand to buy up the whole stock and bond market oooops market mmmmmm dont think we have had one of them for a while if ever. Whats the fukin point of trying to think logically about all this shit and shorting it? The JCB have manged to keep this lala train goin for over 3 decades and its clear thats the plan form the FED, ECB, BOE etc etc. But I appreciate the guys time anyway. BTFD lol

  • AK

    Anton K.

    10 9 2017 10:01

    1       0

    Best interview ive seen on Real Vision so far in H2. If managers are not spending some performance on buying catastrophe insurance heading into Q4 and 2018 theyre not doing their job and should be fired. Valuation dislocations in asset prices due to ETF fund flows are now pretty damn scary and he does a great job of providing factual evidence of this. The analysis on EM Corporate Bond Spreads over bench is insane! I'll be doing a lot of work on hedging out EM downside risk in my portfolios on this. THANKS RV!

  • ct

    constantine t.

    8 9 2017 11:23

    0       0

    CIA factbook figures on Lebanon are perfectly up-to-date

  • CS

    Chris S.

    8 9 2017 08:59

    0       0

    The index PE 'problem' is not new and has not been caused by ETFs. Actually, different data providers have had different methods of calculating index earnings / PEs for decades. It's an index problem not an ETF problem. I find the overall discussion about the 'passive bubble' a little overdone and too general. Not all passive is bad and not all ETFs are passive.

  • MC

    M C.

    29 8 2017 15:13

    3       1

    Unfortuantely some fundamental flaws with his logic - although I do appreciate listening to differing view points. Let's address the bond liquidity. With respect to EM, i doubt there are many credible retail portfolio manager that would advocate individual EM bonds for a client portoflio, The ETF provides a very efficient technology to achieve exposure to a broad based, diversified portfolio of bonds - even those with bonds from Lebanon. With repect to the Lebanese bonds he specifically mentions, while i have no idea on the specifics of the ETF he is referring to what I can opinine on is that, generally, no fixed income ETF is 100% replicated. The underlying index it tracks probably is contructed from 1000s of issues. The ETF's physical portfolio will obviously be an optimized replication of that index such that it will generally own only a sufficient quantity of bonds to minimize tracking error to the index. Therefore the % he mentions of Lebanese bonds may not be physically held by the ETF. But regardless of specific issuers (Lebanon, Russia, Brasil etc), the objective is the risk profile of EM debt as part of a diversifed portfolio with hopefully other uncorrelated asset class to provide better risk adjusted returns. Also, these are not stand alone allocations. An EM bond ETF, IF appropriate for a client portfolio, may only represent a small % of the overall assets.

    This idea that passive is a bubble is just too simplistic. The conversation, again, is not passive vs. active - but COST. Active aboslutely has a place in portfolios but not a 2/20, 1/10 or at traditional mutual fund pricing. Also, well constructed passive ETF indices by tier 1 asset managers are being used as efficient exposures in active portoflios.

  • RT

    Richard T.

    28 8 2017 05:51

    2       0

    To follow up my earlier post, I now have the holdings data for the EMB. It comprises 104 corporates and 273 sovs. Lebanon has 9 issues included totalling USD337mm and 2.85% of the EMB mkt cap. Ave daily turnover by value of the EMB is 266mm needing a daily Lebanon trade of 7.5mm to hedge/disaggregate (assuming all one way). Highest EMB amt this year was June 1 at 818mm requiring a Lebanon trade of 23mm spread across the 9 issues = 2.6 per issue. None of the issues is smaller than 1bn and the largest 2bn. These are tiny amts relatively. There is no trace data on these issues but I warrant that daily volumes are many multiples of EMB requirements and the tail is not wagging the dog.

  • RT

    Richard T.

    26 8 2017 04:23

    3       0

    I am sorry but this guy is way off. Someone has already pointed out that the correct way to calculate the P/E of a portfolio is to invert the P/Es, average and reinvert. How does he not know this? Secondly on the EMB, as pointed out Russia trades much higher in yld and his comments about liquidity are just uninformed. The EMB mkt cap is USD 11bn. I do not have data other than the top 10 holdings but the 10th concerntration is 0.70% so USD77mm. This is the Argent 7.5 2026s which is a USD6.5bn issue. So if someone came into sell 10% of the outstanding EMB ETF (a very high figure) it would require the sale of 7.7mm of the Argent 7.5s. Just tiny. The Lebanon issue is likely no more than 0.25-0.3% of the portfolio so getting a bid would similarly not be a problem. Not impressed.

  • CC

    Charnes C.

    24 8 2017 21:25

    2       3

    Not spamming. Just getting the word out. I'm trying to wrap my head around markets, cycles and how they relate to each other. I created a website to connect with others in the investing community. I am not selling anything and simply want to throw my ideas "out there" for critic / comment. As a practicing physician, no one around me seems the least bit interested in markets, debt, cycles, money, gold, etc. Thanks in advance.

  • VP

    Vincent P.

    24 8 2017 18:38

    0       0

    Just great!

  • ii

    ida i.

    24 8 2017 15:45

    1       1

    could you explain the following? I went on bloomberg to check out this harmonic P/E for the QQQ ETF, ad infact it is indicated at round 22 like on the factsheet which states that it is a Harmonic PE. However I checked the data for the Nasdaq 100 index, and it is the same. the PE for the nasdaq composite is 38 almost 39. Does this mean that even the PE of the index is a Harmonic P/E? so indexes like the nasdaq100 is created for the ETF industry? I hope you can clarify, thanks

  • SP

    S P.

    23 8 2017 02:21

    6       0

    This is a very enlightening discussion. ETFs and passive investing have certainly been taken too far. Thank you for this interview.

    It certainly is misleading for the ETFs to omit companies with negative earnings and those with very large PEs. But isn't the weighted harmonic mean the correct way to estimate the PE of the index?

    Let's assume you had 1000 dollars to invest in an index of 4 stocks A,B, C and D with market caps 100 billion, 50 billion, 30 billion and 20 billion dollars each. Assume their respective earnings of 1, 2, 3 and 5 billion respectively (in other words, PE of 100, 25, 10 and 4 respectively). Your $1000 would be split this way: $500 worth of stock A, $250 of B, $150 of C and $100 of D.

    The $500 of A will entitle you to $5 of the earnings. Similarly B will fetch you $10, C will fetch you $15 and D will get you $25. Your $1000 entitles you to $55 of earnings in total. This is an effective PE of 18.18x. This is the weighted average harmonic PE. In other words, one needs to find the weighted average earnings yield and find its inverse to get the index PE.

    The weighted average PE in this example is 58.15 and simple average is 34.75. But we earn much more than 1000/58.15 = 17.2 dollars as shown above. What a high simple average or weighted average PE really tells us is that there are some very high PE stocks in the index (such as Amazon in QQQ) which pull the averages up. It doesn't tell you what earnings you are entitled to.

  • SC

    Sean C.

    23 8 2017 01:21

    3       0

    Just shows you no matter how great an interview is, there are still down votes. I don't get it. I thought it was brilliant.

  • CM

    Cory M.

    22 8 2017 19:20

    3       0

    The last 2 minutes made me nauseous. Equally brilliant as it was terrifying.

  • DT

    Dmitry T.

    22 8 2017 15:41

    3       0

    Very interesting stuff. However, personally I would love to see more detailed description of how funds are created, how money goes in/out, who decides if asset composition has to change and how often, etc.
    The fact that some stocks are mis priced is in itself an opportunity. When market dislocates, it is time to explore how to profit from it. Can we hear more views or some tradable ideas?
    On a negative note, discussion regarding EM bond ETF is completely misleading. Yes, there is a liquid $ Russian Sovereign 2030 maturity bond which trades at 2+% yield. (it is sinking fund so this bond is under 7 years duration, hence low yield). Plus it is owned by Russians, hence trades tight. And other mentioned bonds are also tradable. And relevant debt statistics are available for discussed countries. iShares J.P. Morgan USD Emerging Markets Bond ETF is a well capitalised fund which provides exposure to 30+ countries. So please check your information, otherwise you confuse people.

  • ZH

    Zack H.

    22 8 2017 00:15

    1       0

    Mind blowing😳
    2007 will be a dress rehersal for the real event when all this comes to an end.

  • RA

    Robert A.

    21 8 2017 21:33

    1       0

    Amen Brother, Amen.

  • GS

    Gordon S.

    21 8 2017 16:40

    0       0

    Quote from the interview:

    "[Lebanese] GDP numbers have not been
    published for years. They can't get it together. The most recent GDP numbers I saw I think were from 2008. And I looked on the website of the US Embassy and I looked at the format. It looked familiar to me. Then I went to see CIA Factbook. I think they just came directly from the CIA Factbook."

    I was interested in that affirmation since a friend of mine is Lebanese. I tried googling a little but found no quick evidence. Has someone any article to recommend on that fact? Thanks!

  • RH

    Robert H.

    21 8 2017 13:14

    2       0


  • AC

    Andrew C.

    21 8 2017 02:56

    2       0

    At the 25mins left mark and still lots to go; But the reason why he left his employer investment bank is exactly why ETFs are popular today. Retail investors are sick of getting ripped off with conflicted advice. The 2 and 20 fee model with underperforming advisors is the very reason.

  • AC

    Andrew C.

    21 8 2017 02:28

    0       0

    At the 25mins left mark and still lots to go; But the reason why he left his employer investment bank is exactly why ETFs are popular today. Retail investors are sick of getting ripped off with conflicted advice. The "2

  • BL

    Bruce L.

    20 8 2017 20:57

    3       0

    Brilliant. ( and Grant it was Druckenmuller's boss you were thinking of)

  • RJ

    Robert J.

    20 8 2017 16:29

    0       2

    Pearls before the swine!

  • PC

    Pedro C.

    20 8 2017 14:11

    1       0

    This is a great interview! Brilliant!

  • MR

    Marten R.

    20 8 2017 02:11

    5       0

    ETF acronym challenge...
    Everyone Totally Fooled ? (I can think of another F word which would be equally appropriate...)
    Grant - great work. Steve - brilliant.
    Incentives matter.
    Low fees require mega scale in a equity world where that is not all that easy to find.
    So, the game is rigged.
    Definitions matter.
    Exchange Traded Fund does not mean Indexation.
    (but seriously - PE... does not mean PE? that's next level stuff.. bravo Wall Street... Joe 6 pack get your magnifying glass out and read that fine print... DEVIL... is in that detail).
    The upshot of all this is... our necks are all in the ever constricting and eventually suffocating noose of - Financial Repression.
    Ye shall not escape.
    The very foundation of price discovery in fiat money is the interest rate.
    As that is corrupted, so everything else eventually goes.
    In the new era of central bank dislocation (as opposed to coordination)... watch out.
    Liquidity shock/risk are rising to 'Red Alert' levels.
    Most objective analysis points to overvaluation.
    In everything and everywhere (the everything bubble)...
    Be overweight cash. Thoroughly analyse what's in your portfolio and if you wouldn't buy it at todays prices.. lighten up or sell completely.
    Stay disciplined and remember rule number 1.

  • DH

    Daniel H.

    20 8 2017 00:44

    0       0


  • JH

    Jesse H.

    20 8 2017 00:34

    8       1

    As an engineer, I can say with a reasonable degree of confidence that harmonic means and weighted means are appropriate in the physical world when dealing with electricity, forces, etc. I have not the faintest idea why one would use a harmonic mean for financial products - these types of means apply to wave distortions associated with AC electricity, not financial products. And using the average of the reciprocals, instead of the straight average, is confusing (27 vs. 20 P/E). Would be interested to hear their technical argument (of Vanguard, for example) for such an approach. My BS alarm is going off.

  • JH

    Jesse H.

    20 8 2017 00:29

    3       0

    Fantastic - and inspiring that Bregman had the guts (and integrity) to walk away from what he knew was an unethical product offering. The magic trick of P/E's and the (incredibly) distorted rates on the Russian, Lebanese and Petrobras bond allocations are disturbing. In some ways, this feels like the CDO crisis (magic trick) all over again, but taken to new heights.

  • BF

    Bruce F.

    19 8 2017 22:44

    2       0


  • MO

    Mike O.

    19 8 2017 20:59

    8       0

    Yowie ... I think I get the big picture (and it doesn't look good).

    Unfortunately (for me), I knew almost nothing about the financial markets until the last couple of years (e.g., what is an EBITDA; how about IRR; what does contango, backwardation mean, etc. ... all sorts of terms that I've had to try and learn and understand as I see them in articles).

    The PE stuff here had me scratching my head a bit as I was trying to follow (although I got the concept).

    In my own defense, I only had a 401K with funds in it to invest in ... why did I NEED to know any of this stuff (since I was fully occupied with the demands of a career that took all of the energy that I had to keep up).

    I literally have to THANK YOU so much RealVision TV for the opportunity of a knowledge transfer that you are providing (there's a pretty big hole to fill in my head) ... I only hope it's not too late to be of help.

  • PB

    Pieter B.

    19 8 2017 20:35

    4       0

    My hat off to both of you! Brilliant!

  • SS

    Sam S.

    19 8 2017 19:53

    4       1

    What's an ETF? Ha, just kidding----however----what's being discussed here is exactly that-----what is it really? Mind blowing facts. Please give us the "safe play" to CYA so when the blowup happens, money has to go somewhere. Love the comments that he doesn't listen to financial news anymore------really---not even RV TV? I get it and agree. Learned helplessness.

  • JE

    Jos E.

    19 8 2017 19:31

    3       0

    The bit about EMHY was genuinely mindblowing

  • WM

    Will M.

    19 8 2017 16:51

    1       0

    Ok my interest is really peaked ,,,,, great

  • SA

    Scott A.

    19 8 2017 16:40

    1       0

    Great interview. A true eye opener.

  • MW

    Matthew W.

    19 8 2017 15:44

    11       1

    Grant - the story you were trying to think of at the beginning is Druckenmiller

  • BL

    Barclay L.

    19 8 2017 15:19

    3       0

    Very best yet for Realvision. The market etf vortex of combined consensual craziness is very real. Wealth destruction to follow.

  • CR

    Charlie R.

    19 8 2017 14:06

    7       1

    Excellent in-depth discussion! Way to go Grant/Raoul/RV team! The elemental build of Bregman's preso is so instructive! RV partnership sub is best investment I made recently!

  • SB

    S. B.

    19 8 2017 12:14

    11       0

    Unfortunately, sometimes ETF's are the only viable option for consumers to invest in certain markets. Buying individual companies in for example Emerging Markets or even Frontier markets is very difficult or almost impossible for an individual investor. The other problem is a number of separate stocks you end up with to diversify. Keeping track of each stock is a lot of work, and almost impossible for a non-professional investor, so diversifying in a sector to mitigate risk is the next-best solution. Actively managed funds are less liquid and it is frequently hard to judge which one will outperform.

  • HU

    Henry U.

    19 8 2017 12:07

    3       0

    Great way to start a Saturday morning, Excited for what's coming next.