While many in the financial industry have lauded the expansion of the ETF vehicle as a significant step toward democratization, particularly for making previously inaccessible assets like cryptocurrency and private credit available to a broader range of individual investors, renowned investor Jeffrey Gundlach holds a contrarian view.
Integrating volatile and illiquid assets into the ETF structure is something to be avoided, DoubleLine CEO and CIO Gundlach said in response to a question about the increasing proliferation of bitcoin ETFs during the DoubleLine Total Return Webcast on June 10.
Gundlach's concern stems from the potential for these novel ETF offerings to introduce systemic risks and liquidity mismatches. This would ultimately harm the very investors these products aim to empower. The ease of access provided by the ETF wrapper might mask the inherent complexities and risks of the underlying assets. This could lead to uninformed investment decisions and potential market instability.
Complex Products Are Rarely Brought to the ETF Market in Time to Capture Performance
When an asset class that was previously reserved for institutional investors suddenly becomes retail-oriented, it typically happens following a period of strong outperformance, according to Gundlach.
This is often presented as a great opportunity for the small Main Street investor. However, as the industry saying goes, "Past performance is no guarantee of future success." Buying an asset after it has already appreciated is essentially chasing momentum. For individual investors, this usually occurs closer to the end of a market move, not the beginning, Gundlach said.
“I do think it's a poor idea to take illiquid products – and I would say bitcoin is quite illiquid just given its daily volatility at times – and put them into liquid vehicles,” Gundlach said. “You're putting a square peg in a round hole.”
ETFs Holding Other Illiquid Assets Will Experience the Same Risks
A similar situation is unfolding with private credit. There's a growing narrative about opening up this great opportunity to Main Street investors. This narrative is largely predicated on the segment’s strong performance over the past five years.
However, a deeper look reveals that private credit is no longer exhibiting the same level of outperformance it once did. The substantial success observed within that five-year period was primarily concentrated in the earlier part of that time frame.
Additionally, private credit remains an illiquid asset class, and challenges arise when it's placed into the ETF vehicle.
“If you put an illiquid asset class into a daily NAV or a daily traded fund, you have a mismatch between the investment’s liquidity and the investor’s perceived liquidity, or promised liquidity, because of the daily liquidity feature,” Gundlach said. “I think that that's something to always avoid.”
This fundamental mismatch between the underlying asset and the investment vehicle's liquidity features is a weakness for investors. It could potentially lead to situations where investors believe they have readily accessible capital, only to find themselves unable to redeem their investments at desired prices or within expected timeframes when market conditions shift.
Other Investment Opportunities Worth Exploring
Bitcoin and private credit ETFs may not be worth exploring in the current environment. But there are ways that investors can position themselves, particularly if worried about economic weakness.
Many investors have wondered if now is the right time to pivot to long-term Treasury bonds. A significant shift toward long bonds could be a sound strategy in the future, but that time has not yet arrived, according to Gundlach.
“Do not buy long bonds if you're worried about economic weakness — not yet,” he said. “My game plan ... is that there will be a shift in governmental policy once the interest rate on long bonds gets too high.”
Therefore, in the face of potential economic weakness, Gundlach sees gold as a more favorable asset than long-term Treasury bonds.
Additionally, investments in international markets may be worth consideration. Germany is currently undergoing reindustrialization and economic stimulation, making it an interesting play, according to Gundlach. This trend is expected to enhance productive capacity and lead to improved stock market performance in the region.
Diversifying away from U.S.-only investments has been a key theme for DoubleLine for the past few years. Gundlach has reiterated his recommendation that one invest in European stocks as well as other non-U.S. stocks in other recent webcasts.
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