Posts filed under ‘Exchange Traded Funds (ETFs)’
All the recent media focus has been fixated on whether the Dow Jones Industrial Average index (“The Dow”) will close above the 13,000 level. In the whole scheme of things, this specific value doesn’t mean a whole lot, but it does make for a great topic of conversation at a cocktail party. Today, the Dow is trading at 12,983, a level not achieved in more than three and a half years. Not a bad accomplishment, given the historic financial crisis on our shores and the debacle going on overseas, but I’m still not so convinced a miniscule +0.1% move in the Dow means much. While the Dow and the S&P 500 indexes garner the hearts and minds of journalists and TV reporters, the ugly stepchild index, the NASDAQ, gets about as much respect as Rodney Dangerfield (see also No Respect in the Investment World).
While the S&P 500 hundred has NOT even reached the level from one year ago, the technology-heavy NASDAQ index has hit a 11+ year record high. Yes that’s right; the NASDAQ has not reached these levels since December 2000. Sure, the NASDAQ receives a lot of snickers since the technology bubble burst in 2000, when the index peaked at over 5,100 and subsequently plummeted to 1,108 (-78%) over the ensuing 31 months. But now the ugly stepchild index is making an extraordinary comeback into maturity. Since September 2002, near the lows, the NASDAQ has outperformed both the Dow and the S&P 500 indexes by more than a whopping 80%+, excluding dividends.
With the NASDAQ (and NASDAQ 100) hitting a new decade-plus high, are we approaching bubble-esque P/E ratios (price-earnings) of the 2000 era? Not even close. According to Birinyi Associates, the NASDAQ 100 index (QQQ) forward P/E ratio is priced at a reasonable 14x level – much lower than the 100x+ ratios we experienced right before the NASDAQ crash of 2000 and close to the P/E of the S&P 500.
With these NASDAQ indexes hitting new highs, does this tell us they are going to go significantly higher? No, not necessarily…just ask buyers of the NASDAQ in the late 1990s how that strategy worked then. Trying to time the market is a fruitless cause, and will always remain so. A few people will be able to do it occasionally, but doing so on a sustained basis is extremely difficult (if not impossible). If you don’t believe me, just ask Alan Greenspan, former Federal Reserve Chairman, who in 1996 said the tech boom had created “irrational exuberance.” When he made this infamous statement in 1996, the NASDAQ was trading around 1,300 – I guess Greenspan was only off by about another 3,800 points before the exuberance exhausted.
While a significantly outperforming index may not give you information on future prices, leadership indexes and sectors can direct you to fertile areas of research. Trends can be easy to identify, but the heavy lifting and sweat lies in the research of determining whether the trends are sustainable. With the significant outperformance of the NASDAQ index over the last decade it should be no surprise that technology has been leading the index brigade. The NASDAQ composite data is difficult to come by, but with the Technology sector accounting for 65% of the NASDAQ 100 index weighting, it makes sense that this index and sector should not be ignored. Cloud computing, mobility, e-commerce, alternative energy, and nanotechnology are but just a few of the drivers catapulting technology’s prominence in financial markets. Globalization is here to stay and technology is flattening the world so that countries and their populations can participate in the ever-expanding technology revolution.
Investors can continue to myopically focus on the narrow group of 30 Dow stocks and its arbitrary short-term target of 13,000, however those ignoring the leadership of the ugly stepchild index (NASDAQ) should do so at their own peril. Ugliness has a way of turning to beauty when people are not paying attention.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, including SPY, but at the time of publishing SCM had no direct position in QQQ, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Over previous decades, there has been a continual battle between the merits of active versus passive management. Passive management being what I like to call the “do nothing” strategy, in which a basket of securities is purchased, and the underlying positions remain largely static. For all intents and purposes, the passive management strategy is controlled by a computer. Rather than solely using a computer, active management pays professionals six or seven figures to fly around to conferences, interview executive management teams, and apply their secret sauce tactics. Unlike passive managers, active managers do their best to determine which winning securities to buy and which losing ones to sell in their mutual funds and hedge funds.
Caught in the middle of this multi-decade war between passive and active management are Vanguard Group (founded in Valley Forge, Pennsylvania in 1975 by John Bogle) and Fidelity Investments (founded in 1946 in Boston, Massachusetts by Edward C. Johnson II). Currently John Bogle and Vanguard’s passive philosophy is winning the war. A changing of the guard, similar to the daily ceremony witnessed in front of Buckingham Palace is happening today in the mutual fund industry. Specifically, Vanguard, the company spearheading passive investing, has passed Fidelity Investments as the largest mutual fund company according to assets under management. Before 2010, Fidelity topped the list of largest firms every year since 1988, when it passed the then previous leader, Merrill Lynch & Co (BAC).
As of July 2010, Vanguard stands at the top of the mutual fund hill, managing $1.31 trillion versus Fidelity’s $1.24 trillion. Vanguard is sufficiently diversified if one considers its largest fund, the Vanguard Total stock Market Index Fund (VITSX), sits at around $127 billion in assets. The picture looks worse for Fidelity, if you also account for the $113 billion in additional ETF assets (Exchange Traded Funds) Vanguard manages – Fidelity is relatively absent in the ETF segment (State Street). Once famous active funds, such as Fidelity Magellan (now managed by Harry Lange – FMAGX) have underperformed the market over the last ten years causing peak assets of $110 billion in 2000 to decline to around $22 billion today. The $68 billion Fidelity Contrafund (FCNTX), managed by Will Danhoff, has not grown sufficiently to offset Magellan’s (and other funds) declines.
The Proof is in the Pudding
Some in the industry defend the merits of active management, and through some clever cherry-picking and data mining come to the conclusion that passive investing is overrated. If you believe that money goes where it is treated best, then the proof in the pudding suggests active management is the discipline actually suffering the beating (see Darts, Monkeys & Pros). The differences among the active-passive war of ideals have become even more apparent during the heart of the financial crisis. Since the beginning of 2008 through August 2010, Morningstar shows $301 billion in assets hemorrhaging from actively managed U.S. equity funds, while passive equity-index funds have soaked up $113 billion of inflows.
On a firm-specific basis, InvestmentNews substantiated Vanguard’s gains with the following figures:
In the 10 years ended Dec. 31, Vanguard’s stock and bond funds attracted $440 billion, compared with $101 billion for Fidelity, Morningstar estimates. This year through August, Vanguard pulled in $49 billion while Fidelity had withdrawals of $2.8 billion, according to the research firm.
Vanguard is gaining share on the bond side of the house too:
Vanguard also benefited from the popularity of bond funds. From Jan. 1, 2008, through Aug. 31, 2010, the company’s fixed- income portfolios pulled in $134 billion while Fidelity’s attracted $33 billion (InvestmentNews).
Vanguard is not the only one taking share away from Fidelity. Fido is also getting pinched by my neighbor PIMCO (Pacific Investment Management Company), the $1.1 trillion assets under management fixed income powerhouse based in Newport Beach, California. Bond guru Bill Gross leads the $248 billion Pimco Total Return Fund (PTTAX), which has helped the firm bring in $54 billion in assets thus far in 2010.
Passive Investing Winning but Game Not Over
Even with the market share gains of Vanguard and passive investing, active management assets still dwarf the assets controlled by “do-nothing” products. According to the Vanguard Group and the Investment Company Institute, about 25% of institutional assets and about 12% of individual investors’ assets are currently indexed (2009). The analysis gets a little more muddied once you add ETFs to the mix.
Passive investing may be winning the game of share gains, but is it winning the performance game? The academic research has been very one-sided in favor of passive investing ever since Burton Malkiel came out with his book, A Random Walk Down Wall Street. More recently, a study came out in June 2010 by Standard & Poor’s Indices Versus Active Funds (SPIVA) division showing more than 75% of active fixed income managers underperforming their index on a five-year basis. From an equity standpoint, SPIVA confirmed that more than 60% domestic equity funds and more than 84% international equity funds underperformed their benchmark on a five-year basis. InvestmentNews provides some challenging data to active-management superiority, however it is unclear whether survivorship bias, asset-weighting, style drift, and other factors result in apples being compared to oranges. SPIVA notes the complexity over the last three years has increased due to 20% of domestic equity funds, 13% of international equity funds, and 12% of fixed income funds liquidating or merging.
Regardless of the data, investors are voting with their dollars and happily accepting the superior performance, while at the same time paying less in fees. The positive aspects associated with passive investment products, such as index funds and ETFs, are not only offering superior performance like a Ferrari, but that enhanced quality also comes at the low price equivalent of a Hyundai. On a dollar-adjusted basis, stock-index funds charge an average of 29 cents per $100, compared with 95 cents for active funds (almost a 70% discount), according to research firm Lipper. For example, Vanguard’s passive VITSX fund charges clients as little as 6 cents for every $100 invested (Morningstar).
There has indeed been a changing of the market share guard and Fidelity may also be losing the debate over active versus passive management, but you do not need to shed a tear for them. Fidelity is not going to the poorhouse and will not be filing for Chapter 11 anytime soon. Last year Fidelity reported $11.5 billion in revenue and $2.5 billion in operating income. Those Fidelity profits should be more than enough to cover the demoted guard’s job retraining program and retirement plan benefits.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in VITSX, PTTAX, BAC, FCNTX, FMAGX, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Still fresh in the minds of investors are the open wounds created by the incredible volatility that peaked just a little over a year ago, when the price of insurance sky-rocketed as measured by the Volatility Index (VIX). Even though equity markets troughed in March of 2009, earlier the VIX reached a climax over 80 in November 2008. With financial institutions falling like flies and toxic assets clogging up the lending pipelines, virtually all asset classes moved downwards in unison during the frefall of 2008 and early 2009. The traditional teeter-totter phenomenon of some asset classes rising simultaneously while others were falling did not hold. With the recent turmoil in Greece coupled with the “Flash Crash” (read making $$$ trading article) and spooky headline du jour, the markets have temporarily reverted back to organized chaos. What I mean by that is even though the market recently dove about +8% in 8 days, we saw the teeter-totter benefits of diversification kick in over the last month.
While the S&P fell about -4.5% over the studied period below, the alternate highlighted asset classes managed to grind out positive returns.
While traditional volatility has returned after a meteoric bounce in 2009, there should be more investment opportunities to invest around. With the VIX hovering in the mid-30s after a brief stay above 40 a few weeks ago, I would not be surprised to see a reversion to a more normalized fear gauge in the 20s – although my game plan is not dependent on this occurring.
Regardless of the direction of volatility, I’m encouraged that even during periods of mini-panics, there are hopeful signs that investors are able to seesaw through periods of organized chaos with the assistance of good old diversification.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
*DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds (including AGG, BND, VNQ, IJR and TIP), but at the time of publishing SCM had no direct positions in VXX, GLD, or any security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Bob Turner is founder of Turner Investments and a manager of several funds at the investment company. In a recent article he reintroduces the all-important, longstanding debate of active management (“hands-on”) versus passive management (“hands off”) approaches to investing.
Mr. Turner makes some good arguments for the active management camp, however some feel differently – take for example Burton Malkiel. The Princeton professor theorizes in his book A Random Walk Down Wall Street that “a blindfolded monkey throwing darts at a newspaper’s stock page could select a portfolio that would do just as well as one carefully selected by experts.” In fact, The Wall Street Journal manages an Investment Dartboard contest that stacks up amateur investors’ picks against the pros’ and random stock picks selected by randomly thrown darts. In many instances, the dartboard picks outperform the professionals.
Given the controversy, who’s right…the darts, monkeys, or pros? Distinguishing between the different categorizations can be difficult, but we will take a stab nevertheless.
Arguments for Active Management
Turner contends, active management outperforms in periods of high volatility and he believes the industry will be entering such a phase:
“Active managers historically have tended to perform best in a market in which the performance of individual stocks varies widely.”
He also acknowledges that not all active managers outperform and admits there are periods where passive management will do better:
“The reason why most active investors fail to outperform is because they in fact constitute most of the market. Even in the best of times, not all active managers can hope to outperform…The business of picking stocks is to some degree a zero-sum game; the results achieved by the best managers will be offset at least somewhat by the subpar performance of other managers.”
Buttressing his argument for active management, Turner references data from Advisor Perspectives showing an inconclusive percentage (40.5%-67.8%) of the actively managed funds trailing the passively managed indexes from 2000 to 2008.
The Case for Passive Management
Turner cites one specific study to support his active management cause. However, my experience gleaned from the vast amounts of academic and industry data point to approximately 75% of active managers underperforming their passively managed indexes, over longer periods of time. Notably, a recent study conducted by Standard & Poor’s SPIVA division (S&P Indices Versus Active Funds) discovered the following conclusions over the five year market cycle from 2004 to 2008:
- S&P 500 outperformed 71.9% of actively managed large cap funds;
- S&P MidCap 400 outperformed 79.1% of mid cap funds;
- S&P SmallCap 600 outperformed 85.5% of small cap funds.
According to the Vanguard Group and the Investment Company Institute, about 25% of institutional assets and about 12% of individual investors’ assets are currently indexed (passive strategies). If you doubt the popularity of passive investment strategies, then look no further than the growth of Exchange Traded Funds (ETFs – see chart), index funds, or Vanguard Groups more than $1 trillion dollars in assets under management.
Although I am a firm believer in passive investing, one of its shortcomings is mean reversion. This is the idea that upward or downward moving trends tend to revert back to an average or normal level over time. Active investing can take advantage of mean reversion, conversely passive investing cannot. Indexes can get very top-heavy in weightings of outperforming sectors or industries, meaning theoretically you could be buying larger and larger shares of an index in overpriced glamour stocks on the verge of collapse. We experienced these lopsided index weightings through the technology bubbles in the late 1990s and financials in 2008. Some strategies may be better than other over the long run, but every strategy, even passive investing, has its own unique set of deficiencies and risks.
Professional Sports and Investing
As I discuss in my book, there are similarities that can be drawn between professional sports and investing with respect to active vs. passive management. Like the scarce number of .300 hitters in baseball, I believe there are a select few investment managers who can consistently outperform the market. In 2007, AssociatedContent.com did a study that showed there were only 22 active career .300 hitters in Major League Baseball. I recognize in the investing world there can be a larger role for “luck,” which is difficult, if not impossible, to measure (luck won’t help me much in hitting a 100 mile per hour fastball thrown by Nolan Ryan). Nonetheless, in the professional sports arena, there are some Hall of Famers (prospects) that have proved they could (can) consistently outperform their peers for extended durations of time.
Experience is another distinction I would highlight in comparing sports and investing. Unlike sports, in the investment world I believe there is a positive correlation between age and ability. The more experience an investor gains, generally the better long-term return achieved. Like many professions, the more experience you gain, the more valuable you become. Unfortunately, in many sports, ability deteriorates and muscles atrophy over time.
Experience alone will not make you a better investor. Some investors are born with an innate gift or intellect that propels them ahead of the pack. However, most great investors eventually get cursed by their own success thanks to accumulating assets. Warren Buffet knows the consequences of managing large amounts of dollars, “gravity always wins.” Having managed a $20 billion fund, I fully appreciate the challenges of investing larger sums of money. Managing a smaller fund is similar to navigating a speed boat – not too difficult to maneuver and fairly easy to dodge obstacles. Managing heftier pools of money can be like captaining a supertanker, but unfortunately the same rapid u-turn expectations of the speedboat remain. Managing large amounts of capital can be crippling, and that’s why captaining a supertanker requires the proper foresight and experience.
Room for All
As I’ve stated before, I believe the market is efficient in the long run, but can be terribly inefficient in the short-run, especially when the behavioral aspects of emotion (fear and greed) take over. The “wait for me, I want to play too” greed from the late 1990s technology craze and the credit-based economic collapse of 2008-2009 are further examples of inefficient situations that can be exploited by active managers. However, due to multiple fees, transaction costs, taxes, not to mention the short-term performance/compensation pressures to perform, I believe the odds are stacked against the active managers. For those experienced managers that have played the game for a long period and have a track record of success, I feel active management can play a role.
At Sidoxia Capital Management, I choose to create investment portfolios that blend a mixture of passive and active investment strategies. Although my hedge fund has outperformed the S&P 500 in 2009, that fact does not necessarily mean it’s the appropriate sole approach for all clients. As Warren Buffet states, investors should stick to their “circle of competence” so they can confidently invest in what they know. That’s why I generally stick to the areas of my expertise when I’m actively investing in stocks, and fill in the remainder of client portfolios with transparent, low-cost, tax-efficient equity and fixed income products (i.e., Exchange Traded Funds).
Even though the actively managed Turner Funds appear to have a mixed-bag of performance numbers relative to passively managed strategies, I appreciate Bob Turner’s article for addressing this important issue. I’m sure the debate will never fully be resolved. In the meantime, my client portfolios will aim to mix the best of both worlds within active and passive management strategies in the eternal quest of outwitting the darts, monkeys, and other pros.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds but had no direct position in stocks mentioned in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Isn’t the market volatile enough without leverage? I believe the vast majority of individuals have plenty of adrenaline in their daily investment lives without the necessity of exotic inverse ETFs (Exchange Traded Funds) or other leveraged investment vehicles. FINRA (Financial Industry Regulatory Authority), the largest regulating body overseeing U.S. securities firms feels much the same way. Many of these ETFs seek to earn a daily return double or triple a designated index – the inverse instruments strive to mirror the return in the opposite direction.
No doubt, many exchange traded funds have some key advantages over actively managed mutual funds such as lower costs, tax efficiency, and improved liquidity; however most investors have no business in trading these crazy leveraged gimmicks. For example, I wouldn’t recommend average investors speculating in the Direxion 3X Inverse Financial Bull (FAS) ETF, which was down more than 95% in its first four months of existence. Do yourself a favor and heed the advice of stuntmen that advise, “Please, do not try this at home.”
FINRA conveyed this sentiment in a recent notice:
“While such products may be useful in some sophisticated trading strategies, they are highly complex financial instruments that are typically designed to achieve their stated objectives on a daily basis. Due to effects of compounding, their performance over longer periods of time can differ significantly from their stated daily objective.”
The Wall Street Journal article goes on to show a return example of how three different funds performed (vanilla index fund, double long fund, double inverse fund) under alternating positive and negative +/-10% day scenarios. After 60 days of alternating up +10% and down -10% on an initial investment of $100, the index fund ended at a value of $40.47 while the double inverse funds finished worth a meager $2.54 each. The example proves that the correlation between the leveraged ETF and the underlying target index can vary dramatically when invested for longer periods than a day.
These levered products make for excellent brokerage and trading software commercials, but rather than getting sucked in to talking baby traders and fast moving graphics, the average day trader or casual investor would be better served by bungee jumping or sky diving to get their adrenaline fix.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in FAS, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Water engulfs our daily lives – we drink, bathe, wash clothes, soak our lawns and brush our teeth with it on a consistent basis. We notice our reliance in our monthly water bills. The earth is covered by approximately 70% water, so if this commodity is so abundant, then how could it be such a scarce, valuable resource? Water is so important; the majority of our body mass consists of the fluid (about 60% in males and 55% in females). Although our planet is covered with this liquid, the main problem surrounding the issue is that only about 2% of the water supply is considered fresh water (predominantly located in Antarctica). Desalinization of salt water is one solution to the limited amount of fresh water, but unfortunately the current technology and energy requirements make it a cost prohibitive process. As a result of the inadequate supply, over an estimated 1 billion people do not have access to clean water and 2.4 billion people are subject to stressed water conditions.
In the “Golden State” of California, budgetary problems are not the only concern on people’s minds – the state is in the middle of a water shortage. Certain water jurisdictions are escalating prices by upwards of +15%. Regardless of your view on “climate change,” objective data points to declining water levels and heightened scarcity. By 2030, OECD predicts that half of the world’s population will live in areas under severe water stress.
I’m certainly not the only believer in this theme as an investment opportunity. T. Boone Pickens, renowned commodity investor, is spending over $100 million on water investments (including access to water rights) because he believes that H2O is the next oil. Water, like oil, is a depleting resource that will experience intensified demand over time.
How to Invest in Water:
Not everyone has millions of dollars like Pickens to invest in land and water rights, so there are different ways for the average investor to participate in the rising demand for water. For example, investors, like Sidoxia Capital Management, can invest in ETFs (exchange traded funds) with a water focus. ETF options include, PowerShares Water Resources (PHO), PowerShares Global Water ETF (PIO), and/or Claymore S&P Global Water (CGW). For those wishing to invest in individual stocks, some water related companies include, Nalco Holding Company (NLC), Danaher Corporation (DHR), Itron Inc. (ITRI), and Valmont Industries, Inc. (VMI).
Water Demand Drivers
- The globe’s population of approximately 6.5 billion people is growing and becoming thirstier. Water demand is expanding much faster than population growth.
- Climate change exacerbates the growing water supply problem.
- Agriculture and irrigation needs are driving the majority of global water demand.
- There is no substitute for water at any price.
Conservation, technology, and efficiency are tools to improve the usage of our finite water resources. As the water problem becomes more acute, profiting from water investments is a way to offset the inevitably higher costs of usage. Now if you’ll please excuse me, I’m thirsty for a glass of water.
Wade W. Slome, CFA, CFP® www.Sidoxia.com
DISCLOSURE: At the time of publishing, Sidoxia Capital Management and some of its clients owned certain exchange traded funds (including PHO & CGW), but had no direct positions in PIO, CGW, NLC, DHR, ITRI, VMI, or any other security referenced. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.