Ishares
and ETFs: Pushing the DJIA Toward the Cliff
How
many of you remember the immortal words of P. T. Barnum? Of Yogi Berra? On Wall
Street, the incubation period for new product scams may be measured in years
instead of minutes, but the end result is always a lopsided, greed-driven, gold
rush toward financial disaster. The dot.com melt down spawned the index mutual
funds, and their dismal failure gave life to "enhanced" index funds, a wide
variety of speculative hedge funds, and finally, a rapidly growing number of
Index ETFs. Deja Vu all over again, with the popular ishare variety of ETF
leading the lemmings to the cliffs. How far will we allow Wall Street to move us
away from the basic building blocks of investing? Whatever happened to stocks
and bonds? The Investment Gods are not happy.
A
market or sector index is a statistical measuring device that tracks the
movement of price changes in a portfolio of securities that are selected to
represent a portion of the overall market. Index ETF creators: a) select a
sampling of the market that they expect to be representative of the whole, b)
purchase the securities, and then c) issue the ishares, SPDRS, CUBEs, etc. that
you can trade on the normal exchanges just like ordinary stocks. Unlike ordinary
index funds, ETF shares are not handled directly by the fund, and as a result,
they can move either up or down from the value of the securities in the fund,
which, in turn, may or may not mirror the movements of the index they were
selected to track. Confused?
There's more... these things are designed for
manipulation!
Unlike
managed Closed-End Funds (CEFs), ETF shares can be created or redeemed by market
specialists, and Institutional Investors can redeem 50,000 share lots (in kind)
if there is a gap between the net-asset-value and the market price of the fund.
These activities create demand in order to minimize the gap between the fund
net-asset-value and the fund price. Clearly, these arbitrage activities provide
profit-making opportunities to the fund sponsors that are not available to the
shareholders. Perhaps that is why the fund expenses are so low... and why there
are now hundreds of the things to choose from. It is also why a famous 30 stock
Market Average has gone up at three times the speed of all the other
indicators!
Two
other ishare/ETF idiosyncrasies need to be appreciated: a) performance return
statistics for index funds typically do not include fund expenses... it should
be fairly obvious that an index fund will always under-perform its market, and
b) some index funds, ishares in particular, publish P/E numbers that only
include the profitable companies in the portfolio. How do you feel about
that?
So, in
addition to the normal risks associated with investing in general, we add:
speculating in narrowly focused sectors, guessing on the prospects of unproven
small cap companies, experimenting with securities in single countries, rolling
the dice on commodities, and hoping for the eventual success of new
technologies. We then call this hodge-podge of speculations a diversified,
passively managed, inexpensive approach to 21st Century Asset Management! How
this differs from the roots of the dot.com mess is a mystery to me. Once upon a
time, there were high yield junk bond funds that the financial community
insisted were appropriate investments because of their excellent
diversification. Does diversified junk become un-junk? Isn't "Passive
Management" as much of an oxymoron as "Variable Annuity"? Whatever happened to the KISS
Principle?
But
let's not dwell upon the three or more levels of speculation that are the very
foundation of all index funds. Let's move on to the two basic ideas that led to
the development of plain vanilla Mutual Funds in the first place:
diversification and professional management. Mutual Funds were a monumental
breakthrough that changed the Investment World. Hands on investing (without the
self-centered assistance of the banks and insurance companies) became possible
for absolutely everyone. Self directed retirement programs and cheap to
administer employee benefit programs became doable. The investment markets, once
the domain of an elite group of wealthy entrepreneurs, became the savings
accounts of choice for the employed masses. But only because the Funds were
relatively safe with their guarantees of diversification and professional
management! ETFs are just not the answer to the problems we've experienced
lately with traditional Mutual Funds. (Those problems are a function of Fund
Manager Compensation, conflicts of interest within Fund Sponsor Organizations,
the delivery and pricing system for the funds, and believe it or don't, the self
directed retirement programs themselves.)
Here's
a thumbnail sketch of how well the major Passively Managed Indices have done
since the turn of the century: For those six years, the DJIA growth rate
averaged Zero % per year, the S & P 500 averaged Minus 2% per year, and the
NASDAQ Composite averaged Minus 8% per year! How many positive sectors,
technologies, commodities, or capitalization categories could there have been?
Go ahead, add in 1999 just to make yourself feel better and you'll come up with
+2% per year for the DJIA, Zero % annually for the S & P, and a stellar
-1.5% per year for the NASDAQ. Now subtract the fees... hmmmm. Again, how would
those ishares have fared? Hey, when
you buy cheap and easy, it's usually worth it. Now if you want performance, I
suggest you try management. Any management is better than no management, so long
as you are receptive to the strategies or disciplines employed by the manager.
If you can't understand or accept the strategy, don't hire the manager. During
the past six years, there have been more advancing issues than declining ones on
the NYSE, more stocks achieving new highs than new lows. Why did you lose money?
Sure,
you might find some smiles in an ishare or two, particularly if you have the
courage to take your profits, and there may be times when it makes good business
sense to use these products as a hedge against a specific risk. But please, stop
kidding yourself every time Wall Street comes up with a new short cut to
investment success. Don't underestimate the value of experienced management,
even if you have to pay a little extra for it. Actually, there is no reason why
you (and I mean every one of you) can't learn either to run your own investment
portfolio, or to instruct someone how you want it done. Every guess, every
estimate, every hedge, and every shortcut increases risk, because none of the
crystal balls used by those creative product hucksters works very well over the
long haul. Products and gimmicks are never the answer. ETFs, a combination of the two, don't
even address the question properly... AND their rising popularity has raised the
risk level throughout the Stock Market. How's that, you ask? The demand for DJIA
stocks included in ETFs is raising their prices to levels that have nothing to
do with company fundamentals.
What's
in your portfolio?
Note:
The 2nd Edition of "Brainwashing" is coming this fall.
Steve
Selengut
http://www.sancoservices.com
http://www.valuestockbuylistprogram.com
Professional Portfolio Management
since 1979
Author
of: "The Brainwashing of the American Investor: The Book that Wall Street Does
Not Want YOU to Read", and "A Millionaire's Secret Investment
Strategy"
IShares, index funds, ETFs, indexed
investing, Dow Jones, NASDAQ, S & P 500, SPDR, Market Sectors, Mutual Funds,
stock market, sector funds, money, investment management,
Ishares
and ETFs: Pushing the DJIA Toward the Cliff
...
ETFs, a combination of the two, don't even address the question properly... AND
their rising popularity has raised the risk level throughout the Stock Market.
How's that, you ask? The demand for DJIA stocks included in ETFs is raising
their prices to levels that have nothing to do with company fundamentals.
IShares, index funds, ETFs, indexed
investing, Dow Jones, NASDAQ, S & P 500, SPDR, Market Sectors, Mutual Funds,
stock market, sector funds, money, investment management,
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