Better Investment Results Often Come When You Don’t Mess With What’s Working

This article was written with Oliver Pursche, the Co-Portfolio Manager of GMG Defense Beta Fund. It was part of a series of articles developed under an agreement with forbes.com to work with a variety of contributors and assist them in delivering actionable investment ideas each week. The site, forbes.com is one of the top 500 sites in the world with nearly 10 million subscribers and nearly 100 million page views a month.

The reason exchange-traded funds earned such tremendous traction in the market place is because they work. The ability to invest ‘real time,’ as opposed to market close, lower fees, little to no tracking error, simplicity, transparency and tax efficiency are a few of the reasons dollars flowed into ETFs.

Just for perspective, according to the Investment Company Institute, ETF assets stand at $1.2 trillion, versus mutual fund assets, which stand at about $12.3 trillion.

But I’m starting to see a small yet troubling crack in the otherwise winning façade of ETFs: actively managed ETFs. Did you ever see those jars with the peanut butter and jelly mixed together in layers? I think that’s just about the right comparison here. Seems like a logical idea–just like mixing active and passive management strategies seems logical–but in reality, not so much.

To see why this is so, let’s start by taking a look at the results of some already quasi-active ETFs. For example, investors who are seeking to invest in consumer staples could select the Vanguard Consumer Staple ETF (VDC), which is about as straight forward of an ETF you could invest in. This fund holds stalwarts such as Procter & Gamble, Coca-Cola and Philip Morris International.

Alternatively, investors could select the “enhanced” PowerShares Dynamic Food & Beverage ETF with the ironically chosen PBJ symbol. VDC has a 7% portfolio turnover rate, and a 0.19% expense ratio. Conversely, PBJ provides investors with a 134% portfolio turnover rate and a 0.63 expense ratio. Like VDC, PBJ owns Coca-Cola. Other top holdings include Monsanto, Hershey and Whole Foods.

VDC has outperformed PBJ. By a lot. For VDC the year to date and one year returns are 10.95% and 17.43%, respectively versus the PBJ’s 3.66% and 1.46%. So, that’s three times the expense for about one third of the performance.

I certainly respect the people at PowerShares, and a single comparison for a single year is hardly an exhaustive study. Moreover, I would not rule out actively managed ETFs for investors where they provide access to some specialized expertise in a far flung corner of the market.

I would say however, that for executing on the basics of most investment strategies, do what every kid over the age of five making a peanut butter and jelly sandwich already knows: don’t mix ingredients meant to be sold separately if you want a good result.

More Posts

Financial Institutions Feeling the Crunch in Countdown to CECL Implementation

I was retained by Big Four accounting and consulting firm KPMG to assist them in their thought leadership efforts centered on changing accounting regulations. In this case, the Financial Accounting Standards Board or FASB had instituted new rules on the measurement of current and expected credit losses, i.e. CECL, that would require massive reorganization of financial reporting for the largest financial services organizations in the world. This thought leadership piece concerned the results of a survey among C-suite executives about their state of preparedness in the final countdown to the CECL implementation.

Read More »
Scroll to Top