This Day On The Street
Continue to site right-arrow
ADVERTISEMENT
This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here
Cramer's Action Alerts PLUS - See his portfolio and get alerts BEFORE every trade. Learn more NOW!

Salmon: Why Guru ETFs Beat Human Gurus

NEW YORK (Reuters Blogs) -- Wall Street is no place for shrinking violets, but even by New York standards, Jason Ader has some serious chutzpah: He said last week "the proliferation of index funds and exchange-traded funds" helps activist investors like himself make money.

These big investors are rarely holding "management accountable for underperformance and are not pressuring boards to hold management accountable for underperformance," Ader said at the Reuters Global Investment Summit.

Funds run by well known activists, including Jeff Ubben of ValueAct, Barry Rosenstein of Jana Partners, and Carl Icahn, have returned roughly 14% on average so far this year, twice the amount that the average hedge fund has delivered, partly because they cajole businesses into running their operations better, the activists say.

In principle, this makes sense. One common criticism of passive investing is that if everybody did it, then there would be no price discovery, and that the more passive investors there are, in a market, the easier it becomes to take advantage of them with a little bit of sophisticated analysis and/or activist investing.

But the point at which passive investing becomes self-defeating is a bit like the point at which the gradient of the Laffer curve turns negative, and tax hikes cause revenue losses rather than revenue gains: Both points are far beyond any state of the world that obtains in real-life America. Passive investors are still a minority of all stock-market investors and, what's more, they could easily become a majority without doing any harm to the markets price-discovery abilities. The only thing that matters is that there's a reasonably large number of active marginal price-setters. Since there always will be a reasonably large number of active marginal price-setters, no one ever need fear that the rise of passive investing is going to become self-defeating.

In any event, it's a simple mathematical truth that activist investing has not outperformed passive investing this year. That 14% return looks downright miserable, if you compare it to the 25% year-to-date return on the S&P 500, or any index fund which tracks it.

Of course, if your dream is to beat the market, then you're going to have to invest in something other than a passive index fund. But don't kid yourself that the rise of the passive-investment gospel is going to make your life any easier: It isn't. And don't kid yourself, either, that paying 2-and-20 to anybody is a sensible way to try to achieve your goal. Indeed, there's an increasing number of relatively low-fee exchange-traded funds that aim to replicate the results you'd get from investing with some of the biggest-name investors in the market. (Or, of course, you could just buy stock in Berkshire Hathaway.)

These guru ETFs, as they're known -- one of them even trades under the GURU ticker symbol -- are an outgrowth of the hedge-fund replication industry, and have varying degrees of sophistication. Charles Sizemore does a good job of comparing them: ALFA is incredibly complex; GURU is simpler; the forthcoming iBillionaire ETF (plugged by Tim Fernholz under the headline How to copy a hedge fund billionaires investment plan) is downright naive, based as it is on a strategy of simply looking for S&P 500 components in the 13F filings of certain billionaire investors.

It's easy to laugh at these things -- 13F filings, for instance, are lagging indicators that don't give any indication of how hedged an investor is, or whether they're putting on some kind of relative-value trade, or what their exit strategy might be. But never mind all that: iBillionaire has lots of pretty charts showing consistent outperformance over various time periods from one month to eight years. This is hypothetical outperformance, of course, and surely the index has been structured, and the billionaires in it carefully chosen, so as to make the index look as attractive as possible from today's perspective. Here more than ever, buyer beware: It's all but certain that the index's outperformance will start to disappear now that it's immune to selection bias.

But the fact is, that not all ETFs need to be passive cap-weighted index-trackers, and buying one of these guru ETFs is no sillier than buying a typical actively managed mutual fund. In fact, it's probably more sensible since the discipline of the ETF strategy is baked in to its structure, and it's harder for an all-too-human manager to make silly mistakes. On top of that, no matter how high the fees on these ETFs might go, they'll never come anything close to the kind of fees being charged by Jason Ader and his ilk. The ETFs just sit back and follow a predetermined strategy rather than feeling the need to do the rounds of media organizations, spouting random conviction trades for the coming year. Cheaper and quieter? It's a winning combination.

-- Written by Felix Salmon in New York.

Read more of Felix's blogs at Reuters.

Check Out Our Best Services for Investors

Action Alerts PLUS

Portfolio Manager Jim Cramer and Director of Research Jack Mohr reveal their investment tactics while giving advanced notice before every trade.

Product Features:
  • $2.5+ million portfolio
  • Large-cap and dividend focus
  • Intraday trade alerts from Cramer
Quant Ratings

Access the tool that DOMINATES the Russell 2000 and the S&P 500.

Product Features:
  • Buy, hold, or sell recommendations for over 4,300 stocks
  • Unlimited research reports on your favorite stocks
  • A custom stock screener
Stocks Under $10

David Peltier uncovers low dollar stocks with serious upside potential that are flying under Wall Street's radar.

Product Features:
  • Model portfolio
  • Stocks trading below $10
  • Intraday trade alerts
14-Days Free
Try it NOW
Only $9.95
Try it NOW
14-Days Free
Try it NOW

Check Out Our Best Services for Investors

Dividend Stock Advisor

David Peltier identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

Product Features:
  • Diversified model portfolio of dividend stocks
  • Updates with exact steps to take - BUY, HOLD, SELL
Trifecta Stocks

Every recommendation goes through 3 layers of intense scrutiny—quantitative, fundamental and technical analysis—to maximize profit potential and minimize risk.

Product Features:
  • Model Portfolio
  • Intra Day Trade alerts
  • Access to Quant Ratings
Options Profits

Our options trading pros provide over 100 monthly option trading ideas and strategies to help you become a well-seasoned trader.

Product Features:
  • Actionable options commentary and news
  • Real-time trading community
Try it NOW
Try it NOW
Try it NOW
To begin commenting right away, you can log in below using your Disqus, Facebook, Twitter, OpenID or Yahoo login credentials. Alternatively, you can post a comment as a "guest" just by entering an email address. Your use of the commenting tool is subject to multiple terms of service/use and privacy policies - see here for more details.
Submit an article to us!
SYM TRADE IT LAST %CHG
AAPL $124.43 0.00%
FB $82.22 0.00%
GOOG $548.00 0.00%
TSLA $188.77 0.00%
YHOO $44.44 0.00%

Markets

DOW 17,776.12 -200.19 -1.11%
S&P 500 2,067.89 -18.35 -0.88%
NASDAQ 4,900.8850 -46.5560 -0.94%

Partners Compare Online Brokers

Free Reports

Free Newsletters from TheStreet

My Subscriptions:

After the Bell

Before the Bell

Booyah! Newsletter

Midday Bell

TheStreet Top 10 Stories

Winners & Losers

Register for Newsletters
Top Rated Stocks Top Rated Funds Top Rated ETFs