By Peter E. Bower
There are many financial tools to consider when implementing an investment strategy. Some that have recently gained popularity are Index Funds, ETF’s and Factor Investing.
An index fund is a type of mutual fund with a portfolio constructed to match or track a market index, such as the Standard & Poor’s 500 Index (S&P 500). An index fund is said to provide broad market exposure, low operating expenses and low portfolio turnover. For these reasons as well as others, over the past number of years index funds have become all the rage. The calculation has been that because so many active managers could not outperform index benchmarks, then why not simply invest in the indices? As long as markets were in up trends, this strategy worked pretty well. However, in trading range markets like we are in 2019, these index funds simply track sideways at best.
During big draw downs index funds must sell the underlying stocks to meet redemption requirements. Since most indices are market weighted, the biggest companies have the heavies weighting; these stocks may drag down the entire index.
This is especially true when high value stocks lose their cache or events go against them as has recently happened to some well-known tech and social media companies. While the former winners may be in downtrends, others may be emerging as new growth opportunities. The indices still dominated by past winners will not reflect the growth occurring elsewhere.
Exchange Traded Funds (ETS’s) are baskets of stocks. The basket may be an index, an industry or sector, or some other collection of companies. Most of these are also market weighted and have many of the same flaws as index funds.
The basket or collection is usually not based upon fundamental analysis, so often one gets the good with the not so good; not a valid reason to own them.
A new approach to selecting the securities in any collection has emerged. This is called factor investing and may be found in some of the so called “smart beta” ETF’s. In these, capitalization is replaced by some other metric for selecting and weighting holdings such as cash flow or return on equity. The metrics chosen are static and do not change with conditions. Also, the approach tends to be mechanistic and cannot consider many qualitative factors.
Although not perfect, fundamental analysis still offers the best opportunity to earn good returns, especially when the investing environment is in transition. That is what Riverplace Capital does. Talk with Us!