Fidelity Capitulates

Dec 06, 2011

Recently, Fidelity announced that is has filed to offer a list of new ETFs.   There were some comments made about how Fidelity ETFs will be within a ‘master-feeder’ structure between the existing mutual funds and the new products.    Quite honestly, who cares?   We as investors don’t unless it’s something that is actually innovative from an investment perspective.   The only thing interesting about this news is the implied competitive duel that is going on in the industry --- as it is this competition that is helping us to pay no commissions and be charged expense ratios that are extremely low. 

The big rivalry in the mass-market U.S. brokerage industry is between the two clear top-tier firms:  Schwab and Fidelity.   TD Ameritrade is making great strides and arguably has one of the best combinations of a software platform and low-cost ETF options but TD Ameritrade is not really in the same class in terms of brand name and size as the first two.   Other large firms like Vanguard, American Funds and Franklin-Templeton are all in a slightly different sphere, in our opinion as their primary businesses are more clearly in-house managed mutual funds.  Fidelity grew to be more than just a mutual fund firm many years ago.   Internally at Schwab, Fidelity is enemy #1– not Vanguard or Ameritrade.

Schwab’s ETF offerings are still pretty weak -- nothing but U.S. growth and value ETFs and some no-frills broad international funds.    Yawn.   There isn’t much money in ETFs for anyone but the investor – which to us makes this all an even MORE interesting game to watch unfold.   Fees that come out of mutual fund and brokerage firms go directly into investors pockets.   The costs of investing are important.  Vanguard has been rolling over the mutual fund industry for years by intentionally passing the savings on to the investor and it’s all a very, very good thing. 

Vanguard was actually quite late to the game when it launched ETFs many years ago so the fact that Fidelity waited until December 2011 to capitulate on ETFs implies just how much kicking and screaming must have gone on inside Fidelity on this secular trend toward ETFs.   The trend is powerful and accelerating.  In both advisor managed portfolios and next in 401(k) plans, ETFs are clearly becoming the core building blocks of modern portfolios, a role traditionally split between individual stocks and mutual funds.

iShares – now a part of Blackrock was the firm that drove the industry forward.   If we had to pick a #2 it would be State Street (SPDR) --- but even they were slow to expand their offerings beyond the basics.   Small firms with just a few good offerings --  like Van Eck (whose brand name is Market Vectors) and WisdomTree have now reached more than $10 billion in assets.   But because fees are low, $10 billion in ETF assets is not that much revenue for a firm the size of Fidelity.  Nevertheless, the world is changing and Fidelity needs to do something about it or Schwab is going to end up owning the 401(k) ETF market by itself -- a massive market currently dominated by mutual fund companies but one that will eventually move to ETFs.

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ETFreplay Review

Nov 29, 2011

The link below is an independent ETFreplay review from Stocks & Commodities magazine:


Stocks & Commodities Product Review:


" is an exceptional website that provides the analytical tools and backtesting capability for..."


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Tracking Error Nuances

Nov 10, 2011

We realize we've written a number of blogs now about 'nuances' in financial analysis. This is the nature of it --- you must learn some of the details involved in assumptions. It is a part of what being a financial analyst is about.

The nuance we will discuss here concerns 'tracking error.' Tracking error just means how closely the ETF price reflects the underlying portfolio value. 

The way an ETF provider measures ETF tracking error and posts on their website is to calculate the midpoint of the closing bid-ask spread vs the underlying per share value of the benchmark it is tracking.  The nuance here is that this is not how regular closing price is determined in your brokerage or quote service.  

Closing price defaults to the last trading price of the day.  So we have a mismatch.   On the one hand, if you went to trade a given ETF, you obviously would get it near the bid or ask.   But if you are looking at the official exchange closing price on any given day, it will be the last price -- not the closing bid-ask midpoint.

This actually has important implications in backtesting as you could have large tracking error on market price -- even if there is low tracking error as calculated by the ETF providers. 

Happily, there is an easy way to adjust for this ---  only use data where the ETF is liquid (and WAS liquid for the backtest period under analysis).  It the ETF is liquid, it will actually be trading at the end of day and the closing price and the midpoint of the closing bid-ask will be very close -- true tracking error will be small.

We will point out that in this case, it is not that the ETF providers are doing something wrong --- they are showing a good reflection of an actual trade if done at the close.  It is clearly up to the financial analyst to think about this and do their own diligence.  You are the one responsible for your decisions in the end -- nobody else.

Let's say an ETF only trades a few times a day -- and let's say that on a particular day the last price was 10am.  Then let's say the underlying index moved materially up or down into the close -- the closing price would reflect the 10am price -- despite clearly not being a true price you could trade -- and note that this difference would NOT be considered 'tracking error' because that is determined by the midpt of the closing bid-ask.   But there clearly will be substantial tracking error using closing price data when the security is illiquid.

Again, there is a simple solution to this --- only use data where there there is substantial liquidity.  We have hundreds of choices of liquid ETFs that have been liquid for many years now -- you don't have to bother with the 8th US Consumer Discretionary ETF that is slightly different than the first 7 but trades no volume.  The data won't be any good.  If its a valid investment -- 9 times out of 10 it will get to liquidity relatively quickly.  If you want to use less liquid ETFs, that is fine so long as you understand the difference.  Take pride in understanding these nuances -- it's part of being a good analyst.

Related to this topic, take note that we've listened to user requests and added a page to show New Additions to  We will continue to add any ETF that trades at least some level of volume.  For what its worth, ETFreplay already covers >98% of overall ETF/ETN assets and >98% of the volume traded.  The bottom 400 ETFs (some of which we do include if they are interesting new products) make up about 1% of overall ETF/ETN industry assets.  There are plenty of choices already.  Other than the handful of innovative new ETFs that come out every 6-12 months, focus your efforts on the existing liquid ones.

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Nov 03, 2011 in Bonds

Junk Bonds back at/near multi-year highs.   If treasury rates are going up, you want to be overweight high-yield to neutralize effects of duration risk.

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Everything Is Correlated Chart Review

Oct 29, 2011

Correlation is vastly misunderstood.   It does not mean there is no room to add material value.



Revenge of the Advisor

Oct 27, 2011

Hedge funds for many years now have received a lot of the attention.  You also see high-fee mutual funds losing assets and this is of course going to continue. 

The power in ultra low-cost ETF investing is significant.   Will ETFs set their sights on hedge funds next?   As we see it, ETF’s will eventually cause trouble for hedge funds just like they have for heavily over-fee’d mutual funds.   

The ultimate beneficiary of the trend toward ETFs is the classic 1-2% fee-only manager that has good ‘risk-aware but long-biased’ strategies.

This all comes down to a relatively simple concept in our view - having a good fixed-income strategy over the long-run beats short-selling strategies, especially when the short-selling comes with a 2+20% price tag.     Let me explain.

Over the long-run, short-selling is a bad strategy.    How many successful bear funds are in existence?   This follows a decade of discussion of how bad the S&P 500 was --- however, a little-known fact is that one of the worst categories in the 2000-2010 period was……   bear funds.

If you discuss this with hedge fund managers – most readily agree that short-selling is really hard and that they don’t make much money at it.    However, they quickly then go on to say it is the short-selling which allows them to be long their great ideas --- and therefore it is justified.    However, if you break out just the short-selling side of hedge funds -- the part that controls risk ----  this group just doesn’t hold up over the long-run vs a good bond manager.    

Aha  you say,  bonds have been in a 30 year bull market and this can’t continue.   We agree that it will be tough to make much money if your bond strategy consists of buying and holding treasury bonds.   But also remember that our comparison group has set a low bar here -- short-sellers are secular underperformers too.  Remember that the admitted goal of hedge fund short-selling is only to mitigate drawdowns and through such magic ‘unlock the value’ in their fabulous long ideas.  

The onus of proof though is on he who is charging 2+20%.   The 1% fee manager that is doing a good job controlling drawdowns has just too large of a head-start.    Don’t get us wrong, hedge fund managers will continue to make huge sums of money --- as will fund of funds and consultants and all the other intermediaries of the industry -- and isn't that all just part of the problem?

But the disciplined advisor who can execute relatively simple carry-trade credit strategies while at the same time adding some value on the equity/risk-asset side  – and does so with ultra low-cost products – this is going to continue to be very difficult to beat.       

Bottom-line, being long treasury bonds is not a good strategy nowadays in isolation – but neither is short-selling.    Yes, the typical 3-10 year treasury bond is down this month--- but the losses are minor compared to those unfortunate enough to be short equities this month.   Meanwhile, risk-assets are appreciating --- dividend indexes (staples/utilities), MLPs,  Investment Grade bonds --- these all hit new multi-month highs this week.   And these are all classic advisor “home-turf” securities.



Drawdown Nuances In Backtesting Results

Oct 21, 2011 in Backtest | Drawdown | Video

We have improved the quality of the backtesting applications again.   All backtests will now display the path of returns on a daily basis, regardless of which update schedule you are on.   This allows for more precise chart visual --- and a few supporting statistics have been improved.   The video below explains this -- there is a nuance that we go over that may not be so obvious here:



Also, just a snapshot of a few indices for YTD drawdowns -- the higher the volatility, the higher the drawdown.


See Also: Drawdown Blog Posts

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Performance Summary Snapshot Sep 30, 2011

Oct 01, 2011

ETF Performance Summary

Bonds have taken over from Gold As YTD leader

Emerging Market Stocks (and particularly higher-vol EM Small Caps) are the worst performers with substantial losses on the year.

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Everything Is Correlated?

Oct 01, 2011

Myth "there is little room for active managers to add value because everything is correlated"


Recent Rebalancing Subsequent Quarter Results

Sep 29, 2011

As we head to the end of the quarter, the idea of re-balancing is back making the rounds in the media and by fund companies.

When treasury bonds outperform the S&P 500, you will often get a rebalancing by large institutions. We saw this at the end of June 2011. Let’s take one type of look at how this rebalancing trade has worked in the subsequent period (quarter).

We used the 5-year treasury bond index and S&P 500 since 2000. 5-Year Bonds have outperformed stocks by at least 3 percentage points in 16 calendar quarters since 2000. In the next quarter, the S&P 500 tended to be very volatile, dropping 9 times with an average -10.6% loss. The other 7 times it rallied on average +11.0%. So in case you weren’t already thinking so --- don’t be surprised to see a big move in Q4 one way or the other.

At the end of June 2011, the story was that funds rebalanced towards stocks. We have always questioned this type of conventional wisdom and wrote instead about the opposite --- that there was relative strength in bonds. As it turns out re-balancing to stocks in June was a poor decision --- stocks suffered significant double-digit losses in Q3 2011 and treasuries continued up. Indeed, the spread between being long ~5 year Treasuries and long S&P 500 is 17.7% since June (with a few days in the quarter left).

Large funds would argue that the trade is not an attempt to be a money-making move --- just a long-term adjustment back to neutral. That is fine -- but others seem to take it and imply its a useful strategy. As we noted previously ( Rebalancing Theory & Nuances ), the value of re-balancing is not a significant source of value-add. The ‘allocate and re-balance’ conventional wisdom is in our view materially overrated by the buy-side community. The results (below) are quite wild so there isn’t a lot to be drawn bearishly either – it’s just more a matter of the fact that this does not have the characteristics of what constitutes good supporting evidence of a strong strategy (lowering risk and/or materially better return relative to that increased risk).


Here is sample of recent results:


New Product, Check It Out:

New Allocations Module Blog


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