High-Quality -- Just Another Exposure

Jan 04, 2011

The history of [traditional] active management is that one-dimensional active strategies tend to do well for a while and then the strategy falls out of favor --- sometimes for long periods of time. Investors traditionally have piled into funds that have done well thinking it was fund manager insight --- but then the funds invariably do worse when the market rotates and the strategy favored by the fund manager underperforms.

The value-add in focusing on one segment of the world is limited over time --- though in the short-run can be lucrative. Over the long-run, it’s the higher level strategy changes that really matter – the tactical adjustments made at a level above security selection. You are far better off focusing on these decisions. Even if you are successful in your stock-picking --- that is, you outperform say U.S. stocks --- U.S. stocks as a group could be flat or down while other market segments do well (preferred stocks, REITs, Int’l stocks, emerging markets, junk bonds, precious metals, agricultural commodities etc…)

On a similar topic, we have noticed multiple discussions of ‘high-quality’ lately --- the managers weren’t that specific about what exactly they meant other than the classic low-debt, high return-on-equity etc…. Yes, high-quality might be the leadership group sometimes and perhaps you would like to bias your portfolio this way ---- but this strategy by itself is hardly that universally appealing to weather the extended periods of underpreformance.

Powershares actually has an ETF (PIV [1]) based on the Standard & Poors ‘High-Quality Index.’ Sounds great, right? I mean, who wouldn’t want to own high-quality and thereby avoid ‘junk.’ But the investment world hardly works like that. ‘High-quality’ is really just another way of saying large-cap U.S. stocks ---- and we know that is what the S&P 500 is too. There are countless ETFs like this. They sound good (high quality, 130/30 etc...) but they are in most cases just marketing hype that only capture the same core exposure as other long-existing indexes. These ETF's might have their day in the sun and outperform for a period --- but treat them for what they are -- an exposure to one particular strategy.

Here are some examples:



[1] Be aware that Powershares pulled a fast one on the ‘high-quality’ ETF (PIV). The price history prior to June 30, 2010 is actually of a different index. As ETF analysts, we do not include price histories of ETFs that change their strategies altogether --- the backtest would be not just meaningless – but potentially harmful. The same thing has happened in other cases and we track these and have adjusted the starting dates to begin when the tracking period began.


Here is a 130/30 Fund doing nothing more than tracking the S&P 500:


This one below (ONEF) is a global equity fund basically capturing the return of a global index like ACWI or VT.



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Comments (1) -

Jan 04, 2011 12:17 #

Nice article...keep up the excellent work guys. you have no clue how much time you guys are saving me.



Lionel Canada

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