Tag Archives: stocks

How To Find The Best Style ETFs: Q4’15

Summary The large number of ETFs hurts investors more than it helps as too many options become paralyzing. Performance of an ETFs holdings are equal to the performance of an ETF. Our coverage of ETFs leverages the diligence we do on each stock by rating ETFs based on the aggregated ratings of their holdings. Finding the best ETFs is an increasingly difficult task in a world with so many to choose from. How can you pick with so many choices available? Don’t Trust ETF Labels There are at least 60 different All Cap Blend ETFs and at least 281 ETFs across all investment styles. Do investors need 23+ choices on average per style? How different can the ETFs be? Those 60 All Cap Blend ETFs are very different. With anywhere from 29 to 3792 holdings, many of these All Cap Blend ETFs have drastically different portfolios, creating drastically different investment implications. The same is true for the ETFs in any other style, as each offers a very different mix of good and bad stocks. Large Cap Value ranks first for stock selection. Small Cap Blend ranks last. Details on the Best & Worst ETFs in each style are here . A Recipe for Paralysis By Analysis We firmly believe ETFs for a given style should not all be that different. We think the large number of All Cap Blend (or any other) style ETFs hurts investors more than it helps because too many options can be paralyzing. It is simply not possible for the majority of investors to properly assess the quality of so many ETFs. Analyzing ETFs, done with the proper diligence, is far more difficult than analyzing stocks because it means analyzing all the stocks within each ETF. As stated above, that can be as many as 3792 stocks, and sometimes even more, for one ETF. Any investor worth his salt recognizes that analyzing the holdings of an ETF is critical to finding the best ETF. Figure 1 shows our top rated ETF for each style. Note there are no All Cap Growth or All Cap Value ETFs under coverage. Figure 1: The Best ETF in Each Style (click to enlarge) Sources: New Constructs, LLC and company filings How to Avoid “The Danger Within” Why do you need to know the holdings of ETFs before you buy? You need to be sure you do not buy an ETF that might blow up. Buying an ETF without analyzing its holdings is like buying a stock without analyzing its business and finances. No matter how cheap, if it holds bad stocks, the ETF’s performance will be bad. Don’t just take my word for it, see what Barron’s says on this matter. PERFORMANCE OF ETF’S HOLDINGS = PERFORMANCE OF ETF If Only Investors Could Find Funds Rated by Their Holdings The ValueShares US Quantitative Value ETF (BATS: QVAL ) is the top-rated All Cap Blend ETF and the overall best ETF of the 281 style ETFs that we cover. The worst ETF in Figure 1 is the State Street SPDR S&P Small Cap Growth ETF (NYSEARCA: SLYG ), which gets a Neutral rating. One would think ETF providers could do better for this style. Disclosure: David Trainer and Blaine Skaggs receive no compensation to write about any specific stock, style, or theme

2 Screens To Avoid Bad Investments

Summary There’s no way to avoid all investments that end up performing poorly, but there are two screens that can avoid some of them: past price performance and hedging cost. We applied those two screens to a list of top investor picks three months ago, and the ones that passed both screens significantly outperformed the others. We elaborate on the two screens, and discuss why they work. We conclude with a suggestion to consider applying these screens to guru picks, and to consider diversifying or hedging to limit risk. A Bad Fall For Top Investor Picks In a late August article (“Best Q2 Picks From Top Investors”), Seeking Alpha premium contributor and hedge fund manager Chris DeMuth, Jr. highlighted what he felt were the best stocks top investing gurus such as Warren Buffett, Carl Icahn, and Seth Klarman (Klarman pictured below; image from DeMuth’s article) added or increased their weightings of in the second quarter. On the whole, these picks have performed poorly over the last three months. In hindsight, this is consistent with the narrowness of the current bull market, one dominated by the “FANGs”, Facebook (NASDAQ: FB ), Amazon (NASDAQ: AMZN ), Netflix (NASDAQ: NFLX ), and Google (NASDAQ: GOOG ), as John Authers noted in a recent Financial Times column. But what’s interesting is the divergence in performance between two groups of these stocks. The first group includes the guru picks that passed two screens to be included in a Portfolio Armor hedged portfolio, and the second group includes the guru picks that didn’t. One of those screens is simple enough you can run it without any specialized tools. We’ll detail both of the screens below, but first, here’s a look at how the two groups of guru picks have performed over the last three months. Guru Picks Portfolio Armor Included, 3-Month Returns: Advance Auto Parts (NYSE: AAP ), -14.43% Precision Castparts (NYSE: PCP ), +1.19% Cigna Corporation (NYSE: CI ), – 1.75% Danaher Corp (NYSE: DHR ), +10.83% Humana (NYSE: HUM ), -8.16% Perigo (NYSE: PRGO ), -16.2% Shire (NASDAQ: SHPG ), -8.5% Time Warner (NYSE: TWC ), -2% Average 3-month return: -4.88% Guru Picks Portfolio Armor Rejected, 3-Month Returns: SunEdison (NASDAQ: SEMI ), -32.06% SunEdison (NYSE: SUNE ), -71.15% Williams (NYSE: WMB ), -40.8% Baker Hughes (NYSE: BHI ), -6.83% Office Depot (NASDAQ: ODP ), -24.33% Altera (NASDAQ: ALTR ), +5.94% Icahn Enterprises (NASDAQ: IEP ), +0.54% Brookdale (NYSE: BKD ), -29.6% T-Mobile (NASDAQ: TMUS ), -6.47% Average 3-month return: -22.75% Screening Out The Worst-Performing Picks In an article published in early September (“Investing Alongside Buffett, Klarman, And Other Top Investors While Limiting Your Risk”), we entered each of the guru stock picks above into Portfolio Armor’s hedged portfolio construction tool. That tool works differently depending on whether you enter your own securities or not. If you don’t enter your own securities, the tool populates your portfolio with the securities with the highest potential returns, net of hedging costs, in its universe (its universe consists of every stock and exchange traded product with options traded on it in the U.S.). If you do enter securities, as we did with those guru picks, the tool performs two screens on the securities you enter before attempting to calculate potential returns for them. Screen #1: Most Recent 6-month Performance V. Long Term The first screen is one you can easily do yourself. The tool looks at how the ticker performed over the most recent six months and compares that to the average six month performance of the security over the long term (ten years, if a stock has been around that long; if not, it uses the long term returns of an industry competitor as a proxy; for exchange-traded products it uses since-inception returns if it hasn’t been around for ten years). The tool will reject any security with a negative return over the last six months, unless the average six month return of the security over the long term is greater than the absolute value of the most recent six months return. To illustrate this, let’s look at one of the guru picks that failed this screen, SunEdison . Below is a chart, via Yahoo, showing the performance of SUNE over the 6 months prior to when Portfolio Armor rejected it for inclusion in that September hedged portfolio: (click to enlarge) SUNE was down 48% over the six months prior to early September. The only way it would have made it past this screen is if its average 6-month performance over the last 10 years was greater than 48%, and, as you might guess, that wasn’t the case, so SUNE failed the first screen. Screen #2: Hedging Cost Since SUNE failed the first screen, it was eliminated. An example of a stock that passed the first screen, but failed the second, was Williams . WMB was down 3.25% over the most recent six month period as of early September, but its average 6 month performance over the previous 10 years was 4.81%, so it passed the first screen. But it was too expensive to hedge against a greater-than-9% decline over the next six months using an optimal static hedge, so it was rejected. We explained how to find optimal hedges in a previous article , if you’re willing to do the work manually, or you could use an automated tool such as our hedging app . Why These Two Screens Work Although these two screens don’t eliminate all poor-performers, they work to eliminate some of the worst performers. They both employ what New Yorker columnist James Surowiecki termed the wisdom of crowds : Large groups of people are “smarter” than an elite few, no matter how brilliant — better at solving problems, fostering innovation, coming to wise decisions, even predicting the future. The large group of people in screen #1 is the stock market, and the large group of people in screen #2 is the option market; the elite few are the top investors who picked the stocks. Conclusion If you’re going to buy gurus’ stock picks, consider buying ones that pass these two screens. And since these screens don’t eliminate all poor-performers, consider limiting your stock-specific risk by diversifying or hedging.