What Makes A Lousy ETF

September 25, 2013

Putting your eggs in multiple baskets is the surest way to minimize risk and build wealth, right? You can add that to the list of homespun nonsense that sounds good but is patently false:

  • Wear a stupid wool hat, you lose 60% of your body heat through your head
  • The more you shave a particular body part, the faster the hair grows back
  • Standing in front of a microwave oven will bombard you with deadly gamma rays
  • Smoking is bad for you.

Behold the ETF (exchange-traded fund if you’re new here), a mutual fund that trades on a stock exchange. Like a mutual fund, it consists of the stocks of various companies, often numbering in the hundreds or even thousands. Unlike with a mutual fund, investors can buy and sell ETFs throughout the day. They have a ticker symbol and an immediately available price and everything. Mutual funds’ values aren’t calculated until the day closes and all their components’ prices have settled. Plus mutual funds don’t trade on exchanges, of course.

So what’s a good ETF to invest in? Let’s look atop the leaderboard. Never forget the 1st rule of investing, Past performance is a perfect predictor of future performance. 

(Kidding. The line about smoking was deathly serious, though.)

Your top 5 over the past year, regardless of market sector:

 

Screen Shot 2013-09-08 at 6.12.04 PM

 

Confused? Don’t be. The naming convention is standard: fund company, followed by description. Price is self-explanatory. That’s followed by performance since January 1 and performance since September 18 of last year.

Let’s take a look at the first one, iPath Long Extended Russell 1000 TR Index ETN. iPath isn’t a company, but rather a subsidiary of BlackRock. As for BlackRock, that’s an investment firm with a good reason for concealing its name. It’s owned by public charity case Bank of America, rate-fixing British bank Barclays, and PNC Financial Services (Pittsburgh National Corporation, the eponym of the Pirates’ ballpark.)

The ETF in question is actually an ETN, or exchange-traded note. The difference is that it’s composed of unsecured corporate notes, rather than stocks.

Extended Russell 1000 TR Index means that the ETN tracks the Russell 1000 Total Return Index. That’s an index composed of the prices of 1000 large firms that, according to Russell Investments, represent 92% of the U.S. market. As for Russell Investments, it’s a subsidiary of Northwestern Mutual, an insurance and financial services firm out of Milwaukee. And we are now 3 degrees removed from the subject at hand.

What about the worst fund in existence, defined as the one that’s lost the most money in the past year?

NUGT

Behold NUGT, the too-clever stock symbol for the Direxion Daily Gold Miners Bull 3X Shares ETF. That’s a name with enough qualifiers that we should deconstruct it:

Direxion. Investment firm founded in 1997, based in Milwaukee. Or as their impregnable website copy puts it,

We offer practical investment solutions to today’s market challenges with a broad suite of highly liquid, institutional-style alternative investment strategies.

Well, that said nothing. What they mean is that the funds they sell are supposed to complement your investments, not be them.

“Institutional-style.” Here are some more empty buzzwords, all from a single “About” page:

  • risk-adjusted performance through evolving market conditions
  • position portfolios opportunistically for near- and long-term market trends
  • access to strategies that provide exposure to multidirectional opportunities
  • innovative investment products and services

Innovative? Don’t flatter yourself, Jim. The last “innovative investment product” was the hedge fund. You’re not creating the cotton gin or the mp3 player here.

No wonder most of our recent college graduates can’t find jobs. They can barely communicate.

Daily, in this instance, means that the fund sets daily goals for itself. That alone should be a clue for an individual investor to step back and be cautious. You’re in this for decades, remember? Who gives a damn what an ETF does from Tuesday to Wednesday? We’ll skip over the next couple of qualifiers, get back to them in a minute.

3x. The aforementioned daily goal is to outperform a particular index, and do so threefold. In other words, if the index rises 1% in a given day, the Direxion Daily Gold Miners Bull 3X Shares ETF should rise 3%.

Gold Miners. The index in question is not the Dow, nor even the S&P 500, but something considerably more specialized: the NYSE Arca Gold Miners index.

Do we need to break this down even more? We probably do. The New York Stock Exchange’s most famous index is, of course, the Dow Jones Industrial Average. But that’s just one among hundreds that the NYSE calculates. (Arca, by the way, is short for Archipelago Exchange – a Chicago-based electronic exchange that the NYSE’s parent company bought in 2005. We have to specify “electronic” because unlike NASDAQ and just about every other stock exchange on Earth, the NYSE still, incredibly, conducts much of its business via open outcry. That is, ill-tailored traders yelling at each other.)

The NYSE Gold Miners index is a constant multiplied by the total of the prices of the stocks of 29 gold mining companies, as follows:

index components

 

As you can see, the index isn’t close to evenly weighted. By the time you reach the bottom, the companies are small. Golden Star Resources, whose operations consist entirely of 2 mines in Ghana, has a market capitalization of about $140 million. That’s still one more mine than Nevsun has (in Eritrea.) Anyhow, the Gold Miners index changes daily and Direxion tries to beat the changes with this particular ETF.

Finally, Bull. Because there’s a corresponding Bear ETF that tries to do the exact inverse: achieve a daily return 3 times the opposite of the change in the Gold Miners index.

So there you go, with a definition that necessitated a long discussion. Now, onto the question that 99% of ETF owners never bother to ask:

What’s in my fund?

Well, that depends. Seeing as NUGT tries to take advantage of daily price fluctuations, its holdings change every day. Direxion’s own website offers no help on this issue, listing a useless summary of price movements in lieu of a comprehensive list of holdings. This is 2013, we’re better than this.

The good news is that Direxion won’t let you buy its daily funds unless you’ve proven that you’re rich and experienced. But this isn’t just an academic exercise. You owe it to yourself, almost literally, to find out what’s in your mutual funds. We’re teaching you to fish here. It takes just a minute or two. For instance, the T. Rowe Price Value Fund is the most widely held in the world. Regular investors just like you own pieces of it. Google the name of the fund, find its relevant page on the investment firm’s website, find out what it’s composed of, and stop complaining.

Filed Under: Economics, Finance, Net Worth Tagged With: ,

The Lats Hurrah

June 7, 2013

 

The only international coin with Ron Jeremy on it.

The only international coin with Ron Jeremy on it.

 

(UPDATED, June 9: Correction made, thanks to an observant reader. We confused Latvia with Lithuania in one instance.)

This week Latvia became the 18th country to join the Eurozone. It’s easy to mistakenly equate “Europe”, or even “Western Europe”, with “nations that use the euro”, but there are some glaring omissions:

  • United Kingdom
  • Norway
  • Sweden
  • Denmark
  • Switzerland

Latvia becomes the 2nd former Soviet republic to join up, following Estonia in 2011. By this time next year Latvia’s current currency, the lats, will go the way of the franc (French, that is. The Swiss is very much alive) and the Deutschmark.

The Eurozone isn’t come-one come-all, like the Universal Life Church is. There’s a membership committee, a list of benchmarks you have to meet, even something of an apprenticeship program. So in that respect the Eurozone is more like a college fraternity. Specifically, any aspiring member has to spend 2 years in the European Exchange Rate Mechanism.

The hell is that?

It’s a precursor to the euro, developed in the late ‘70s. The idea was that since the major countries of free Europe planned to eventually unify their currencies, those currencies should be allowed to trade only in narrow ranges before unification. The mechanism was supposed to be a compromise between formally tying one currency’s value to another (like the Bahamian dollar is pegged to the U.S. dollar), and running the risk of one currency being arbitrarily devalued with respect to another (like the Zimbabwean dollar and everything else in the world.) So the lira could only trade between, let’s say, 200 and 250 to the peseta. That’s a gross simplification – the bands were usually narrower than that, except for certain currencies, and those only at certain times – but we try not to overwhelm you with semi-relevant data here. Anyhow, the lats now trades within 1% of the euro, which will be irrelevant a year from now when the lats goes defunct.

For what it’s worth – $1.89 right now – the lats is the 4th most valuable currency on the planet. And Latvian inflation is minimal, around 1.3%. Which makes sense, given the mechanism. Which brings up a question:

Why would Latvia join a club that would have Greece as a member?

The short answer is “politics”. See the line above about Estonia being the only former Soviet republic that uses the euro officially. Of the 6 unambiguously European former Soviet republics excluding Russia (the other 4 are Lithuania, Belarus, Ukraine and Moldova), each has had to make a momentous decision: embrace the West and all the resultant benefits from doing so, or set the clock back a few decades and re-hitch the wagon to Russia?

Belarus chose the latter, the others the former to varying degrees. By adopting the euro, it makes it extremely difficult for Latvia to fall under Moscow’s influence yet again. Short of an invasion, anyway, and if you think that sounds drastic tell it to the old Latvians who vividly remember the Soviet tanks rolling into Riga in 1940.

Is the euro shaky? Less so than a year ago. The bailouts have stopped, largely because the pool of rich nations to “borrow” from is finite. But more importantly, Latvia doesn’t exist in a vacuum. There are only certain options for its short-term economic future at its disposal, and maintaining the lats isn’t one of them. Joining the Eurozone is the least bad choice at Latvia’s disposal, and it might even turn out to be a good one. Besides, the nation can’t exactly backpedal after consenting to the exchange-rate mechanism in the first place. Extricating would be impossible, and probably not in Latvia’s best interests anyway.

Is this just a piece of international finance and geopolitical esoterica, or does it mean anything to your life? Well, first of all it doesn’t hurt to know a little more about how exchange rates work and how the euro gradually envelops the currencies of Europe into its cocoon of horror (awkward simile ©Peter McNeeley, 1996.) Second, damn straight there’s a microeconomic lesson here. If you need to put food on the table, you take the steady job (Eurozone membership) over the risk of unemployment (a currency of limited utility, and besides euros are accepted throughout Latvia anyway and have been since their inception.)

Criteria for membership in the eurozone are not trivial nor easily achieved. Latvia’s economy is humming, at least relative to its former Soviet counterparts. Its gross domestic product per capita is 50th in the world, and there are 200-odd countries across the globe. Once you start the conversion to the euro, it’s hard to go back, which is why the United Kingdom (wisely) never started. Accepting Eurozone membership now, effective in 2014, also puts Latvia ahead of the next countries scheduled to join: its neighbor and rival Lithuania, and Old Europe mainstay Denmark. The imprimatur of the euro distinguishes Latvia as a promising economic force. Also, symbiotically, it strengthens the euro’s status as a currency of importance. The more members the Eurozone has, the greater the likelihood of the euro supplanting the U.S. dollar as the international reserve currency of choice.

Filed Under: Capitalism, Finance Tagged With: , , ,

DOW GAINS .0000000000000002%

April 5, 2013

Alright, we took a little decimal license with that one. The actual headline that appeared on Fox Business Network’s After The Bell was “DOW GAINS .02%.” It should have appeared on WGSC, better known to Howard Stern aficionados as “the Who-Gives-A-Sh*t Channel.”

This is all noise, zero signal. Every daily change in the Dow is. Even the historic ones are. Every daily change in just about anything is.

As self-aware humans, we plan. That’s largely a good thing. The act of, say, enrolling in college happens with the understanding that 4 or more years down the road, and decades beyond, it’ll start paying off. Even the simpler act of planting a tree is done with a nod to a future that the planter might never be alive to see. Having kids goes on this list too, of course.

Yet for some reason, when regarding the stock market, we become mayflies. It’s as if we’re thinking, “But if the Dow fell 20 points this morning, how am I going to be able to retire at 7 p.m. and live off my investments from then until midnight?” If you want, you can blame the journalists for this: they have to talk about something, and the stock market is pretty much guaranteed to close at some level on every day that it’s open. (Curiously, the days that the Dow doesn’t close at any level are the truly newsworthy ones. 9/11, for instance.)

There’s too much information in every realm, not just finance and business. The only parts of the daily news that always contain legitimately important and timely information are sports and weather. The fluctuation in Archer Daniels Midland stock or the price of gold means nothing to the average investor over the course of a day, a week, a month, even longer. To illustrate the point, here’s the market level at yesterday’s close of business:

5 years

No, wait. This is the market level at yesterday’s final bell: 1 day

Oops. Sorry. No, it’s this:

5 day

Wait wait wait wait wait. Swear to God, this is it:2 years

In ascending order of length, the periods represented by these graphs are day, a week, 2 years and 5 years. But do you have any idea which is which?

(Answer: 5 years, a day, a week, 2 years.)

We removed the numbers on the vertical axis, and there’s no sense of scale, but that’s not the point. Whether you believe in a “permanent bull market” or not, a continually rising line isn’t visible in any of these charts. The 1-day changes seem considerably less abrupt than the 1-week changes, which would be unlikely in a rational world.

Tune out. Here’s a challenge, with absolutely no reward from us if you meet it: examine your portfolio no more than quarterly. Some wags would replace “quarterly” with “annually”, but we’re not at that level quite yet. What happens hour-to-hour is of zero consequence, and what happens over a period of weeks isn’t much more critical.

Look at other investments, ones whose price isn’t as easy to calculate. You bought your house in the hope that it’ll appreciate in value, right? If your $150,000 three-bedroom gets assessed at $149,703, what are you going to do? Sell sell sell? Pray for a bump? Or live your live confident that your house is an asset with a permanent tangible value, and that should you ever want to sell it, today’s prices will bear no relationship to those future prices?

Unplug. Read a book. Play with your kids. Go cycling. Whatever you do, don’t fool yourself into thinking that exposure to an onslaught of financial information is necessarily going to educate you. While you’re at it you ought to stop reading other personal finance blogs and just concentrate on this one. And read it largely for entertainment. (Which makes it sound as though our advice is unserious or unimportant, which is untrue. We meant entertainment in the literal sense: be entertained, while absorbing subject matter that can often be dry depending on who’s presenting it.)

It’s a cliché, but a valid one: for the most part, you make your money going into an investment, not out of it. Buy undervalued assets, and wait for them to appreciate. A stock bought at the top of the market – for example, Enron at its localized zenith – is not an undervalued asset. For a more contemporary and less notorious example, take Amazon, which is close to its current (and all-time) peak of 276½ or so. A fixation on short-term movements, no matter how drastic, will rapidly drive you insane. Considering your presumed lifespan, you want any eventual insanity to manifest itself as slowly and methodically as possible.

The average daily movement in the Dow is less than .026%. Or as CNBC might put it, “DOW UP .026%!!!!!!!!!!!!!” Journalists, even financial ones, are not renowned for having perspective. You’re smarter than that.

Filed Under: Finance, Newsflash Tagged With: , , ,
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