The popularity of Exchange Traded Funds (ETF) has reached fever pitch in the last few years as their simplicity, and low fees have come to be the default setting for many investors and their advisers seeking share market exposure. This outcome has been no surprise. Particularly given the number of active fund managers in this industry that I represent, and am a participant in, have failed to deliver for their investors over the long-term.
Despite the focus needing to be on the long-term, many commentators incessantly focus on short term returns. We saw this in January when we rolled out the usual underperforming active managers based on a one-year league table that we are all scored by. Naming and shaming based on a short-term cycle shift which may have caught them off guard and with a hard 31 December end date, no time to recover.
ETFs may be simple to explain, but they are complicated to run, as mindless machines and algorithms make the buying and selling decisions in a merry dance of margins. Though some, including ourselves, see their rising influence as the start of a potential future perfect storm, as long as over a period there is an investor, commentator and/or fund manager that fails to perform for a period, the war cry of ETFs will remain strong.
The beauty many see in ETFs is that one does not have to pick stocks, providing insulation for those who cannot to do so. But don’t fall into the trap of thinking they are perfect in their abilities. Holding an index fund based on the ASX200 means you are a proud investor in AMP, TLS, ORG and STO – all of which delivered poor investment returns over the past 5 years. Not to mention Paladin and Slater and Gordon, once proud members of Australia’s large-cap club, until significant recapitalisation rendered the value of existing holders worthless.
So, if ETF’s don’t get it right 100% of the time, why is it unreasonable to suggest that in your portfolio, not every stock you hold will go up in price? And, while active managers will have periods of under and over performance of the market, with ETFs you will always underperform, since fees take a piece of the market performance.
We steadfastly believe that it is possible to achieve better than mediocre market returns consistently by being a proactive manager of your money, by avoiding the stocks mentioned above and investing in tomorrow’s great businesses today. According to Morningstar^ the Lincoln Australian Growth Fund was the top performing small/mid cap equities fund in Australia. Since inception and over the last five years, we have outperformed the Fund’s benchmark, and we contend retail DIY investors can do it too.
So where do you start?
Start with a strategy that allows you to stay focused and disciplined. An ETF has a strategy to track the market. You too should have defined buying and selling triggers within an investment plan.
Be armed with tools and develop an ability to pick stocks from a sound base. History has proven time and time again that companies’ quality factors drive long-term share price performance. Value, on the other hand, does not. There is no need to reinvent the wheel, stick with what works throughout all cycles. Using quality factors such as Financial Health, earnings efficiency and quality as your base for filtering stocks puts the odds in your favour. You can then overlay other factors like growth, momentum, income and/or dare I say it value to help guide the final decision.
^Source: Morningstar Fund Report
ELIO D’AMATO (@Elio_DAmato)
Elio D’Amato is the Executive Director at Lincoln Indicators, a leading boutique fund manager and creator of Stock Doctor share market investment platform. www.lincolnindicators.com.au