One readers sent this excellent question about ETFs: Hi Gary, thanks for the interesting report. At first glance I believed the idea of ETFs to be a great opportunity, however, after a deeper look it seems the parasites are having their way with ETF investors as well. I am not sure about all of the ways in which the bankers fix ETFs to their favor but, for example, I see that some ETFs don’t rise as much as the index they are tracking rises, and falls further when that index falls. Also, with an ETF your investment is only as good as the ultra leveraged derivative bets made by the investment bank that issues them. So if that investment bank goes bust, your investment probably will too. In other words, by purchasing an ETF issued by Morgan Stanley you are taking on some of the risk that Morgan Stanley remains solvent and that the entire derivatives market remains liquid. Unlike holding real shares of real corps in Germany, for example, that are tied directly to the solvency and liquidity of those businesses.
The title of this message, “Not All ETFs are Created Equal” is the first answer to this question. Four websites are linked below to help clarify this fact. Like all investment types there are different horses for different courses.
Here are a few points to help each reader decide if ETFs are good for their financial strategy and if so, which ETFs are the right ones.
To begin we need to remember the overlying rule of all investments, “Caveat Emptor”, buyer beware. A better phrase is “Buyer Be Aware”. We need to be sure we understand the strategy of the specific ETFs we invest in. We need to look inside the ETF to see what shares are held in its portfolio. ETFs are required to disclose their portfolio on a daily basis at the fund’s website.
We need to read the prospectus carefully to understand the investment strategy of the ETF as this can have a significant impact on, income, tax and timing of profits.
Some ETFs use cap-weighted baskets of securities, others use fundamental-weighted baskets, and some even use derivative products. There are even some now that use an active or quasi-active management style. Each investment approach carries with it very different risk/return profiles and tax consequences.
Many index ETFs look the same, but operate very differently. Review risks, costs and timing with your advisor to be sure that the ETFs you choose fits your specific situation. ETFs are a hybrid of stock and mutual fund. As a mutual fund, good ETFs have very low fees, but as stocks their price is ruled by supply and demand. ETF market prices can differ from net asset value. We want to avoid buying ETFs at a premium (price much higher than net asset value).
The purchase of an ETF creates a brokerage commission every time it is bought or sold. Brokerage commissions are usually fixed from a few dollars per trade to $20 a trade. The more we buy at one time the lower the cost as a percentage of the investment. This favors larger lump-sum investments and means that dollar cost averaging in small investments should be avoided. The transaction costs can hurt a dollar-cost averaging in small amounts. Larger quarterly or semi annual investments may be better than small monthly purchases.
We should consider the total costs before investing. An expense ratio tells how much an ETF costs. The expense ratio doesn’t include the brokerage commissions.
The average ETF has an expense ratio in the 0.50%, which means the fund will cost you $5.00 in annual fees for every $1,000 invested. The best bet for small investors is to use online brokers that charge low or no commissions, IF the ETFs they offer fit our needs. We look for brokers who offer what we need. Smaller brokerage firms may have a limited selection of ETFs.
We look for the most widely-used and easy to trade ETFs for safety and to reduce buy and sell spreads. Many ETFs that track long-standing indexes such as the S&P 500 have stood the test of time. Many new ETFs stretch the definition of indexing. Be careful of new indexes that track unusual segments of the market. Avoid newfangled ETFs unless you understand them well. Beware of leveraged ETFs. These investments are usually composed of derivative instruments and aim to provide investors with daily performance that tracks the underlying index (including leverage). These are helpful for professional traders making bets on a daily basis, but ordinary investors should avoid them.
We need to be careful of thinly traded ETFs. We can usually sell an ETF at any time during the trading day, but the growing number of narrowly-focused and exotic ETFs have not passed the test of time and many are more expensive.
We avoid these funds unless we really know what we are doing and the ETF specifically fits our strategy. Passively managed ETFs are designed to track an index. Actively managed ETFs permit the fund manager to buy and sell securities and derivatives according to a stated strategy, described in the prospectus. A benefit of index ETFs is they are transparent and are not dependent on a fund manager who might lose his touch, retire or quit. The exotic and managed ETFs do not provide this benefit.
ETFs can be sold short and many have related options contracts, which allow investors to control large numbers of shares with less money than if they owned the shares outright. These positions can create short term aberrations in the ETF share price so we check them out.
Esoteric ETFs can have low trading volume and larger spreads which increases cost and volatility. Avoid a liquidity problem, by using larger funds that have proven themselves. We avoid this problem by looking for substantial assets and large daily trading volume.
Here is a summation of what Merri and I do and you may want to do as well. We look for two types of ETFs. One is passive ETFs that fit into our strategy of investing in good value markets around the world. The second are active ETFs that focus on high income, good value shares in good value markets. We dollar cost average on a quarterly basis to keep buying commission costs down. We buy long term positions to keep tax and selling costs down. We look for ETFs in these two categories, that have low expense rations, large portfolios and high trying volume.
(1) New York Stock Exchange What you should know about ETFs
(3) CNCB- ETFs – what you should know
(4) Wall Street Journal How to Choose an ETF
If I Live Long Enough“If I Live Long Enough, I’ll really cash in next time”. I made this promise to myself in the 1980s. A remarkable set of economic circumstances helped anyone who spotted them become remarkably rich. Some of my readers made enough to retire. Others picked up 50% currency gains. I didn’t do much to invest then, but I did what I could as the profits rolled in for about 17 years.
Then the cycle ended. Warren Buffet explained the importance of this ending in a 1999 Fortune magazine interview. He said: Let me summarize what I’ve been saying about the stock market: I think it’s very hard to come up with a persuasive case that equities will over the next 17 years perform anything like—anything like—they’ve performed in the past 17!
Now I see those circumstances headed our way again.
The Dow Jones Industrial recently soared past 18,000 and reached an all time high. So why aren’t average investors all rich? There are several answers. First, even though the Dow has peaked, for the last 17 years the US stock market has been in a bear trend. You’ll see why in a moment. Another reason why the investors have not done so well is because of currency loss. One final reason why profits have not been so good. Someone, probably someone you trust, has been stealing from you.
Let’s review why one of the biggest obstacles in profiting from the upcoming circumstances has been and remains the financial system. The reality is that these banks and brokers have been structuring investments that are sure to lose. They sell you on these investments and then another division of the very same bank (or broker) that recommended the investment, bets against you. The bank knows that the investment is toxic. To add insult to injury, many of these same institutions cheat you on the way in and the way out (when you buy and sell a share) of the bad investment.
The New York Times best seller “Flash Boys: A Wall Street Revolt” by Michael Lewis tells the tale of how big banks and brokers have been ripping off investors. The book shows how since the late 1800s banks and stock brokers and traders have been legally stealing (and sometimes illegally) from investors by front running. Front running is the practice of a bank, stockbroker, trader or someone taking advantage of advance knowledge of your order to buy or sell a stock or bond. The front runner executes an order for its own account and immediately resells at a higher (or lower if you are selling) price to you.
“Flash Boys” looks at high-frequency trading (HFT), a new form of front running created by electronic stock markets. Lewis claims that HFT traders front run orders on most US stock exchanges because differences in fiber optic routes, switches and cable allows some traders to gain just milliseconds of advantage. That’s a millionth of a second, but with this edge, when your bank or broker place an order, HFTs can see it, buy the share and the resell at a higher price.
The slice in each case is small but it is estimated that these high frequency traders are pulling as much $5 billion per year, perhaps as much as $15 billion per year or even higher. Those billions are dollars out of your pocket (and mine) and every other investor who is trying to make an honest investment. Speed is so essential that one company spent 300 million dollars to bury an 827-mile fiber optics cable that saved just a few milliseconds off of the response time of trading shares. Your problem is that your bank or brokers is probably in on the HFT deal. They either have their own high frequency tool or are paid by a high frequency trader.
Flash Boys shows how much of the financial industry is geared up only for their profit rather than yours. The system creates a gap between investors and the market, a group of middlemen who earn fees, commissions, and rebates from order flow and volume. They add little actual value to the market but take huge amounts of pay.
The day after the book’s release the Federal Bureau of Investigation announced an investigation into high frequency trading, in particular about possible front running, market manipulation, and insider trading. On May 1, 2014 the SEC announced a $4.5 million fine for the New York Stock Exchange and two affiliated exchanges, on charges related to Lewis’ book. The exchanges neither admitted, nor denied the charges.
Stock Exchange excesses are just a tiny fraction of the problem. Alayne Fleischmann, a securities lawyer for Chase JP Morgan, became a whistle blower in one of the biggest cases of white-collar crime in American history, exposing secrets that it is claimed JPMorgan Chase CEO Jamie Dimon paid $9 billion to keep the public from hearing. This was pointed out when she said: “I could lose everything. But if we don’t start speaking up, we’re going to get the biggest financial cover-up in history. It was like watching an old lady get mugged on the street, I thought, ‘I can’t sit by any longer.'”
This one rip off is just the tip of the iceberg that has been chilling our investment, savings and pensions for 17 years. The SEC website (1) shows a list of over 170 fines levied on some of the biggest financial institutions that mislead their customers into bad investments. The SEC site says that they charged Citigroup’s principal U.S. broker-dealer subsidiary with misleading investors about a $1 billion. Just a few of the other banks and brokers you’ll read in that list include names you see every day. Merrill Lynch, Bank of America, Wachovia, Wells Fargo, UBS Securities, Goldman Sachs, Credit Suisse Securities (USA), Morgan Stanley are a few. These same firms that tout “We are here to help your finances,” have really been out to rob you.
The book reveals that the cause was a loophole in a law that aimed to stop front running. Research back to the late 1800s found the entire history of Wall Street littered with scandals and shows how every systemic injustice arose from some loophole created to correct a prior injustice. The book says: No matter what regulators did, some other intermediary found a way to react so there would be some form of front running. If you read the book, you’ll see that your chances of knowing what really goes on with your investments are pretty slim. Learn about the book Flash Boys at Amazon.com
Beat the robbers with 50% profits.
Despite the predators on Wall Street who are waiting to take big gouges out of your savings and wealth, equities are still the best place to invest for the long term. This chart from the 24 page Keppler Asset Management 2014 Asset Allocation Review shows that over the past 80+ years equities have dramatically outperformed other types of investments.
Because of the predators on Wall Street (and every stock market in the world) the search for good investments requires a relentless search for value. Your investments have to be good enough to reap an outstanding profit even after the parasites siphon off part of the profit.
To take advantage of the once every 17 year circumstances, I chose to track Keppler Asset Management who continually researches developed and emerging markets globally. Keppler is one of the best market statisticians in the world and numerous very large fund managers use his analysis to manage funds such as State Street Global Advisors. Keppler compares the value of each share in each market based on current book to price, cash flow to price, earnings to price, average dividend yield, return on equity and cash flow return. From this study of monumental amounts of data Keppler develops a Good Value Stock Market Strategies. The analysis is based on long term, rational, mathematical facts and does not worry about short term ups and downs.
From Keppler I learned that market timing is not the way to get these high profits. Another graphic from the 2014 Keppler Asset Allocation Review explains why.
Click on image to enlarge.
A dollar invested 88 years ago in Treasury bills rose to $20.58. The same dollar invested in U.S. stocks over the 88 years grew to be was worth $4,677, UNLESS you missed the best 43 months. Literally all of the the Dow’s growth in 1,056 months came in 43 of those months. Your odds have been one in 24, better than roulette perhaps, but not good enough. Plus even after these odds, the predators are going to take their cut. You have to ask, “Am I that good at timing?”
The better alternative to timing is investing long term indexing based on value. Long term strategic investing in market indices reduces the amount of trading. Low trading activity is important because trades are where you are most vulnerable to predatory tactics.
A part of the long term strategic trading is to invest in low fee diversified Index ETFs. This simplifies your search for value because it focuses your research into lumps.
A comparison of US versus German stock market indexes gives an example of lump research and you can create good value, low cost, diversified portfolios that offer maximum potential for profit as they reduce risk.
Keppler’s research shows that Germany’s stock market is a good value market. Keppler lumps all the shares (or at least 85% of the shares) into the calculations. There is no attempt to select any one specific share. Keppler’s research shows that the US stock market index (a lump of about 85% of all the US shares) is now a bad value.
Germany has the world’s fourth largest economy. The country is the third largest exporter in the world and in 2013 recorded the highest trade surplus in the world making it the biggest capital exporter globally. Yet German shares have been overlooked. German share prices are cheap.
The German Stock Market as of January 2015 in terms of US dollars has a relative price to book value ratio of .78, a relative price earnings ratio of 0.87 and a relative dividend yield of 1.12. The US Stock Market has a much higher relative price to book value ratio of 1.29, a relative price earnings ratio of 1.07 and a relative dividend yield of 0.81. German shares cost much less, compared to the values and earnings, than US shares. German shares pay much higher dividends as well.
Keppler predicts that the US Stock Market (which is ranked as a sell market by Keppler) will have an annual index gain for the next five years of 3.1% and a total return (with dividends) or a total five year return of 21.7%. The same calculations for the German Market predicts an average annual index gain over the next five years of 7.5% and a total return (with dividends) or a total five year return of 47.3%.
Which would you rather buy, a 47.3% return sold for 78 cents on the dollar or a 21.7% return sold for $1.29 on the dollar?
You can forget about any specific share in the US or Germany and invest into an index (in this case the Morgan Stanley Capital Index) which represents about 85% of all the shares traded on the exchange.
You can invest in ETFs that passively invest in all the shares of the index in stock markets that offer good value. iShares investment company for example has an ETF that invests in 85% of the shares traded on Wall Street.
This ETF icalled the iShares USA (symbol EUSA) has risen from 22.91 to 43.40 or 89% in the past five years.
iShares also offers an ETF that invests in about 85% of the stocks listed on the German Stock Exchange (Symbol EWG). EWG has risen from 19.70 to 28.13 or 42% in the past five years.
Keppler’s lump reseach shows that Germany is a good value market. One simple (even very small) investment in iShares Germany MSCI Index ETF gives you a portfolio of almost all the shares traded on Germany’s largest stock exchange in Frankfurt. This ETF is a share traded on the New York Stock Exchange. The ETF invests in 85% of the shares in Germany. This ETF is a passive fund that does not try to outperform the growth of the German Stock Market. The managers simply track the investment results of the MSCI Germany Index. The MSCI Germany Index is designed to measure the performance of the large and mid cap segments of the German Index which is composed of the stocks of 54 different German companies and covers about 85% of all the German equities. Germany’s ten largest companies compose about 60% of the index. These ten companies are: BAYER (Health Care) composes 9.91% of the index – SIEMENS (Industrials) 7.89% – DAIMLER (Consumer Discretionary) 7.04% – BASF (Materials) 6.81% – ALLIANZ (Financials) 6.65% – SAP STAMM (Info Tech) 5.69% – DEUTSCHE TELEKOM (Telecom Srvcs) 4.46% – DEUTSCHE BANK NAMEN (Financials) 3.66% – VOLKSWAGEN VORZUG (Consumer Discretionary) 3.18% – BMW STAM (Consumer Discretionary) 3.15%.
You lump your research. You lump your investment. This makes it easy to capture the powerful economic circumstances that are unfolding now.
Just investing in Germany is not enough. There are currently ten good value developed markets, Australia, Austria, France, Germany, Hong Kong, Italy, Japan, Norway, Singapore and the United Kingdom. Plus there are 12 good value emerging markets. You can easily create a diversified portfolio in each or all of these countries with Country Index ETFs.
Investing in many stock markets through ETFs gives you opportunity in the second economic wave, a rising US dollar. Preserving the purchasing power of your earnings, savings and wealth requires currency diversification.
The current strength of the US dollar is a second remarkable similarity to 30 years ago. The dollar rose along with Wall Street. Profits came quickly over three years. Then the dollar dropped like a stone, by 51% in just two years. A repeat of this pattern is growing and could create up to 50% extra profit if you start using strong dollars to accumulate good value stock market ETFs in other currencies.
For example because of fears about the euro, EWG, the German ETF is down 9 percent over the last 12 months and down 8 percent over the last six months. These declines are created by currency concerns. When the euro regains strength, the shares have the potential to appreciate even more.
This is the most exciting opportunity I have seen since we started sending our reports on international investing ideas more than three decades ago. There is so much more to write and the trends are so clear that I have created a short, but powerful report “Three Currency Patterns For 50% Profits or More.” This report shows how to earn an extra 50% from currency shifts with even small investments. I kept the report short and simple, but included links to 153 pages of Keppler Asset Stock Market and Asset Allocation Analysis so you can keep this as simple or as complex as you desire.
The report shows 22 good value investments and a really powerful tactic to use that allows you to accumulate these bargains now even in very small amounts (even $5,000). There is extra profit potential of at least 50% so the report is worth a lot.
Research shows that most people worry about having enough money if they live long enough. I never thought of that. I just wanted to live long enough to see the remarkable economic opportunity that started in 1980 start again and those that continue to offer opportunity. This powerful profit wave has begun. I made it and am glad you did too. Even more I look forward to the next 17 years and sharing how to have more than enough money for the rest of your life.