The Traders Journal

Why ETFs Are Best-of-Breed for Only 50% of Your Asset Classes


Investors have once again been misled by the media, bamboozled by Blackrock, duped and frisked by the financial community.   Exchange traded funds (ETFs) are not the panacea for every asset class as they all want you to believe they are. 

In my own portfolio, approximately 45% of my asset classes are covered by ETFs, but another 45% are no-load mutual funds. Individual stocks account for about 10%.  My objective with this blog is to shatter the myth that ETFs should replace all your mutual funds and stocks.  I’ll show you that achieving outperformance is best done by blending a mix of both passive ETFs and active mutual funds depending on your asset class.  

Upfront, I need you to embrace the fact that the biggest determination of your profitability as an investor is not which stock, ETF or mutual fund you select but how you allocate your assets amongst your different asset classes.  Having said that, the first two steps are about being in the right asset classes and then optimizing the dollar allocations within each asset class.  Having taken care of that business, let’s move on.

I’ll use my asset class of U.S. Mid-Cap Stocks as my first example.  I search out the best mid-cap ETFs using Morningstar and  I do the same with mid-cap mutual funds.  This produces a small universe of mid-cap possibilities upon which I can now perform in-depth comparisons.  Your brokerage house websites will have useful comparison tools for this that will highlight costs and performance which I do utilize, but I have found that over time I always gravitate to using the lens of a visual investor. to the rescue! The PerfChart in the hands of a knowledgeable investor is indeed a profit generating tool.  In fact, similar to ChartList #10.07 (59 asset classes from our book and in our ChartPack), I personally maintain a ChartList with 20 charts, each representing one of the 20 asset classes across which I have diversified my own portfolio.

The following chart is from my personal ChartList. I maintain this mid-cap chart and update it as better ETFs or mutual funds appear.  You’ll see that the mid-cap ETF (JKG) is my preference for best ETF. I considered IWR, JKG and IJH, but my pick was JKG.  For mutual funds, you see that I have plotted AKREX, BUFTX and JAENX.  I also always plot Vanguard Total Market (VTI) in green to constantly monitor the asset class versus the market.  It’s a habit I suggest for you all.  In addition, I use the representative ETF for each asset class chart as my heading.  This ticker always prints as a black line by default and for visual consistency.

So the benefits of maintaining these 20 charts of my asset classes are as follows:

  1. My personal investment allocation to USA Mid-Cap Stocks is achieved through POAGX and is constantly monitored in relation to its peers and the market.
  2. Since it clearly outperforms the best ETF, it justifies its management fees.
  3. It also clearly outperforms the market (VTI).It continues to outperform its peers (AKREX, BUFTX and JAENX).
  4. When new options present themselves for consideration, such as JAAGX or UMBMX, I plot them on this chart and can quickly ascertain if they are candidates worthy of my investment dollars.
  5. Monitoring extraordinary closed mutual funds also allows you to pounce on an opportunity if and when they reopen a closed fund.

This first example clearly proves that paying PrimeCap higher fees than an ETF (JKG) is justified due to their consistent outperformance. I welcome your alternatives if you disagree!

My second example will be cheered by the S&P - ETF crowd.  Biotech is an asset class that I deem as a long-term hold.  From the chart, you can see that XBI is outperforming its sister ETFs (IBB and BBH), as well as three top mutual funds (FBIOX, JAGLX and RYOIX).  

I choose XBI as my Biotech investment vehicle, not simply based upon its outperformance but also because of the following:

  • equally weighted equities
  • low expenses
  • large asset base leading to small trading spreads
  • broad basket of 84 holdings
  • mid-cap company focus

In this asset class, the mutual fund managers have not proven to me that they can justify their higher fees with long term outperformance. Therefore, the winner is an ETF in the Biotech asset class.

The third example is the moderate allocation asset class which means funds that maintain a mix of bonds and 50-70% equities. This example is an investing testimonial on three fronts:

  • for long term investing
  • for asset allocation executed by competent money managers
  • for active mutual funds over passive ETFs

In this asset class, there are a good number of active managers to choose from who add value over the passive ETF alternatives. My vehicle of choice for this asset class is the T. Rowe Price Capital Appreciation Fund.

The fourth and last example is the Emerging Markets asset class. Score one for the ETF cheerleader! The winner here is the iShares ETF - IEMG.  It has low fees, over $49 Billion in assets and holds over 1,904 equities. Other alternative ETFs are SCHE, VWO and EEMV. Mutual fund managers are challenged to compete here as expenses are high in this asset class and consistent outperformance has proved elusive historically.

The key takeaways from this blog as I see it are these five points:

  1. Your asset allocation decisions really matter big time! To do it like a pro, watch our 5-hour DVD.
  2. Passive ETF investing might be the rage, but it’s only best roughly 50% of the time.
  3. Maintaining a ChartList of your different asset classes that plot the best ETFs and mutual fund alternatives will yield outperformance and minimize your fees. It’s one of the rare instances where “you’ll get what you don’t pay for.”
  4. When you are presented with a new investment candidate, you can easily compare it to your best-of-breed charts and either embrace it or jettison it.
  5. Plotting VTI on each asset class chart challenges you to consistently compare your asset class and investment vehicle to the total U.S.A. market.

So now you know!   You will no longer be deceived or be duped by the media into  believing ETFs are the only way to invest.


Financial Freedom Awaits You.

As you may have heard, Grayson and I recently announced our upcoming Investors Boot Camp, which kicks off this May 19th - 20th here in Seattle.

2 days. 14 investors. 1 transformative experience.

Join us for two enriching days in my downtown Seattle trading office among a small group of just 14 investors. With a seminar this size, in a unique environment this engaging and intimate, it will be unlike any other investing event you've ever attended. It's no wonder that, for Grayson and I, the Boot Camp has quickly become our favorite teaching forum. Whether you're new to the markets or a seasoned trader, the Boot Camp will make you a better investor. Period.

To learn more or register for our Spring 2018 Investors Boot Camp, CLICK HERE.


Trade well; trade with discipline!
Gatis Roze, MBA, CMT

Gatis Roze
About the author: , MBA, CMT, is a veteran full-time stock market investor who has traded his own account since 1989 unburdened by the distraction of clients. He holds an MBA from the Stanford Graduate School of Business, is a past president of the Technical Securities Analysts Association (TSAA), and is a Chartered Market Technician (CMT). After several successful entrepreneurial business ventures, Gatis retired in his early 40s to focus on investing in the financial markets. With consistent success as a stock market trader, he began teaching investments at the post-college level in 2000 and continues to do so today. Learn More
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