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Problems for ETFs that don’t seem to ask the price

Problems for ETFs that don’t seem to ask the price

Whether you’re investing or shopping, you need to pay attention to the price tag before you buy. But looking at exchange traded funds (ETFs), it’s clear that some fund managers are failing to fully consider the price of the stocks they invest in. Take, for example, the new offerings from ProShares.

This week ProShares, the $27bn manager of ETFs, was readying three new funds for investors to benefit from the deterioration of brick-and-mortar retailers.

ProShares intends to launch a long/short fund which invests in retailers who benefit most from the continuing trend to online shopping, while ‘shorting’ large US retailers that are most threatened by the same trend. In addition, the manager will offer two other vehicles which more aggressively bet on the demise of traditional retailing.

Both of these vehicles only short the challenged store owners, but they do so with double and triple leverage – to magnify any gains when the stock prices of these companies turn down. Sounds fine in theory. Long the winners, short the losers.

But there may be a problem.

We have no problem investing in online retailing winners. Our global funds own Amazon and Alibaba, two wonderful online technology platforms that will benefit from an increasing propensity to shop online over many decades. We have no problem shorting the brick-and-mortar losers. We have made a good share of profits in Montaka (our long/short fund) by shorting retailers like Prada and H&M. But where we do have a problem is making investments for clients without regard to price. This is where ProShares ETFs appear to do a disservice to investors.

I tabbed through the offer documents for the 3 ProShares funds and zeroed in on the “Principal Investment Strategies” section. Stock selection seems to be determined by “revenue from sales compared to overall company revenues” and “number of, and square footage of, physical stores” rather than by price and value. This is an adequate start to screening investment ideas, but it’s entirely insufficient for an investment case.

Buying cheap (and selling expensive) is the most important tenet when it comes to success in investing, yet nowhere does the concept of price and value get a mention in the ProShares filings. Moreover, the ProShares filings state that portfolio “constituents are equal-weighted”. How could price/value matter to these ETFs if they intend to weight every idea the same regardless of the stock price? ProShares’ style is like picking up that tee-shirt that you have to have without checking the price tag first – only to be shocked when you reach the check-out (or pay your credit card bill)! This is not an issue for investors in our global funds.

On the long side, we undertake a rigorous process to determine a range of values for the companies we invest in. We only invest when the stock price looks cheap compared to these valuation “goal posts”. And when the shares become expensive, we stop buying and start trimming. In this way we reduce our risk of loss and can redeploy capital into shares of great businesses with better return potential.

On the short side, we sell expensive businesses that are deteriorating. But once the stock price falls significantly, we put on our long value investors cap to determine where the shares might be a bargain – even if the business is doomed to failure at some point. In this way we avoid a rebound in the shares of poor quality companies which might just be cheap enough for another investor to make a trading profit from.

In shopping and investing alike, the only way to do well is to pay attention to the price tag before you buy!

Christopher is a Portfolio Manager at Montgomery Global Investment Management. Christopher joined Montgomery in January 2015 after spending more than four years at LFG, the private investment group of the Lowy family, where he was most recently a senior member of the research team based in New York. Prior to this Christopher worked as a research analyst at One East Partners, a hedge fund based in New York, and as an investment banker at Goldman Sachs in Sydney.

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This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564) and may contain general financial advice that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking advice from a financial advisor if necessary.

2 Comments

  1. andrew ronan
    :

    Hi Chris, looks like sales to me, just give them what they want, I recently read that there are many more of these “intsuments” and derivatives etc on the market than all the companies listed on these markets put together. My view is that there is to much money chasing not enough things, so just make more things, and my bet is that most of the investors have no clue as to what these “things” really are, they just buy them because there there and they sound good in theory, but when the tide eventually turns and people want money instead of things, it will be quite a spectacle, it’s just more wood on the pile waiting for a match. Also I would like to say you guys have done a great job at Montaka in the last couple of years, and I’m a happy investor,ps I hope that US dollar doesn’t keep falling to much.

  2. I just took a look at the website – “ProShares is a leading provider of exchange traded funds (ETFs) designed to help investors reduce volatility, manage risk and enhance returns”.

    Seeing as a lot, if not most of their products are geared and / or involve shorting, I question whether this really would “reduce volatility”, especially in a downturn. When you are driving and the road surface changes or undulates, you DON’T speed up, because that just makes it worse and you are also far more likely to crash. Speeding up is the same analogy as using excessive gearing, it’s great when it works, it can easily be fatal when it doesn’t. In a downturn and you’re losing money, you don’t ‘double down’ – that’s stupidity !

    Personally, I’ve had enough of it because it’s gotten stupid. There’s ETFs over everything now, over indices I’ve never heard of, with too much gearing and doing things that ETFs offered by the ‘traditional, vanilla’ providers were never intended to do and probably never will. It’s interesting that I don’t see these older, more established providers doing this and instead, sticking to their knitting of passive, plain old boring ETF trackers over indices.

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