We have been commenting here about the growing complexity of the ETF marketplace. What was once a cheap and simple way to get access to indexed asset class returns has become infinitely more complex. This apparently is rubbing off on the writers of investment newsletters as well.

Mark Hulbert in the New York Times has analyzed the returns of all-ETF portfolios generated by these investment advisors and has found them lacking (and laggin).

Over the last several years, the nearly 200 investment newsletters monitored by The Hulbert Financial Digest have created no fewer than 25 model portfolios that invest exclusively in exchange-traded funds. On average, they have significantly lagged the non-E.T.F. portfolios that the newsletter industry recommends.

This comes as a bit of a surprise, given the many strengths of E.T.F.’s. Unlike mutual funds, which are priced only once a day, after stock trading has ended, an exchange-traded fund can be bought or sold — and even sold short — at any time during the trading day. And unlike closed-end funds, E.T.F.’s rarely trade at notable discounts or premiums to their per-share asset values.

These results are indeed puzzling. Given all the advantages of ETFs it would logically follow that advisors should be able to generate portfolios that outperform those that hold open-end mutual funds. However Hulbert does give us an explanation.

The newsletters’ E.T.F. portfolios have actually been slightly riskier, on average, than the non-E.T.F. portfolios, as measured by the standard deviation of their monthly returns. So on a risk-adjusted basis, the average E.T.F. portfolio lags even further behind.

There’s another possible reason, and it makes the most sense. The very advantages of exchange-traded funds — their low cost, coupled with the ability to trade them throughout the day and to sell them short — may be encouraging newsletter editors to make riskier bet.

That jibes quite well with a comment by Andrew Feinberg at Kiplinger’s is nervous about how some investors use ETFs in their portfolios versus the way he uses ETFs.

My anxiety about ETFs is that individual investors will use them just as they’ve used sector funds over the years. And that would be a disaster.

Statistics show that individuals invariably buy sector funds after the sectors have already made big moves — and then those investors lose money as the inevitable correction or bear market occurs. They do worse with sector funds than they do with plain-vanilla mutual funds. And that’s a terrifying thought, considering how the average fund investor dramatically underperforms the S&P 500.

Feinberg is indeed correct in calling ETFs a “wonderful tool.” However the well-publicized advantages of ETFs can become a disadvantage in the wrong hands if used incorrectly. Unfortunately the ETF industry is continuing to populate the universe of ETFs with ever more complex and narrowly-based funds. Choice is indeed great, but as costs and complexity rise, the chance (and costs) of making a wrong decision also rise.



This content, which contains security-related opinions and/or information, is provided for informational purposes only and should not be relied upon in any manner as professional advice, or an endorsement of any practices, products or services. There can be no guarantees or assurances that the views expressed here will be applicable for any particular facts or circumstances, and should not be relied upon in any manner. You should consult your own advisers as to legal, business, tax, and other related matters concerning any investment.

The commentary in this “post” (including any related blog, podcasts, videos, and social media) reflects the personal opinions, viewpoints, and analyses of the Ritholtz Wealth Management employees providing such comments, and should not be regarded the views of Ritholtz Wealth Management LLC. or its respective affiliates or as a description of advisory services provided by Ritholtz Wealth Management or performance returns of any Ritholtz Wealth Management Investments client.

References to any securities or digital assets, or performance data, are for illustrative purposes only and do not constitute an investment recommendation or offer to provide investment advisory services. Charts and graphs provided within are for informational purposes solely and should not be relied upon when making any investment decision. Past performance is not indicative of future results. The content speaks only as of the date indicated. Any projections, estimates, forecasts, targets, prospects, and/or opinions expressed in these materials are subject to change without notice and may differ or be contrary to opinions expressed by others.

Please see disclosures here.

Please see the Terms & Conditions page for a full disclaimer.