EC Seeking Future Results, Not Past Returns

Some of my favorite posts are spawned from readers asking questions that challenge my thesis in one way or another. Often, it’s the result of decisions or preferences that don’t conform to their methods of analyzing investments. This topic is no exception as I received an inquiry regarding a recent post on how investors can overcome the obstacle of owning thinly traded ETFs.

My explanation was based on the real-world experience of purchasing the SPDR MSCI USA StrategicFactors ETF (QUS) for my clients. To which a reader promptly challenged:

“Who in their right mind would buy QUS when it has underperformed SPY over the last two years?”

It’s a completely valid question and one that I’m sure many investors would presuppose as well. The reader is accurate in that QUS has underperformed SPY by a little over 3% on a two-year look back.The charts are roughly similar, but you are see how the smart-beta index has started to diverge more prominently since the beginning of the year.

To put things in context, we need to compare the two indexes to understand what they offer. The SPDR S&P 500 ETF (SPY) is the penultimate benchmark of U.S. stock performance.  It is a market-cap weighted representation of the 500 largest stocks domiciled in the United States as chosen by the index committee at Standard and Poors. It’s also the largest and most heavily traded ETF in the country.

Virtually any stock-only ETF is going to be (rightly or wrongly) judged against this index at some point throughout its history. Whether you love it or hate it, it’s just the way the investment community has been trained to measure the relative success of any equity strategy.

QUS is comprised of a basket of more than 600 U.S. stocks chosen based on multiple factors that include value, low volatility, and quality. The way this is implemented is by equally blending a single composite index from three separate MSCI methodologies. The stocks with the highest scores in each category ultimately make the cut.Its broader interpretation of the investment universe also ensures that mid-cap stocks are fairly represented alongside their large-cap peers.

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Disclaimer: FMD Capital Management, its executives, and/or its clients may hold positions in the ETFs, mutual funds or any investment asset mentioned in this post. The commentary does not ...

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Moon Kil Woong 3 years ago Contributor's comment

Increasingly the market is favoring selection over broad based exposure. As time passes companies with strong cash flow, decent growth, and low debt will be favored. I agree with the author to start trimming, but I'd go a lot further faster. To deal with the future you need to look into the balance sheet and cash flow statements.