ITA Wealth Management

David F. Swensen, the brains behind Yale’s endowment fund, has written an excellent book, “Unconventional Success: A Fundamental Approach to Personal Investment.” On page 334 [copyright 2005] he warns investors of poorly structured ETFs. With all the specialized ETFs hitting the market, one better pay attention to Swensen’s advice. Rydex Global Advisors comes in for criticism for their equal-weighted S&P Index Fund “for the ridiculous charge of 0.40 percent of assets, relative to the Barclays charge of 0.09 percent for the standard market-capitalization-weighted S&P Index Fund.” Equal weighted simply means all stocks in the S&P 500 receive equal weight vs. the normal weighting system where the larger companies receive more weight in the index. Swensen goes on, “Not only do Rydex fund investors pay more than four times a fair price for index management services, but the equal-weighted ETF holders face the possibility of adverse tax consequences from the quarterly rebalancing trades required to maintain equal security weights.”

Rydex Advisors is not the only “fleecing” outfit. Consider PowerShares Capital, where they offer an even more expensive ETF, charging 0.60 percent of assets or 60 basis points. PowerShares employs the same quarterly rebalancing as Rydex. In the prospectus of PowerShares Dynamic Market Portfolio they state, “seeks investment results that correspond generally to the price and yield…of an equity index called the Dynamic Market Intellidex Index.”

Swensen takes off on the ‘Intellidex’ term this way. “Intellidex, presumably a compression of intelligent and index, represents a contradiction in terms. By using what a Morgan Stanley research report calls “rules based quantitative analysis” to evaluate and select securities, PowerShares engages in active management, not in passive index replication. The so-called index construction process ranks companies “based on a variety of criteria including fundamental growth, stock valuation, timeliness and risk factors.” Belying the assertion that the Intellidex constitutes an index, the prospectus clearly describes an active-management process that seeks to buy growing companies at reasonable prices in a timely fashion without undue risk. By dressing the active-management wolf in passive-management sheep’s clothing, PowerShares fools the investing public and sullies the otherwise purely passive character of the ETF arena.”

Compare performance on the Yahoo site by bringing up PWC or PWO. Then compare with the S&P 500. After that, compare PWC and PWO with Vanguard’s blend ETF, VV. Draw your own conclusions.

In the process of constructing the AA-Mosaic Portfolio and other Premium portfolios, we avoid esoteric ETFs and stick with the basic low cost ETFs that are tied to well known indexes.

It is important that investors do their own research as some of these “enhanced” ETFs my fit your investment requirements.  Here at ITA Wealth Management we prefer to keep things as simple as possible.

Photograph: Backyard – Portland, OR

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