This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today's article features Paula Wieck, portfolio manager at Nebraska-based CLS Investments.
One of the most difficult investment strategies is value investing (buying assets at a price below fair value). Value investing goes against human nature.
When a stock or sector is doing really well, a plethora of positive research becomes available. It’s much more difficult for people in the media (or even professional investment managers) to write positively about something that’s beat up.
To a novice, it can be pretty easy to get wrapped up in the hype of what’s hot. And that leads to buying at a price higher than fair value, an act that can be devastating to future returns.
As value managers, we look for segments of the market that have had poor returns, seeking a bargain. We have to decide when the timing is right, because if it’s wrong, investors will demand an explanation, and may grow impatient with underperformance. Usually, there are perceived drawbacks with value companies. Those warrant closer attention to breaking news, which may further devalue the company.
We as value managers don’t follow the crowd, and we sometimes feel stupid for our contrarian views. A perfect example at CLS is our recent allocation to Spanish equities. We added exposure toward the end of 2015 after Spain equities had lost nearly 16% that year. In 2016, it declined another 2%. It was only this year that the trade paid off, as the region is up more than 27% year-to-date.
As value managers, if we allocate to a position that underperforms, our investors may be tempted to abandon ship and not let the strategy play out. In addition, with the surge of technological innovation, prime stock information is readily and freely available, removing some of our competitive advantages of the past. Yes, value investing is hard. But ETFs make it easier.
ETFs Offer Value Diversification
One value-oriented ETF will often hold well over 100 individual stocks. Of course, we don’t want any of these stocks to go down, but the diversification benefit of holding a basket of stocks adds security. If one or several stocks go under, there are hundreds of others that will not.
While the ETF isn’t going to outperform the best-performing stocks, we lower our overall risk by taking this approach. It works much like a mutual fund, but with greater transparency and flexibility.