I’m excited to announce the launch of four new ETFs. That they’re imaginary and I’m being sarcastic doesn’t mean there aren’t critical lessons to be learned from them. After I describe my ETFs, including my flagship (NMAD), I’ll explain what those lessons are.
Triple Random Stock ETF (RRR) – The market is random, as noted by Burton Malkiel’s Book “A Random Walk Down Wall Street. If you don’t believe me, then just explain how the total stock market gained more than 52% in 2020 and 2021 in spite of horrible economic news, a pandemic, political dysfunction and social unrest. Rather than backtest to find a pattern out of randomness, let’s just bet on randomness.
RRR will hold a random number of randomly selected stocks that will be updated on random dates. Since random works better than performance-chasing backtesting, triple random will work three times better. With a geometric relationship, perhaps it will work nine times better (32).
Short Hot ETFs (SHOT) – This is a behavioral ETF that counts on investors continuing to be predictably irrational and pour billions of dollars into the latest hot ETF. Take Cathie Wood’s ARK Innovation ETF (ARKK), which saw billions of dollars flow into it just in time to turn icy cold and prove what Morningstar uses as an illustration of how not to invest. Investors did much better with the inverse Tuttle Capital Short Innovation ETF (SARK).
Think of SHOT as SARK on steroids. It will be an ETF that selects the ETFs with the greatest percentage of fund flows over $500 million in the past year and short those ETFs. Unlike SARK, SHOT will be more diversified. What could be better than diversification and doing the opposite of performance chasing?
Biggest Back Testing Failure (BBTF) – To my knowledge, the ETF industry has never launched a new product that hasn’t worked on a backtested basis. Each one works brilliantly by finding patterns of strategies that outperformed in the past. After launch, however, regression to the mean occurs and many of the ETFs tracking those backtested strategies go extinct.
BBFT will take a strategy that should have worked in theory but failed miserably on a backtested basis. BBFT bets on the powerful force of regression to the mean and invests in an underperforming strategy to benefit from its eventual reversion. This fund combines irrational human behavior with the mathematics of regression to the mean.
Neutral Opposite Mad Money ETF (NMAD) – This is a market-neutral fund and the flagship of the Roth family of ETFs. It’s going to be a hit. The goal here is to be market neutral while using the picks from Jim Cramer’s Mad Money show. NMAD (think “no mad”) will go long on stocks Jim Cramer recommends selling and short those he says to buy. The logic of why this will work is compelling.
First, it’s pretty widely known that Cramer’s picks have substantially underperformed the S&P 500 for many years. Luckily for him, Cramer uses index funds for his equity investing. Let’s look at some individual picks and how he flip-flops with precisely wrong timing.
In 2012, Cramer came out with two stocks to sell, sell, sell immediately. Those two stocks were Best Buy (BBY) and Hewlett Packard (HPQ). They ended up being two of the four best-performing stocks over the next six months and, along with a couple other picks, I calculated a 1 in 13.1 billion odds to be that wrong.
Still, that’s old news. Let’s fast forward to several weeks ago and how I arrived at the idea for this can’t-miss NMAD ETF. I was watching Cramer on CNBC when he came out with just two stocks to buy. You guessed it—BBY and HPQ. After both trounced the boring Vanguard Total Stock Market Index ETF (VTI), he gave them a buy!
NMAD can’t lose, but I suspect the SEC won’t let me say that.
I’m not serious about launching these four ETFs—though I’m not sure NMAD is such a bad idea. I think these imaginary funds are even more brilliant than these four recent and fascinating ETFs that actually launched.
My ETFs also appeal to emotions, and each one has a pretty compelling explanation of the logic behind the strategy. None is diversified (despite my claim), so one could have stellar performance by lucking out on where it happened to be concentrated. And while I haven’t disclosed my expense ratios, I assure you they would not be cheap.
These imaginary ETFs would likely be better for me, the issuer, than you the investors. But if one makes it, I’ll be interviewed daily by the TV talking heads—though maybe not by Mad Money.
Beware of new financial products (ETFs or others) with high fees and low diversification. The compelling explanations are aimed at the emotional side of your brain rather than the logical side, and are typically much better for the issuer than the investor.
When you see a new ETF that excites you, think about it for a few days before jumping in.
Allan Roth is founder of Wealth Logic LLC, an hourly based financial planning firm. He is required by law to note that his columns are not meant as specific investment advice. Roth is also the author of the blog daretobedull.com.