Exchange-traded funds have a new weapon in their fight against actively managed stock mutual funds. It’s the strategy-based ETF.

Instead of tracking indexes that give a window on a market, industry or class of stocks, strategy-based ETFs focus on indexes that use various factors to identify promising stocks—not unlike the way an active manager might use those same criteria.

Russell Investments is one of several investment firms now offering strategy-based ETFs. According to Mark Roberts, head of research at Russell Investments, the company’s Investment Discipline ETFs are an attempt to evaluate “what an active manager might consider when selecting stocks,” without the human weaknesses that can influence trading decisions, like favoritism or style drift.

Offered predominantly by Russell Investments, Guggenheim Partners LLC, Invesco Ltd. and WisdomTree Investments Inc., strategy-based index ETFs require investors to pay attention to how stocks in the index are chosen, what the strategy is, how the index is maintained and its expected performance.

Here are key questions that potential investors should ask:

What is the strategy?

The first strategy-based ETFs were designed to identify promising high-dividend stocks or to incorporate “technical analysis” in their methodologies, such as by favoring the stocks in an index that have been advancing most strongly. More recently, Russell Investments and QuantShares, a group of funds from Boston-based investment advisers FFCM LLC, have homed in on other measures including the volatility of an individual stock in relation to the market, and what constitutes “growth” or “value” stocks.

For example, Russell Equity Income is based on an index targeting stocks in the Russell 1000 Index that have paid or are expected to pay a dividend. The index excludes stocks with very volatile earnings, low return on equity or negative earnings forecasts. While the strategy sounds reasonable, the fund holds more than 250 stocks and has yet to differentiate itself from other large-cap value ETFs and funds.

Like all index-based ETFs, the strategy of the index will be detailed on the product fact sheet, prospectus and reports. The rules and standards of the index will either be linked to by the ETF provider or available from the index firm. In some cases, as with this Russell product, the index provider may be an affiliate of the ETF sponsor. If investors think that is too cozy a relationship, they may want to see if another ETF and/or index provider offers a similar strategy.

How does this strategy fit into my portfolio?

Strategy-based ETFs can be a tough fit for traditional index investors or advisers who use index-based ETFs to construct portfolios. These ETFs are largely geared to attract investors who prefer the styles and theories espoused by many active managers, but without the whims of human decisions.

How much to allocate to a strategy-based ETF depends on your own investment style. If you believe share buybacks are an indicator of corporate strength, you might consider PowerShares Buyback Achievers. The $58 million ETF, which has outperformed the average fund in Morningstar’s large-blend category over the past three years, is based on an index from Mergent Inc. that tracks companies that have bought back at least 5% of their shares over the past year. To track the performance of companies created through corporate spinoffs or asset sales, there’s Guggenheim Spin-Off.

What is the appropriate benchmark?

Because these ETFs are based on an index, you can start evaluating a fund’s performance by looking at the index itself. Even though many of the indexes were built specifically for the ETF, the ETFs may have a surprising tracking error due to fluctuations from ETF trading. Some of the ETFs also have some flexibility to vary their holdings from the index.

Tom Lydon, editor of website ETFtrends.com, suggests that investors monitor the ETF for a while to make sure that it actually follows through on what the strategy dictates.

For its funds, iShares offers both tracking-error and premium/discount data on its website. Strategy-based products from iShares, a unit of BlackRock Inc., are currently based on indexes from unaffiliated providers. In an August filing with the Securities and Exchange Commission, however, iShares indicated it was looking to offer ETFs based on yet-to-be-created BlackRock Indexes. An index-to-ETF strategy is also used by Van Eck Global, Guggenheim, Russell, IndexIQ and WisdomTree.

After seeing how well the ETF tracks its own benchmark, the ETF can be benchmarked against a category average appropriate for the size (large-cap, small-cap) and style (growth, value) of the fund’s stock holdings.

How actively does the strategy rebalance?

For strategies based on relative valuation metrics, earnings forecasts or even volatility, how often the index and ETF reconstitute can be important for capturing the return on securities as they pass into the screen. Some indexes are reconstituted as frequently as monthly, others quarterly or semiannually, and some only yearly. Indexes also rebalance frequently as well. Rebalancing, unlike reconstitution, adds or subtracts shares proportionately to get back to the index’s defined rules.

Just like overall portfolio rebalancing schedules, index rebalancing should be geared toward taking advantage of opportunities in a dynamic market while also minimizing turnover. Generally, index providers test for optimal rebalancing periods when constructing a new index. Only in extraordinary circumstances are index rules reconsidered.

“Consistency in the rules and taking the emotion out of the product is key to a successful index strategy,” says Adam Patti, chief executive of IndexIQ.

With the frequent portfolio changes made by these ETFs, one might think they would lose some of their tax efficiency. This is not the case, so far. Like other ETFs, these funds can use shares that no longer fit the ETF’s mandate to pay institutional investors who redeem their ETF shares. That minimizes actual sales of appreciated stocks and thus limits capital-gains distributions for the ETF’s investors.

Is the strategy worth the higher cost?

This depends on where you prefer to take your costs. Most strategy-based ETFs tend to have higher expense ratios than standard index and sector ETFs, but far lower expenses than actively managed stock funds. As with any exchange-traded product, you may have to pay a commission each time you buy, whereas mutual funds generally have higher expense ratios.

For example, the $7.3 billion SPDR SP Dividend has a 0.35% expense ratio tracking the SP High Yield Dividend Aristocrats. That’s high when compared with the less-than 0.1% expense ratio of its broad-market cousin, SPDR SP 500, but low compared with the $9.1 billion Fidelity Equity-Income mutual fund, which charges 0.69%.

Mr. Weinberg is an editor for The Wall Street Journal Digital Network. He can be reached by email at ari.weinberg@wsj.com.

Article source: Wall Street Journal

 

Recent gyrations in the financial markets resulting from the recent downgrade of US government credit by Standard and Poors has been a roller coaster ride for investors.  Persistent decreases followed by a sharp increase, then a decrease, and another increase has investors wondering what to expect next.  The financial markets have become a roller coaster of volatility.  And this roller coaster is not only constrained to stocks.  The debt downgrade created a paradoxical result of stoking new fears for widespread default in the euro-zone, and actually channeled more capital toward US treasuries, which pushed down yields.

In addition to this, the housing market is still extremely soft, with very few buyers able to qualify for financing, and very few sellers able to price their property at the market rate, due to being under water on their loans.  In addition to this, there is still a persistent hangover of foreclosure inventory that is dragging on the resale of properties.  This has created a strange dichotomy in many markets where new construction or default/foreclosure properties are the only inventory that sells.  This creates another roller coaster for people attempting to move resale property since the intensity of competition results in lowball offers and excessive demands from buyers that would have been completely unheard of in the past.

What this all comes down to is the fundamental truth that the future is intrinsically uncertain.  During the stock market bubble of the late 1990′s and the real estate bubble of the early 21st century, people came to expect continued rapid escalation of their investment assets.  The resultant collapse of these bubbles left many people in dire financial condition.  This problem was amplified even more so with the most recent bubble, due to the high number of people who had purchase property with high rates of leverage.  This meant that when the values compressed, the owner suddenly found themselves ‘upside down’ with more in debt than the market value of their property.

Now that we are in the middle of sorting out the mess from the real estate bubble, people are wondering what to do.  This problem is further complicated by the fact that our current economic difficulties are being addressed with many of the same policies that created the last bubble.  This has led many to speculate that a new bubble of some sort is in the process of forming.  With all of these swirling factors to consider, many investors are befuddled and confused.  Most people just want to earn a reasonable rate of return so that they can retire in relative comfort.  However, this task is proving to be much more difficult than financial planners make it out to be.

Opportunistic Investing

In a market environment that is highly volatile, the best results typically come from being opportunistic.  This means acquiring investment assets when confidence is low and buyers are distressed.  For stock market investors, this means finding companies that are fundamentally strong, and pay good dividends, then targeting them for purchase when market values dip.  In this way, investors purchase a stream of future dividend cash flows for a rock bottom price.  This strategy can also be employed for growth based companies as well, but it relies exclusively on future value appreciation, which is more volatile, but can also deliver greater total returns.

For property investors, market dips are the best time to acquire income producing real estate assets.  This is especially true since the high rates of default and foreclosure are driving many people who used to be homeowners into the renter pool.  Over time, this will become a boon for income property investors, as the overall increase in the renter population strengthens rents.  It means that investors must deal with the inevitable difficulties that accompany tenants and rental properties.  However, many investors are finding that the risk of tenants is preferable to the roller coaster volatility of financial markets.

Dynamic Course Adjustments

Another key characteristic of success in the current market environment is the ability to change course as the financial landscape evolves.  The strategies that worked best in the past may not be optimal in the future.  The investments that work the best now may not work the best in 20 years.  Astute investors must do more than “follow a system” … they must “create a strategy.”  The strategy should be what informs your decisions.  The strategy should be bigger than a single investment category, and it should encompass more than simply making money.

The purpose of a strategy starts with what you are attempting to achieve with all of your income producing activities.  It could be retirement, it could be a lifestyle, it could be paying for your children to attend college.  Whatever the goal is, it is very important to understand that part of your strategy first.  The second most important characteristic is your risk tolerance.  By and large, the more volatility and hassles you are willing to deal with, the higher rates of return you will be able to achieve.  However, these rates of return will not come in a smooth, even stream.  In order to achieve the “Big Kid” rates of return, you will need to move beyond packaged investments like mutual funds.

Once your end-state goal and risk tolerance has been defined, then it is time to decide what category of investment and specific opportunities are right for you.  The answer to this will most certainly be different for everybody.  Thus, it is less important to find the “best” opportunity, and far more critical to find the “right ” opportunity.  The way that you will be the most successful in business and in life is to pursue the opportunities that are right for your personality, temperance, and life situation.

 

In the book “Rich Dad, Poor Dad” Robert Kiyosaki outlines the profile of two different types of investor.  The first type of investor (Type I) is primarily interested in packaged investments like mutual funds, bonds, and CD’s.  These investors are generally looking for a passive strategy that allows them to generate modest compounded returns with minimal active management.  Being a Type I investor requires consistent budget discipline to continually save a sufficient amount of funds for contribution to their investment plan.

The second type of investor (Type II) is a ‘deal maker’ that is looking to find opportunities that are not being exercised by the majority of investors.  Generally speaking, Type II investors are interested in finding creative methods for financing deals and bringing together multiple stakeholders to get a deal put together.  This type of investing tends to involve higher risks and higher rewards.  A Type II investor must be willing to invest in a large breadth of education on investment strategies, and is also willing to actively deal with the difficulties of getting deals closed.

An important thing to consider is that both types of investor can be quite successful.  Type I investors can create a significant asset base if they are willing to invest diligently over a long period of time.  Conversely, Type II investors can grow wealth very rapidly by structuring ‘deals’ but also run the risk of losing significant sums of money on deals that do not go as planned.  Somebody who is looking to pursue a Type II strategy must be willing to accept the failure of a deal and then move on to the next deal.

Many people naturally want to find a ‘best’ strategy, but it is much better to think of the context of a strategy that is best for you.  Some people are more naturally inclined toward a strategy of steady compounding, whereas others are willing to take the risks necessary to be a deal maker.  The exact profile you choose to pursue is less important than being honest with yourself about which strategy most closely fits your personality.

 

We’ve seen it time and time again, large retailers are focusing more of their web marketing on Facebook, a strategy we should begin paying attention to. For all businesses, though, Facebook offers a lot of customization in terms of information, media and other content that consumers within the Facebook community can interact with. The fact that it is inexpensive from a hard-cost standpoint, makes using Facebook as a sole web-marketing strategy seem appealing, but on the other hand, could deter businesses from other successful web-marketing strategies since it can take up a lot of time.

One reason, and likely the main reason why businesses favor a page on Facebook over a website is due to the fact that their target customers are all using Facebook. From that point alone, it makes having a Facebook page justifiable since there are very few clicks needed to land on a page leading to a conversion.

However, using Facebook as a business website also has its limitations. Due to the fact that a business has to make all customizations within the Facebook platform, it’s difficult to control branding elements and conversions since businesses are using Facebook’s set of tools instead of their own.

Most businesses out there are going to fall in the bucket of using Facebook as a secondary search marketing strategy. Having a stand-alone business websites gives businesses complete control over branding, content, design, and web platform. What we see often nowadays, is using business websites and blogs to push content out to a social networking site like Facebook. This is a good strategy because it gives businesses the ability to see which content is appealing to visitors and which social networking site generates the most referral traffic (I recommend using the free tool, Google Analytics, to track this sort of behavior because it can tell you a lot about where to spend time marketing).

Facebook is not going to replace websites any time soon. And, although apps are very popular nowadays, it’s also safe to say those won’t replace websites either; but that’s a whole different topic. Both of those tools serve as a secondary strategy and one to drive traffic to the business website where a conversion will take place.

Article source: Search Engine Marketing for Small Business

 

In the tenacity of life and living, there is a constant interplay between efficiency and effectiveness.  These traits are demonstrated by the metaphors of a clock and a compass.  Efficiency is the art of conducting current activities more quickly.  The pursuit of efficiency inevitably results in ‘working against the clock.’  On the other hand, the pursuit of effectiveness is more concerned with ensuring that the endeavor is moving in the direction of its goal.

The next level of this interplay is determining when to pursue efficiency, when to pursue effectiveness, and in what order to prioritize these initiatives.  When engaging in this thought experiment it is very important to avoid the natural human tendency to believe that one answer is ‘right’ and the other answer is ‘wrong.’  Creative understanding requires that seemingly opposing principles be considered in parallel to one another so that the virtues and shortcomings of each can be rationally examined.

The pursuit of efficiency while ignoring effectiveness will inevitably result in doing stupid things at a very high rate of speed.  Unfortunately, this situation frequently plays out in many political arenas as the ‘pet projects’ of a so-called leader are pushed on the organization.  Another extreme to avoid is the pursuit of effectiveness, in absence of efficiency.  This situation lends itself to endless discussion and hashing over ‘mission statements’ and ‘company values’ without driving any real action.  Many of us are ruefully aware of the self-important bloviating of business leaders and politicians about strategy and vision, with no real impetus for action within the imagined leader or the reluctant followers.

On balance, the clock and compass are both necessary components of success.  The direction provided by the compass must necessarily come first to establish the vision and strategy.  At this point, the efficiency of the clock must be brought to bear so that action is taken to turn the strategy into reality.  As time goes on, efforts must necessarily oscillate between the compass and the clock so that strategy never becomes stale and action never becomes absent.

 

In the American version of Football, there is a ‘system’ known as the “West Coast Offense” that has become a revolution in sports.  Bill Walsh implemented the system as head coach of the San Francisco 49ers in the late 1970′s and went on to win three world championships, with two more achieved using this philosophy after Coach Walsh retired.

Up until Coach Walsh implemented the West Coast offense, there were two competing offensive philosophies that dominated Football.  The first was that of a ‘ball control’ offense where one team would attempt to control the clock by running the football repeatedly.  The effectiveness of this strategy came from the fact that the clock continues to tick after a running play or completed pass, but stops for an incomplete pass.  This means that if a team is large and powerful, it can dictate the pace of the game by controlling the clock and preventing the other team from taking the field.  When paired with a stout defense, ball control can be a highly effective strategy.  The Pittsburgh Steelers exemplified this style of play during the 1970′s.

The second offensive philosophy was a vertical passing or “Air Coryell” offense, named after Don Coryell.  The basis of this philosophy was to have fast receivers positioned near the sidelines and send them on deep passing routes if the defense crowded the line of scrimmage to stop the run.  This style of offense still relied on ‘establishing the run’ to open up deep passing lanes, but made its mark with the ability to produce big plays from long passes.  The Dallas Cowboys of the 1990′s were successful in using an Air Coryell system.

The problem that Bill Walsh sought to solve with the West Coast Offense was one of finding a way to win Football games if you didn’t have a large, physical offensive line and powerful running back required for a ball control offense or the explosive receivers and strong armed quarterback required for a Coryell offense.  The West Coast Offense relied on an intelligent quarterback making quick reads and short passes with precise timing.  By focusing on high percentage passes, it would allow an offense to control the clock by achieving many first downs.  Furthermore, it relied more heavily on disciplined execution from its players than physical prowess.

In this fashion, Coach Walsh changed the paradigm of professional Football from being about who is biggest, strongest and fastest to who is the smartest and most disciplined.  By focusing on quick passing plays, the opposing team had a difficult time tackling the quarterback before the ball was thrown.  By creating plays with multiple passing options, the system was difficult to defend without leaving at least one player open.  By instilling a culture of disciplined execution, the 49ers were able to achieve victory against other teams with more talent.

This philosophy is not only applicable to American Football, but also to your investing career.  There are some people who advocate for a ‘ball control’ strategy of investing that focuses on ‘safe’ investments like CD’s, bonds, and other low risk instruments.  The object of this strategy is to avoid losing.  Like in Football, this strategy requires you to have a large, powerful portfolio in order to produce sufficient cash flow.  Other people advocate a ‘big air’ strategy of investing that focuses on speculative opportunities with the opportunity to produce big gains.  This system requires just the right investments to be executed at just the right time in order to make the big play happen.  If any of the conditions are not right, things can fizzle very quickly.

An alternative strategy for your investing career is to focus on a system of disciplined execution that looks for multiple options and takes the opportunities as they are presented.  People who invest the “West Coast Offense” way will look for the things that are undervalued so that they can capture the opportunities while they are available.  The windows of opportunity will frequently shift, and are not always open for very long.  This system focus on producing steady, reliable gains one decision at a time.  As these gains compound over time, they will march you closer and closer to financial freedom, similar to a football team marching toward the end zone.

The strategy that you choose for creating your financial future will determine what is needed for you to be successful.  Many people are born without wealth, and few have inside information on hot opportunities, but anybody can develop intelligence and discipline.  Which way will you choose?

Champions Pay the Price

One of the great characteristics of Bill Walsh’s teams was the disciplined repetition that they would go through until every aspect of their game plan was executed perfectly.  For key plays, this would frequently mean practicing hundreds or thousands of times so that when game time arrived, the plays could be done without any hesitation or second guessing.

True champions ‘pay the price’ for their success long before the victory is won.  The place where champions really come from is not the game field . . . it is the practice field.  By doing the work and investing the time, champions are completely prepared for game time.  When the time of opportunity comes, they have done the work to perform flawlessly.  This same principle applies to business and investing.  The people who prosper are those who are disciplined and pay the price for success.