On Fixed Income ETFs and Passive Investing

by: Roger Nusbaum

IndexUniverse is reporting that Van Eck has filed for a bond ETF that would target Latin American debt and one that would target Asian debt. Per the article, there would be a mix of sovereign and corporate paper and it would allow for a mix of local currencies and dollar denominated debt. These two along with the Guggenheim (formerly Claymore) Bulletshares, are the corporate bond ETFs with maturity dates, and go a long way to democratizing bond strategies for do-it-yourselfers.

There are plenty of other very useful fixed income ETFs out there, to be clear--iShares really has a thorough offering and several other providers filling some important gaps (WisdomTree and Van Eck among others). Some folks don't like to hear or think about this but the last decade has shown that investing is not getting simpler. People who took the time (this is more about time spent than analytical skill in my opinion) to understand different investment destinations, asset classes and exposures did better than those who did not and that is very likely to repeat again in the new decade.

I'm sure someone would read that last paragraph and note that a portfolio of 50% equities and 50% bonds did just fine in the oughts and that is true, but most people go far heavier in equities than 50%. From here, looking forward, bonds are now expensive and equities cheap. Bonds could get more expensive and equities could get cheaper but the valuations are what they are. While equities may be cheap with the threat of getting cheaper I think there will be far more reward in the decade going more into foreign, which is of course a repeat theme.

Sticking with IndexUniverse, they posted an interview with Larry Swedroe that is worth mentioning. He had some good one-liners about passive investing that should be explored.

He makes a big deal that, "it’s actually mathematically impossible that it (active management) can win in the aggregate." The word aggregate is what makes the sentence correct (probably) but it is an incomplete thought for a couple of reasons. First how do you define win? Also based on other comments along this line what sort of time horizon are we talking about?

In many past blog posts I have mentioned John Serrapere's 75/50 portfolio (75% of the upside with only 50% of the downside as the stated goal). Successful execution by Serrapere would mean lagging on the way up and beating on the way down. Over the course of a complete stock market cycle that would outperform the market. While I do not have performance data from Serrapere the goal is over a longer period of time. This is of course similar to Hussman.

Per Morningstar, since inception in 2002 a $10,000 investment in the Hussman Strategic Total Return Fund (HSTRX) is now worth $18,297 whereas $10,000 in the S&P 500 Total Return Index (so price plus dividends) would be worth $15,354 and it has been a dramatically smoother ride. There have been plenty of short periods in there of course where he trailed but assuming the data is correct is eight years enough track record? What about Lynch, Buffett or Druckenmiller? What about all the people you've never heard of? Our firm has a six-year track record that I think stands up well and I'm not that bright--but I do spend a lot of time.

The notion that outperformance is impossible is incorrect and the way Swedroe framed it in the interview incomplete. Part of an effective financial plan is understanding time horizon and what it is you need the portfolio to do. If you want to reframe this to say it is difficult and that the majority of people will not "beat the market" whatever his precise and undefined (in the interview) meaning then I absolutely agree; most people will not beat the market. I would go on to say that many people will be done in by emotions, poor decisions and other behavioral issues.

The bigger picture goal needs to be having enough money when you need it. I have stated countless times that the idea of trying to beat the market for a quarter or a year is less important than the long term result. If you have enough money when you need it (assuming you are not incredibly wealthy to start with) that will be far more important than whether you beat the market when you were 50 years old.

Disclosure: None