Buyback ETF: Valuable Idea or Value Trap?

Value investors have been getting burned in ways that they could not possibly have imagined. Bill Nygren's fabled Oakmark Fund (OAKMX) posted -20% over the past year compared to a loss of -14% for the S&P 500. The more famous Bill, Mr. Miller, is down more than 30% YTD in Legg Mason Value Trust (LMVTX).

The problem is well-documented. Many of those who achieved star manager status found "value" in beaten-up financial companies. The stock market punished these stock-pickers severely for selecting shares of "value trap companies."

Surprising some, dividend ETFs have also fallen into the bear's "value trap." The theory is supposed to go that, dividend-paying companies are more reliable and more stable over the long run... and that investors tend to hold onto dividend company shares rather than selling them. Thus, many "say" that dividend investing cushions the blow from the bear.

Well... not this time. Dividend-weighted indexing from WisdomTree may ultimately work out in the very long run. However, the line-up of large, small, high-yield and international dividend ETFs have seriously underachieved relative to peer indexes.

Why did this happen? Dividend funds typically have a higher weighting in financial, telecom and consumer stocks. These areas have been brutalized by this particular bear. In contrast, energy, materials and tech have been a bit better performers, yet these segments are less dividend-friendly. With less energy/materials/tech in these dividend funds, they've underperformed.

So I wondered about another theoretical, value-oriented construct. It goes like this... companies that buy back more of their shares have greater confidence in their company going forward. Moreover, the less the number of shares available on the open market a la supply, the greater the possiblity for an increase in demand.

Sounds good in theory... right? And there's even an ETF to capture companies that invest in themselves. It's been dubbed the PowerShares Buyback Achievers Portfolio Fund (PKW).

Bill Fisher at Marketwatch recently wrote a very favorable review of this exchange traded vehicle. (Perhaps ironically, the Value Investing Express has quite a few "Bills" on board.)

Year-to-date through 8/12/08, the Buyback Achievers Fund is down 8.5%. Meanwhile, the S&P 500 SPDR Trust (SPY) is down 10.7%. 2 percentage points in 8 months/2weeks sounds pretty good.

However, is the year-to-date outperformance really attributable to the buyback construct? Only 2/3 of the Buyback Achievers Fund are large company stocks. The other 1/3 are mid-sized and small-sized companies. That additional 1/3 is more likely representative of the bigger gains from companies in the Mid Cap SPDR (MDY) and/or the Russell 2000 Fund (IWM).

Still one more observation: It's hard to see how the Buyback Achievers Fund has a long-term advantage, as it's fared no better than the S&P SPDR Trust since its inception. Moreover, if its strength is supposed to come in the bear markets, it may have a rough go of it when growth comes into vogue in a recovery.

Genuinely, I want investors to take all of the available info into consideration. It is not my goal to shoot down the buyback construct.

From my vantage point, the Buyback Achievers Fund isn't likely to hurt you over the long run. Yet one has greater price execution and better cost advantages by sticking to the higher-volume index funds like the S&P 500 SPDR, MidCap SPDR and iShares Russell 2000 Fund.

(Here are more thoughts that I have had about diversification as well allocation with ETFs.)

Disclosure Statement: ETF Expert is a web log ("blog") that makes the world of ETFs easier to understand. Pacific Park Financial, Inc., a Registered Investment Advisor with the SEC, may hold positions in the ETFs, mutual funds and/or index funds mentioned above. Investors who are interested in money management services may visit the Pacific Park Financial, Inc. web site.

Comments

[California ...:]

Fine article. I have PKW for about 19 months now. The performance has been disappointing. The good news is that PKW owns many fine companies. The bad news is (and mentioned by the article writer) is that in the long run, PKW may not be any better than the S & P 500 or the Russell 1000.

The fund family for PKW (Powershares) website shows statistics showing that the buyback index should handily out perform the S & P 500 and/or Russell 1000 over a long period. However, I am now skeptical for this to happen. Perhaps there are too many random and unusual and infrequent events in the stock market for PKW handily beat the common stock indexes over the long run. Only time will tell. For now I would rate PKW as a "Hold" not as a "Buy."

2008 Aug 16 05:37 PM

[California ...:]

Also keep in mind that PKW doesn't have much daily volume/liquidity

2008 Aug 16 06:00 PM