No One Wins 'Em All - And That Is OK, Revisited

Includes: EEM, MSCI, VWO
by: Roger Nusbaum

Yesterday's article was about no one being able to be correct with every single holding in their portfolio all the time, and that occasionally a holding will get blindsided -- more correctly, the person with the holding gets blindsided.

Right on cue, one of the stocks we own for large accounts and the fund we subadvise got crushed. MSCI (NYSE:MSCI) finished the day down 26.8%, although it had been down a little more earlier in the day, on news that Vanguard will be switching away from MSCI indexes for several traditional funds and several ETFs (22 in all). It appears as if Vanguard might save a little money on licensing, which, if correct, would allow it to more easily remain competitive with ETF providers like Schwab that are probably willing to operate their ETFs at a loss. The bigger reason might be to allow for differentiation in its Emerging Market ETF (NYSEARCA:VWO) and iShares Emerging Market ETF (NYSEARCA:EEM), which for now both use the same index. (Thank you, IndexUniverse for the above information.)

IndexUniverse also devoted quite a few pixels to quotes from people at iShares about doing more business with MSCI. The revenue loss from these Vanguard funds, although not de minimis, is pretty small and does not merit a 30% decline in the share price (the stock was down that much during the day) in my opinion.

The arc thus far is not a new one. Bad news that catches the market by surprise causes the stock to overreact. The question then is: What happens next? One typical path is that after the panic, the stock then quickly retraces a meaningful chunk of the decline. If the trading yesterday is the overreaction I believe it was, then a snapback as described above seems very plausible. We'll see.

In terms of impact on the portfolio, it was quite small. The NAV of the fund we subadvise was down 0.28% yesterday vs. lift of 0.09% for the S&P 500. Any client accounts may have been more or less. The rest of the portfolio had a good day coincidentally, or the NAV would have had a bigger drop.

This is exactly why I target relatively small weightings for individual stocks. From here, the stock will either be a good hold or a bad hold but it is not a realistic concern that the company will cease operations. For now this was merely a bad day for the portfolio, but not even that bad. Time will tell whether this was a hiccup or a mistake. But as I write about quite regularly, the consequence -- if it really turns out to be a mistake -- will not be ruinous.