FB30ETF: Beating the Market?

THE OLD TIMERS of this chatbox will know that I have been a long-time proponent of ETF for investors with little or no knowledge (whether new or old).

If you don’t know what is an ETF, this is a 3 letter acronym for "Exchange Traded Funds". Basically, these are passively managed funds with minimal expenses, i.e. the manager who manages the fund is not permitted to engage in active trading. Instead, the ETF goal is to simply track the performance of a Benchmark Index, with minimal “tracking error”. This is done by simply buying the Index component shares and holding them until such time when the Component Shares are altered. The Manager then swaps the shares in line with the change in the Index component. That’s pretty much the extent of trading done in those funds, which is almost none. Most of the time, the Manager just twiddle his/her thumb and does nothing, relative to his Actively Managed Fund counter-part.

Anyway, in the specific case of FB30ETF, the Benchmark Index is the FTSE Bursa Malaysia Large 30 Index, which comprise of the largest 30 stocks in Bursa Malaysia by market capitalization.

In reality, there will be some very small differences between the actual ETF performance vs the Benchmark Index. This is because the ETF is an actual physical fund with running costs (such as operating, accounting, compliance, reporting, share swapping, and other costs). Notwitstanding the above, FB30ETF’s goal is to achieve a performance over time, with a correlation of 95% or better between the Fund's portfolio NAV and the Benchmark Index.

Also, there can be differences between market price of the ETF, and its theoretical value, although Mr Market should in theory correct such mispricings.


Why FB30ETF can beat the average Market Participant?

It is counter-intuitive, but the majority of stock market participants do not beat the market after fees and expenses. Various research studies have shown that approximately 70%-80% of stock market participants simply don’t beat the market after fees and taxes. Yes, the majority do NOT beat market.

Since ETF are passively managed with the lowest fees amongst all types of equity funds, they track market performance pretty well. And that by definition, beats the majority of the stock market players!


Advantages of ETF

Besides beating the majority of stock market players including the professionals ...

1. No Fundamental Analysis required. Yes! You can throw away Balance Sheets, Income Statements, Cashflow Statements, and anything to do with FA! That's right - throw them away, and no need to even worry about not understanding the difference between earnings vs cashflow, or how to identify a "strong" Balance Sheet, or how to assess future prospects of a company, etc.! Investing in ETF is a no-brainer. The only decisions required are simple ones like when to buy, when to sell. Easy stuff isn't it? :-)

2. Automatic Diversification. The ETF is automatically invested in the Top 30 Blue Chips. No need for you to actively worry and decide whether you have enough diversification or not, or which stock's fundamentals are deteriorating and thus requires selling, etc., since these decisions are automatically made for you. Linked to 1., you do not need to monitor the fundamentals of the 30 shares!

3. No risk of a single company bust causing the entire fund to go bust. This is linked to 2. above. When a company starts to under-perform, its market cap will diminish, and Bursa will automatically (within prescribed rules) throw that company out and replace it with a new one. So, the chance of FM30ETF going to zero is practically non-existent.

4. Lowest (minimal) fees.


Disadvantage of ETF

Only average market returns, not more. Cannot become like the Top Managers like Ed Seykota, Minnervini or Buffett. However, the performance will be better than the average participant (e.g. in the Top 33% - 50% band), with absolute returns that are marginally below Benchmark Index performance in the long run. For many if not all newbies, they would consider this an advantage (depending on one’s perspective).

FB30ETF Performance So Far

FB30ETF was introduced in Bursa nearly a year ago, on 19 July 2007. The opening price was $8.68. The highest price was $10, and the lowest price is $7.30.

Yesterday (8 July 2008), the fund closed at $7.35, with a total return to date of -15.3% since inception.

Interestingly, the FB30ETF actually outperformed the KLCI over the same period! See below.

Other Thoughts & Observations

Despite the above out-performance, I note with irony that the FB30ETF has not been popular with investors and traders alike this year.

After the excitement in the first few months, volume has declined to very low levels, and is recently only a small fraction of what it used to be during the first few months of IPO.

Perhaps the reason is due to the way the ETF has been marketed. One possibility is that ETF are only appealing to “Do Nothing” investors who just want to obtain “market” returns, by “doing nothing”. Hence Do Nothing = low trading volume.

However, I think this is actually unfortunate.

This is because, I think ETF has the potential to introduce the new trader to learn the skills of trading using Technical Analysis.

In fact, my main purpose in writing this article is not to introduce you to Buy and Hold, but if you are a beginning trader, to stimulate your thoughts further as a Trader.

In fact, I sincerely believe that those who trade this fund only using Technical Analysis actually have an edge over the “Do Nothing” investor, as well as having an edge over FA investors. The "edge" is important, because in the long-run, it will translate to higher returns.

This is because with this fund, it is futile to do a Fundamental Analysis on the Top 30 stocks by market capitalization. No FA investor will bother to do this and then invest in such a fixed diversified fund!

And since this fund is fairly stable in price, and it can never practically go to zero, I personally believe that this is an excellent vehicle for small time and new traders to learn and practice market timing. It is more forgiving if errors are made.

In particular, I believe this is a good vehicle for part-time traders with full-time jobs and a family, and want to focus on their career, besides wanting the opportunity to earn returns higher than Fixed Deposits 3.7% per annum rollover returns.

I believe, with an initial training, one only need to spend less than 5 minutes a day to note the closing price, and if there is an action required, another 5 minutes to place either Buy / Sell order, at the next day’s opening price.

In other words, this is done AFTER market closes. No need to monitor prices during trading hours. No intra-day monitoring is required even on days when actions are required, since Buy and Sell orders are always done at market opens the next day.

(Of course, if you are an experienced trader, you can fine-tune and enhance the method to your own liking).

And what if I tell you that it is possible to achieve returns that significantly outperform the market, by simply trading the FB30ETF and nothing else?

You see, the Buy and Hold investor in FB30ETF since inception managed to obtain a minus 15% return during that (approximately) 12 month period.

What if I tell you that with simple Technical Analysis tools, you could achieve a POSITIVE return, instead of a MINUS 15% return that a Buy and Hold investor achieved over the same period?

Sounds too good to be true isn't it?

After all, I'm claiming that through market timing, you can achieve at least +15% outperformance relative to the market!

And this only takes 5 minutes a day after market closes!

And this requires buying/selling when market opens the next day!

And it requires learning about charts and Technical Analysis!

In fact, I know a lot of people will simply not believe it!

In fact, the entire personal financial services industry is full of people who will be against this idea, simply due to vested interest. (Think life insurance agents selling high commissioned investment linked products, or bank salaried/commissioned staff selling higher fee products, mutual funds, unit trusts, etc.). Do not under-estimate the extent of vested interest here, as I was once on their side.

In fact, the mere fact that I mentioned it here means that if I disclose the detailed methodology, I risk a change in future market behaviour, due to vested interest above!

As this article is long enough, I will stop here. Think about it. This is not BS. If you are a long time fundamental investor with little knowledge of Technical Analysis, then, try to see how you can get a POSITIVE return since July 2007, if you had Bought and Hold till today. There's no need to use Technical Indicators, although this can sometimes helps.

I will follow this up with another article later detailing the back-test transactions when I have the willingness and the time to format it in blog format, and when I feel you have done enough of your homework trying to figure this out :-)

Happy thinking :-)