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Wednesday, July 9, 2008

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 :-)


dennisctp said...

hi seng,
actually i had this type of idea after truly understanding market efficient theory and the situation in our market.

basically we can say that most of the stock for example those in FBM30 are either fully valued or overvalued. And there are very little time that these stock will be undervalued.

thats why i had this idea long time ago. but instead of trading FB30ETF, i'm considering Index Fund and use switching to bonds or money market fund as a way of selling. With the switching fees fixed in most trust unit, the fees used in trading will be very low.

Chee Meng said...

i will love to read your coming article on this

Seng said...

Hi Dennis,

My own belief is similar to Buffett, i.e. markets are efficient most of the time, but not all the time.

My own personal observation of KLSE is that they are quite inefficient sometimes :-)

Personally, I prefer to stick to equities and cash, as opposed to bond funds. With bond funds, there are additional considerations such as higher interest rates causing bond prices to fall, not to mention the fund fees charged.

Hi chee meng,

I'm afraid it doesn't quite work that way. I like to see at least 5 to 10 attempts first before I disclose my own methods ... :-) I prefer to see readers trying to figure it out first, if not, I probably won't share it publicly ... :-)


KC said...

ETF is no diff than futures & Index, a product created for TRADING PURPOSE.


What will Investor benefited from this product.

Seng said...

Hi KC,

I'm not sure what you mean by "Index".

Actually, there are huge differences between Futures and ETF.

Futures are "highly geared", whereas ETF is more like other funds with lower management fees.

Futures have expiry dates (usually cash settled, but not always), whereas ETF being a fund of equities don't.

ETF is actually a good vehicle for investors, just like equities.

As I mentioned in the "Advantages", there are at least 5 benefits to investors.

Perhaps you would like to reread that again.

Whilst it is not a bad vehicle for investors, the main point of my article is to share with readers my belief that beginning, small time traders can also benefit by trading the FB30ETF as opposed to futures or other speculative stocks.


ahboy said...

hi seng,

I was considering to trade this ETF, with only the moving averages (50, 100 & 200) as guide. As in buy when the price cross up, and sell when it crosses down. I am not able to back-date test this, so I'm unable to come out with specific values. But from the charts, looks like it will be able to capture big moves, such as the ones we saw these last 3 years.

However, I am unsure how this will work out in periods of flat prices, such as those before this bull run.

Care to comment?

Seng said...

Dear ahboy,

Conceptually, I understand what you are suggesting, but without actual transaction Buy/Sell date, I wonder if your understanding is the same as mine in detail.

If you run through your suggestion on a day by day basis, you might be surprised by the results.

With any methods, I urge you to consider writing down at least the first 3 complete trades (signal date, buy date, signal date, sell date).

You will gain additional insights from this process.

I am sure that after the first signal date is written down, you will want to modify the parameters, or seek improvements :-).

Yes, you are quite right. In flat markets, you will get whipsaws, which will cost money. Writing down the trades will allow you to know exactly how much you lose.

Specifically, the problem with 50day MA is that it doesn't get you in the trade "early enough", and it's "too late" to get out by the time the signal is given, although with such a big trend like this, one should be able to come out ahead. Even though it should beat the Buy and Hold investor, I think one can do better.

Of course, there is no Holy Grail too. Every method has its advantages and disadvantages, but it doesn't mean all methods are equal.


PS. Thanks for the post. Hopefully, it will inspire others to improve on your methods, to share and to write down the first 3 completed trades based on their suggested methods.

ahboy said...

Hi seng,

For example, I am refering to 22-Apr-08 as buy signal, and 2-June-08 as sell signal for the KLCI (assuming the ETF tracks CI perfectly). Since I monitor only closing prices, the execution of order will be the next trading day. Is this the same as how U would understand it?

I did some basic back-date testing, and tested June06-Jan08 as the up market (gain 56%), Jan04-Oct05 as flat market (gain 21%), and Feb08-May08 as down market (loss 0.3%). This is not too bad, but not great either. And yes, there's room for improvement, which is only appropriate considering SMA is the basic stuff of TA.

I hope other experts around can show me how to trade the ETF better.

p/s: Seng, can I request you to share your idea on trading this ETF, even if others seem not to be too interested. I was planning to use SMA (mainly) to trade this ETF until your comment comes along..:p

Seng said...

Dear ahboy,

In my article, I refer to FB30ETF. But since your comments refer to KLCI, let's use KLCI instead because the 2 are different entities. Most of the time they may behave similarly, but sometimes, they CAN behave very differently. Best NOT to ass-u-me they behave identically.

Using the KLCI for the rest of this comment today ...

Since you are using 50 day MA, the KLCI first crossed the 50dMA on 23 April 2008 using closing price (not 22 April as in your note). So, the Buy would be done on 24 April, which is 1289.38.

Of course, in real life, you cannot buy KLCI.

You can buy FKLI, but that is futures and is not recommended to new investors, as it is highly geared, and most newbies would be completely wiped out if they don't practice sound money management techniques including stop loss.

Why don't you rework using the FB30ETF, since this is an actual case, whereas one can't really buy the KLCI at face value.

Remember, since we are comparing against a Buy & Hold investor who does basically nothing except to monitor price every day after work for 1-5 minutes, we have to assume that the trader is the same as the investor, i.e. both full-time work, both have no time to monitor intra-day prices, and both willing to only spend 5 minutes a day.


PS.Why don't you give me your comments on FB30ETF, and then, I'll use that as a platform for another article to invite comments from others. Thanks.

ahboy said...

Hi Seng,

First thing first, I really do appreciate you commenting further.

For FBM30ETF, the buy date would be 24-Apr and selling on 29-May. I notice the candle touching the MA line on 3-6 May, but I would think the whole candle need to clear the MA line for a sell signal.

The reason I back-date tested CI instead of ETF is because the ETF is fairly new, not able to get enough historical data for the testing. :p. I don't intend to trade futures, I am sure I will be mauled.

I am sure a lot of guys will want additional info from other indicators, but I think the others such as RSI, MACD, etc should only serve as confirmation signals for adding/reducing to the position. I still prefer MA as the dominant trigger. And buy more if I see things like double bottom, b/out, etc.

As for the reason for ETF, the main one for me personally is because I had a better experience 'sensing' the direction of CI, compared to individual companies. As I am a full-time employee, outside the finance world, I find myself at a disadvantage, in-terms of accessing the latest info about the company's fundamentals and news. The news impacting CI is more readily known (most the time), and it is less volatile (yet volatile enough for trading). And reading Moo's blog convinced me further that there's a lot of dodgy companies out there that can burn you up if you're not careful.

I used to trade (using the term loosely here) brokerage companies such as OSK, as a proxy of CI. To a certain extent, it worked OK particularly in big moves such as this recent one, but the divergence is sometimes too frequent to my liking.

Other than that, the instant diversification is helpful, if you don't have a lot of capital. If a guy really wants to average down (I strongly disagree in averaging down), he faces less risk of the counter going kaput.

A note though. I think the main attraction for ETF in the US is because of the performance of their market, which is around 10% average over a loong period of time. So, just tracking it will be good enough for most of them. And ETF is offered to track the market at a minimal cost. However, as KLCI is NOT S&P500, I dont think this is the reason to trade our ETF. I don't think index funds are a great idea either, due to the crazily high charges they impose to us, just to track the index!!

I notice I am being preachy, sorry for that.