The WSJ Asks If Stockpicking Is Dead

The Heard on the Street column asked if stock picking is dead noting the proliferation of ETFs among other things which have served to cause higher correlations. Obviously the higher the correlation the harder it is to add value from stock picking.

A little more specifically, I would tie in the notion of selecting sectors, themes and countries. Eddy Elfenbein posted a table of sector returns which underscores the point of avoidance that I have been making for a long time. I forget who said this but there is a nugget about major league baseball that might relate here that goes something like in a 162 game season there are 60 games that a team is going to win no matter what, there are also 60 games that a team will lose no matter what, so what matters is the remaining 42 games, that is what makes or breaks a team’s season.

The way I apply this to investing would be to realize that in a reasonably diversified portfolio that goes narrower than SPY/EFA/IWM is that some large portion of the portfolio will do well relative to your benchmark, some portion will do poorly but what will be most important is just handful of decisions that have a disproportionately large impact on the outcome of the portfolio.

Look at the funds run by Bill Miller and Bruce Berkowitz. At some point they each made a big decision to go heavy in financials and the outcome on the funds has been disproportionately large in a bad way on their respective results. As a matter of opinion the results we have had over the years can be largely attributed to a few large macro calls that were built into the portfolio along the way which is consistent how top down management is supposed to work; find some (hopefully) very obvious ideas and figure out how to avoid what should be avoided and own what should be owned.

From the top down someone believing in Jeremy Grantham’s Malthusian idea could pick a narrow ETF like the Global X Fertilizer ETF (SOIL) and capture the outperformance they seek versus the market without having to pick a stock. If Grantham turns out to be correct it is very likely that SOIL would do well. If it went up 100% over five years versus 10% for the SPX you’d have a decent contributor to the portfolio’s overall result. Sure it would be better to pick the stock that went up 150% but the hypothetical result from the ETF would be very good and capture a healthy chunk of the effect.

While the above might justify going heavy with ETFs, unfortunately it can be difficult to capture much in the way of dividends using only ETFs. Dividend investing was another big theme at the WSJ yesterday. Over long periods of time dividends deliver a large portion of total return. As a theoretical matter the greater the dividend yield the less stock market volatility one needs to take on. In the real world going for too high of yield is obviously a very dangerous thing. I think 100-150 basis points above the SPX can be done and still have a properly diversified portfolio. Getting that type of yield just using ETFs can be difficult to do and obviously not every theme or country you care about will be adequately addressed with ETFs.

As a quick note, if you look you will find a handful of broad based ETFs that yield 4% or more but they do not solve the problem necessarily. With ETFs, there can be no certainty with future dividend payments. Not only can the dividend policies of the constituent companies change but rapid growth in AUM can reduce the yield of the fund. A great example of the lumpiness is with the iShares TIP ETF (TIP), which is a client holding. Sometimes the dividend annualizes out to 4% and some months it pays nothing.

6 Comments

  1. Stock picking is a long way from being “dead”. However, thanks to blogs like yours, the WSJ is pretty much there.
    No longer a WSJ subscriber.

    Reply
  2. @anon – I am with you on the WSJ. Not sure what value they bring any longer. By the time it hits their headlines, I’ve already read it in real-time via various other sources.

    Reply
  3. I attended a Schwab-sponsored presentation by a large ($5b) wealth management firm last week.

    This company only uses ETFs to manage money, and has almost all funds in ETFs with assets of over $200m. They have three distinct portfolios to chose from.

    My point is that if a successful money management company can use (and travel between) ETFs to gain a competitive edge over other companies – and Schwab bought them out last November because they were so well respected- why should an individual investor own singleton companies within a portfolio?

    When I asked the presenter why they did not use individual stocks to juice performance his answer was
    “our objective is not to lose money – there is too much risk involved”.

    Can’t argue his point. And I was impressed with the company track record.

    T

    Reply
  4. I liked Elfenbein’s table of sector returns. Has anybody done a table of country returns?

    Reply
  5. Kekepan, Bespoke is the best resource I know of.

    Reply
  6. Good stock picking is far from dead, bad stock picking will kill you. Tactical ETF management (back tested of course) will lead a new generation of investors to slaughter. It is this decades version of the Vanguard Index 500 leming jump of 2000. Avoid fundamental research and valuation at your own risk.

    Reply

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The WSJ Asks If Stockpicking Is Dead

The Heard on the Street column asked if stock picking is dead noting the proliferation of ETFs among other things which have served to cause higher correlations. Obviously the higher the correlation the harder it is to add value from stock picking.

A little more specifically, I would tie in the notion of selecting sectors, themes and countries. Eddy Elfenbein posted a table of sector returns which underscores the point of avoidance that I have been making for a long time. I forget who said this but there is a nugget about major league baseball that might relate here that goes something like in a 162 game season there are 60 games that a team is going to win no matter what, there are also 60 games that a team will lose no matter what, so what matters is the remaining 42 games, that is what makes or breaks a team’s season.

The way I apply this to investing would be to realize that in a reasonably diversified portfolio that goes narrower than SPY/EFA/IWM is that some large portion of the portfolio will do well relative to your benchmark, some portion will do poorly but what will be most important is just handful of decisions that have a disproportionately large impact on the outcome of the portfolio.

Look at the funds run by Bill Miller and Bruce Berkowitz. At some point they each made a big decision to go heavy in financials and the outcome on the funds has been disproportionately large in a bad way on their respective results. As a matter of opinion the results we have had over the years can be largely attributed to a few large macro calls that were built into the portfolio along the way which is consistent how top down management is supposed to work; find some (hopefully) very obvious ideas and figure out how to avoid what should be avoided and own what should be owned.

From the top down someone believing in Jeremy Grantham’s Malthusian idea could pick a narrow ETF like the Global X Fertilizer ETF (SOIL) and capture the outperformance they seek versus the market without having to pick a stock. If Grantham turns out to be correct it is very likely that SOIL would do well. If it went up 100% over five years versus 10% for the SPX you’d have a decent contributor to the portfolio’s overall result. Sure it would be better to pick the stock that went up 150% but the hypothetical result from the ETF would be very good and capture a healthy chunk of the effect.

While the above might justify going heavy with ETFs, unfortunately it can be difficult to capture much in the way of dividends using only ETFs. Dividend investing was another big theme at the WSJ yesterday. Over long periods of time dividends deliver a large portion of total return. As a theoretical matter the greater the dividend yield the less stock market volatility one needs to take on. In the real world going for too high of yield is obviously a very dangerous thing. I think 100-150 basis points above the SPX can be done and still have a properly diversified portfolio. Getting that type of yield just using ETFs can be difficult to do and obviously not every theme or country you care about will be adequately addressed with ETFs.

As a quick note, if you look you will find a handful of broad based ETFs that yield 4% or more but they do not solve the problem necessarily. With ETFs, there can be no certainty with future dividend payments. Not only can the dividend policies of the constituent companies change but rapid growth in AUM can reduce the yield of the fund. A great example of the lumpiness is with the iShares TIP ETF (TIP), which is a client holding. Sometimes the dividend annualizes out to 4% and some months it pays nothing.

Submit a Comment

Your email address will not be published.

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